Sydney, April 30, 2018 -- Moody's Investors Service has affirmed Virgin Australia Holdings Limited's B2 corporate family rating and B3 senior unsecured ratings and changed the outlook on the ratings to stable from negative.
Moody's also affirmed the ratings assigned to the company's Enhanced Equipment Notes (EEN's), Virgin Australia 2013-1A Trust's Baa1 rating, Virgin Australia 2013-1B Trust's Ba2 rating, and Virgin Australia 2013-1C Trust's B1 rating. The affirmation reflects the sizeable equity cushions of about 60%, 55% and 50% on the Class A, Class B and Class C notes, respectively, and projected increases in the equity cushions in upcoming years. These levels are before the priority claims of liquidity facility providers and for costs under an insolvency scenario where the company rejects the financing. The outlook on the EEN ratings is changed to stable from negative.
The outlook on Virgin's rating had been negative since June 2016. While Virgin's free cash flow has not improved to a level where Moody's believes it can maintain its B2 rating without further improvements in operating cash flow, reductions in capital expenditure, or reliance on shareholder support, Moody's expects debt to EBITDA for fiscal 2018 and 2019 to be between 4.9x and 5.2x, down from 5.8x in fiscal 2017. This is largely due to the equity raising in 2017 which was used to strengthen the balance sheet, as well as an improvement in EBITDA, driven in part by the company's Better Business initiative which is a three year program launched in July 2016 targeting AUD350 million of annualized cash flow savings. This level of leverage provides Virgin with headroom versus the 6.0x downgrade threshold for the rating.
While Virgin's EBITDA has been improving and is expected to continue improving, operating cash flow remains insufficient to fund capital expenditure, including for aircraft, and therefore the company remains free cash flow negative.
The outlook could return to negative if debt to EBITDA starts to trend upwards, with the catalyst being the trajectory rather than the absolute number approaching the threshold of 6x.
The EEN ratings reflect Moody's belief that under an insolvency scenario where Virgin Australia was to reject the transaction, the trustee would timely repossess the aircraft and sell them for more than the remaining debt, given expected ongoing favorable demand for narrow-body aircraft because of strong growth in global passenger demand and limits on Airbus' and Boeing' production capacity in upcoming years.
The transaction originally financed 24 of the company's aircraft. The aircraft were delivered new between August 2003 and August 2011. Notes on six of the aircraft have been paid off, notes on seven more aircraft, including the one B777-300ER in the transaction, will mature in 2018, leaving 11 B737-800s in the collateral. The B737-800s are the backbone of the company's shorter haul fleet serving routes within Australia and to and from New Zealand. The 17 current remaining 800s represent 24% of the current total 737-800 fleet of 72 aircraft. Given the cross-default and cross-collateralization of the transaction, Moody's believes the company would eliminate other aircraft of this type should it seek to downsize the network under a formal corporate reorganization. The vintages of the B737-800s in the transaction range from 2003 to 2011, the youngest remaining in the transaction to 2022, the year the transaction matures, while the two 2003 vintages and two of the 2004 vintages will mature in 2019.
Moody's assigns ratings to the EENs by adding or subtracting notches to or from an airline's corporate family rating, based on the rating agency's opinions of the importance of the aircraft collateral to the airline's network, whether there is a liquidity facility, its estimates of the size of the equity cushion, and each Class' position in the waterfall.
The ratings of the EENs could change if Virgin Australia's corporate family rating is changed, or if the equity cushions erode relative to Moody's projections.
Moody's Pre-Sale Report available to subscribers on www.moodys.com provides a detailed summary of the Virgin Australia EENs.
WHAT COULD CHANGE THE RATING
Moody's would consider upgrading the corporate family rating if Virgin demonstrates that it can maintain its credit metrics at a B1 level on a sustained basis without shareholder support, and has reached a level where it is free cash flow positive. Specifically, Moody's would expect to see debt/EBITDA below 5.0x for at least 12 months.
Downward rating pressure could emerge if Virgin's debt to EBITDA starts trending upwards and exceeds 5.5x. We would expect the catalyst to be the trajectory rather than the absolute number approaching the threshold of 6x.
The principal methodology used in rating Virgin Australia Holdings Limited was Passenger Airline Industry published in April 2018. The principal methodologies used in rating Virgin Australia 2013-1A Trust, Virgin Australia 2013-1B Trust and Virgin Australia 2013-1C Trust were Passenger Airline Industry published in April 2018, and Enhanced Equipment Trust and Equipment Trust Certificates published in December 2015. Please see the Rating Methodologies page on www.moodys.com for a copy of these methodologies.
Virgin Australia Holdings Limited headquartered in Brisbane, is Australia's second largest airline following its launch in 2000 and listing on the Australian Securities Exchange in 2003. As of June 2017 it generated revenues of AUD5 billion.
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