Frankfurt am Main, March 19, 2020 -- Moody's Investors Service, ("Moody's") has today downgraded the Probability of Default and Corporate Family ratings of TRANSPORTES AEREOS PORTUGUESES, S.A. ("TAP") to Caa1-PD and Caa1 from B2-PD and B2 respectively. Concurrently the agency has downgraded the Baseline Credit Assessment to caa2 from b3 and the instrument rating assigned to €375 million of senior unsecured notes to Caa1 from B2. The outlook is negative.
RATINGS RATIONALE
The rapid and widening spread of the coronavirus outbreak, deteriorating global economic outlook, falling oil prices, and asset price declines are creating a severe and extensive credit shock across many sectors, regions and markets. The combined credit effects of these developments are unprecedented. The passenger airline sector has been one of the sectors most significantly affected by the shock given its exposure to travel restrictions and sensitivity to consumer demand and sentiment. More specifically, the weaknesses in TAP's credit profile, including its exposure to Brazil, the US and Europe have left it vulnerable to shifts in market sentiment in these unprecedented operating conditions and TAP remains vulnerable to the outbreak continuing to spread. We regard the coronavirus outbreak as a social risk under our ESG framework, given the substantial implications for public health and safety. Today's action reflects the impact on TAP of the breadth and severity of the shock, and the broad deterioration in credit quality it has triggered.
The downgrade was prompted by the very sharp decline in passenger traffic since the outbreak of coronavirus started during January 2020, which will result in a significant negative free cash flow in 2020, a weakening liquidity profile and a significantly higher leverage. TAP's previous ratings were based on the expectation of improvement of credit metrics and free cash flow generation, which is no longer feasible. From a regionally contained outbreak the virus has rapidly spread to many different regions severely denting air travel. The International Air Travel Association's (IATA) latest scenario analysis forecasts a decline in passenger numbers of between 11% and 19% for the full year 2020.
Moody's base case assumptions are that the coronavirus pandemic will lead to a period of severe cuts in passenger traffic over at least the next three months with partial or full flight cancellations and aircraft groundings, with all regions affected globally. The base case assumes there is a gradual recovery in passenger volumes starting in the third quarter. However there are high risks of more challenging downside scenarios and the severity and duration of the pandemic and travel restrictions is uncertain. Moody's analysis assumes around a 50-60% reduction in TAP's passenger traffic in the second quarter and a 20% fall for the full year, whilst also modelling significantly deeper downside cases including a full fleet grounding during the course of Q2.
TAP has felt the negative impact from declining passenger traffic later than some other network carriers that have exposure to the APAC region but has been hit hard since the outbreak started spreading in Europe. The travel ban announced by the United States on non-US citizens from 26 European nations will further affect many of TAP's routes and Moody's expects travel restrictions to deepen. TAP will also be negatively impacted by the sharp depreciation of the Brazilian real against both the US Dollar and Euro in recent weeks. The sharp decline in demand comes at a time when TAP was improving its credit metrics but was still highly levered with an estimated Moody's adjusted Debt/EBITDA of around 7.0x at fiscal year-end 2019. As a consequence of the negative free cash flow generation and much lower profitability, leverage metrics will deteriorate in 2020 and will be way outside of our requirement for the previous rating category in contrast to our previous expectation of leverage improvements. The recovery in metrics to a level commensurate with the current rating within 12 to 18 months is seen as very remote at the present time hence the downgrade of TAP's CFR to Caa1.
Moody's also anticipates that the airline industry will require continued and further support from regulators, national governments and labour representatives to alleviate pressures on slot allocations, provide indirect or direct financial support and manage airlines' cost bases. An extension of slot alleviation beyond the current provisions to June 2020 in Europe is also likely to be important. In light of its relatively weak point-in-time liquidity position and the severity of the passenger traffic reduction we believe that TAP will need financial support from its shareholders during the course of Q2.
LIQUIDITY
TAP's liquidity position is considered as weak in light of the very challenging market conditions the issuer is currently facing. As per 31st December 2019, TAP had approximately 430 million of available liquidity (€267 million pro-forma of a debt maturity repaid in February 2020). In addition TAP has access to €174 million of credit card receivables from Brazilian customers. Significantly lower pre-bookings and very depressed passenger traffic year-to date will lead to material cash burn and we do not expect any improvement at the least in the short term. TAP will need to undertake other measures to bolster its liquidity and would most likely require support from the Portuguese government.
RATIONALE FOR THE NEGATIVE OUTLOOK
The negative outlook assigned to the ratings reflects our expectations that travel restrictions and the decline in passenger traffic will continue to worsen in coming days and weeks and that TAP will be challenged to preserve a sufficient liquidity position during this challenging time in absence of additional support from its shareholders.
WHAT COULD CHANGE THE RATING UP / DOWN
Given the current market situation we do not anticipate any short term positive rating pressure. A stabilization of the market situation leading to a recovery in metrics to pre-outbreak levels could lead to positive rating pressure. More specifically adjusted Debt/EBITDA would have to drop back sustainably below 7.0x.
Further negative pressure would build if TAP fails to stabilize its liquidity profile. A prolonged and deeper slump in demand than currently anticipated leading to more balance sheet deterioration and a longer path to restoring credit metrics in line with a Caa1 credit rating could also lead to further negative pressure on the rating.
The methodologies used in these ratings were Passenger Airline Industry published in April 2018, and Government-Related Issuers Methodology published in February 2020. Please see the Rating Methodologies page on www.moodys.com for a copy of these methodologies.