New York, May 04, 2018 -- Moody's Investors Service, (Moody's) has today upgraded the Corporate Family rating (CFR) of LATAM Airlines Group S.A (LATAM) to Ba3 from B1. At the same time, Moody's upgraded to B1 from B2 the foreign currency rating assigned to its $500 million senior unsecured notes due in 2020. Moody's also upgraded LATAM Pass Through Trust 2015-1A to A3 from Baa1 and the LATAM Pass Through Trust 2015-1B to Baa3 from Ba1. The outlook for all ratings is stable.
List of affected ratings:
Issuer: LATAM Airlines Group S.A (LATAM)
-- Corporate Family Rating: upgraded to Ba3 from B1
-- USD500 million senior unsecured notes due 2020: upgraded to B1 from B2
..Issuer: LATAM Pass Through Trust 2015-1A
....Senior Secured Enhanced Equipment Trust due 2029: upgraded to A3 from Baa1
..Issuer: LATAM Pass Through Trust 2015-1B
....Senior Secured Enhanced Equipment Trust due 2025: upgraded to Baa3 from Ba1
The outlook for all ratings is stable
The ratings upgrade is a result of LATAM's improvements in operating performance, leverage and liquidity observed during the last two years. The upgrade also considers our view that the improved results are sustainable and leverage will continue to improve during the next 12 to 18 months. Accordingly, LATAM has posted a marked recovery in its operating margin and leverage measured by total adjusted debt to EBITDA that have reached 9.0% and 4.6x, respectively at the end of 2017. The company has also increased its cash balance, which reached almost 22% of net revenues at the end of 2017. Operating improvements are a consequence of capacity reduction, cost cutting, and stronger demand for air travel stemming from a gradual strengthening in the economies in Latin America as a whole and more especially in LATAM's largest market - Brazil, which Moody's believes will continue during 2018. Improvements in liquidity were a consequence of positive FCF generation and the upsize in the company's committed credit facility to $450 million.
LATAM Airlines' Ba3 corporate family rating reflects the company's leading market position in Latin America with a well-diversified business portfolio of air transportation services, superior network connectivity and strategic alliances, along with an improving operating structure and liquidity that will allow it to remain competitive going forward. The ratings also incorporate the benefits from its diversified capital structure, track record of financial support from local banks and international capital markets, long term aircraft financing, and a relatively low debt cost. On the other hand, the Ba3 Corporate Family rating considers the company's still high gross leverage and the volatility and uncertainties inherent to Latin American economies, especially Brazil. LATAM's ratings also incorporate its exposure to foreign currency, fuel price volatility, tough competitive environment and other risks inherent to the industry.
Despite the upgrade of the unsecured notes to B1 from B2, the rating remains one notch lower than LATAM Airlines' Ba3 CFR in order to reflect the effective subordination of those unsecured creditors to the company's other existing secured debt. LATAM Airlines' consolidated debt is composed mainly of long-term secured bank obligations and capital leases collateralized by aircrafts, representing about 73% of its total debt. As such, the unsecured notes rank below all the company's existing and future secured claims.
The upgrade of the EETC ratings accompanies the upgrade of the Corporate Family rating. Moody's assigns ratings to EETCs by adding notches to an airline's Corporate Family rating, based on its 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 Classes' position in the waterfall. Moody's estimates the peak LTVs at about 61% and about 74% for the Class A and Class B certificates, respectively. These levels are consistent with Moody's expectation when it first rated the transaction in 2015. Moody's has increased the annual depreciation rates for each of the aircraft models in the collateral, to 5% from an average of 3.9% used previously. This change reduces the projected improvement in the equity cushion over the transaction's remaining term, but not enough to cause Moody's to lower the notching. The still sufficient equity cushions, the ongoing importance of the models to the company's network, the cross-default and cross-collateralization of the equipment notes and Moody's expectation that repossession would be timely under an insolvency scenario support the EETC ratings.
The B787-9s in the transaction are powered by Rolls-Royce Trent 1000 Package C engines. The utility of 787s with this engine is currently curtailed because of reliability issues of turbine blades in the engines' intermediate pressure compressor that have led to the imposition of operating restrictions by regulatory authorities. Moody's anticipates that the issue will be corrected within the next 12 to 24 months, preserving the long-term value of Rolls-powered 787s. Although Moody's does not expect airlines to change engines, the 787 is the first aircraft model that allows for the interchange of engines between the two available types, the GE GEnx-1B being the other engine for this aircraft.
Our Pre-Sale Report available to subscribers on www.moodys.com provides a detailed summary of the LATAM Airlines Group Series 2015-1 EETC.
LATAM Airlines reported net revenues of $10.2 billion in 2017, an increase of 6.7% as compared to 2016, and 7.7% in the 4Q'17 compared to 4Q'16 driven by higher traffic, stronger load factor and continuing yield recovery. Despite the improvements in demand and increased ASKs in 2017, LATAM continued to reduce its cost structure by a material decrease in its workforce and the number of operating aircraft that were cut by 9.7% and 22 aircraft respectively in 2017, allowing the company to post strong improvements in its operating income of almost 26%.
The positive developments in operating income, reduction of fleet commitments, along with the upsize in the company's committed credit facility to $450 million, helped improve LATAM's liquidity. The company reported unrestricted cash and short-term investments in the amount of $1.64 billion at the end of 2017, enough to cover 1.3x its short-term debt maturities. Including the $450 million committed credit facility, LATAM's cash to net revenues achieved almost 22% in 2017. We believe the company's $450 million committed credit facility further mitigates its liquidity risk.
LATAM's debt is composed mainly of long-term secured bank obligations and financial leases. After the merger with TAM, the company's adjusted gross leverage to EBITDA increased significantly to 8.0x in 2012 from 4.2x in 2011. Since then, LATAM has undertaken several leverage reduction initiatives including debt prepayment and renegotiation of more expensive debt to reduce interest expenses such as the payment of the $300 million 7.375% senior unsecured notes issued by TAM's subsidiary TAM Capital Inc completed in April 2017, and the prepayment of the $500 million 8.375% senior unsecured notes due 2021 issued by TAM's subsidiary TAM Capital 3 Inc in September 2017. Still, gross leverage remains high at 4.6x total adjusted debt to EBITDA at the end of 2017.
The stable outlook reflects Moody's expectation that the company will continue to increase its operating margins, expand internal cash flow generation and reduce leverage going forward. The stable outlook also assumes that management will continue to timely implement the financing strategy in anticipation of debt maturities.
A rating upgrade could be considered if LATAM Airlines is able to successfully reduce leverage to below 3.5x (4.6x in 2017) total adjusted debt-to-EBITDA, along with maintaining strong profitability, as illustrated by an EBIT margin higher than 12.5% (9.7% in the end of 2017), and strong cash generation measured by RCF to total adjusted debt higher than 20% (14.6% in the end of 2017).
The rating could be downgraded if the company's liquidity is strained due to a prolonged market downturn or continued revenue constraints, which combined with its aircraft acquisition program would lead to weaker free cash flow generation. Downward pressure on the rating could occur if LATAM Airlines' adjusted EBIT margin deteriorates to below 8% (9.7% in 2017), if its adjusted leverage remains above 5.0x (4.6x in 2017), or if Funds from Operations + Interest to Interest decreases to below 3.0x (4.0x in 2017) for a sustained period of time.
The ratings of the EETCs could change if the Corporate Family rating of LATAM Airlines Group changes, or if equity cushions erode relative to Moody's projections.
The principal methodology used in rating LATAM Airlines Group S.A (LATAM) was Passenger Airline Industry published in April 2018. The principal methodologies used in rating LATAM Pass Through Trust 2015-1A and LATAM Pass Through Trust 2015-1B were Enhanced Equipment Trust and Equipment Trust Certificates published in December 2015 and Passenger Airline Industry published in April 2018. Please see the Rating Methodologies page on www.moodys.com for a copy of these methodologies.
LATAM Airlines Group S.A. (LATAM Airlines) is a Chilean-based airline holding company formed by the business combination of LAN Airlines S.A. of Chile and TAM S.A. of Brazil in June 2012. LATAM Airlines is the largest airline group in South America with local presence for domestic passenger service in six countries (i.e. Brazil, Chile, Peru, Ecuador, Argentina, Colombia). The company also provides intra-regional and international passenger services and it also has a cargo operation that is carried out through the use of belly space on passenger flights and dedicated freighter service. In 2017, LATAM Airlines generated USD10.2 billion in net revenues and carried over 67 million passengers and 896 thousand tons.
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