Moody's Investors Service lowered British Airways' corporate family further one notch further into junk territory, commenting that pension woes would be a burden into "the foreseeable future" (Dow Jones/Marketwatch, 17-Mar-2010). However, the ratings agency added that the company's liquidity remains satisfactory, noting that the carrier's planned merger with Iberia Lineas Aereas de Espana represents a positive development for both airlines, although it believes the financial impact will be longer term. Moody's also lowered BA's corporate family and probability of default ratings by one notch each to B1 (which is four notches into junk territory). Last month, Standard & Poor's Ratings Services lowered BA by one notch to BB- (which is one notch above Moody's new rating), citing expectations of only a gradual improvement in the sector in 2010 and 2011, as well as potential for labour issues and uncertainty about pension issues.
Moody's cuts British Airways' rating further into junk territory
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An agreement between China and the UK to more than double their air service agreement is good timing for both sides. Chinese airlines are finding an imbalance: they are taking delivery of widebody aircraft and more Chinese airlines are flying long haul but traffic rights to major markets – the US, Canada, Germany and France – are becoming depleted. Negotiations to add traffic rights have not succeeded, typically due to the foreign side being concerned about accessing Chinese slots or Russian overflight rights.
The agreement with the UK to expand the number of weekly passenger flights from each side from 40 to 100 reflects considerable pragmatism on the part of the UK: British Airways and Virgin Atlantic are not growing in China, and China is a large growth opportunity. The UK has lagged on Chinese tourism. It was only in 2015 that China became the UK's largest inbound market.
Chinese long haul secondary city air routes: BA's Chengdu exit does not reflect the broader market
The fastest long haul airline growth is not occurring with Gulf airlines but rather, with services to and from secondary Chinese cities. It is not a secret that local incentives and subsidies, generally common in any market, are especially large in price and duration for secondary Chinese cities. An airline might expect over a third of revenues to be subsidised. This drastically alters the business case in a low-margin industry, hence the proliferation of secondary city services. This extreme dependence on subsidies raises the question of how long governments are willing to issue generous subsidies, and how many routes can be sustainable without them.
British Airways' decision to exit its only secondary Chinese route to Chengdu, in Jan-2017, might suggest the music is ending and the secondary long haul bubble is popping. There is added colour given the recent UK-China air service agreement expansion, and Brexit/British pound depreciation overhangs.
BA's exit does confirm market fundamentals: secondary city yields are low, and some routes are ahead of their time. Yet a number of factors unique to British Airways suggest caution in concluding that BA's Chengdu exit could foreshadow other withdrawals.