US airline debt and balance sheets Part 1: American, Delta and United opt for nuanced strategies
Delta Air Lines reached a milestone in Feb-2016 when it achieved investment grade status with ratings firm Moody’s. It is a goal the airline has been working towards for some time, reflected in its efforts to drive down debt during the last few years. Among the three large global US network airlines, Delta is the first to have its credit ratings restored to investment grade.
American and United have each made solid progress in their balance sheet management and debt reduction during the last couple of years, and United has cited reaching an investment grade rating as a specific goal. American obviously would also like to rise to that status, but seems in less of a hurry to attain investment grade given the current borrowing rates the airline is enjoying.
Both United and American have outlined liquidity targets as part of their respective balance sheet management, and American’s levels will settle above its rivals for the foreseeable future, which the airline believes is necessary given its leverage. The company’s debt ratios are larger than its peers; but American has concluded borrowing at current interest rates is in its shareholders best interest.
Delta has no plans to rest on its laurels after reaching coveted investment grade status
In early 2016, Delta CEO Richard Anderson predicted the airline would receive an investment grade credit rating during the year. Moody’s in Feb-2016 awarded Delta that status, which is an important accomplishment for the airline. Since 2009 Delta has cut its debt by more than USD10 billion, and its net debt at YE2015 was USD6.7 billion. The company has outlined a goal of reducing its debt to USD4 billion by 2020.
The airline has explained that its debt reduction was the largest driver of USD35 million in lower interest expense year on year in 4Q2015 and USD170 million for the full year of 2015.
Reaching investment grade does not mean that Delta plans any monumental shift in its balance sheet strategy. Indeed, staying the course is now more relevant than ever to further reduce its debt while balancing the necessary re-investment back into its business and delivering shareholder returns. Delta in 2015 issued USD2.6 billion in capital returns, which was 70% of the airline’s annual free cash flow. It plans roughly USD3 billion in capital expenditures in 2016, which is lower than the nearly USD6 billion planned by American and in line with the USD2.7 billion to USD2.9 billion forecast by United.
American is in the midst of a significant re-fleeting, and has opted to acquire brand new aircraft for the endeavour. American has the highest number of aircraft on order among the three large global US airlines, but boasts that the age gap of its fleet with those competitors will continue to grow.
Delta’s strategy is to operate a surprisingly older fleet; its 17+ year old average is well above industry levels. Its main international partner Air France for example operates with an average age 5.5 years younger. Only LCC Allegiant Air, with its unique low utilisation strategy, has an older fleet. Delta's logic is that those aircraft carry a lower capital costs, one that works well with low fuel prices and a solid maintenance platform. With a very small order book also, it does raise questions about the medium term funding of the new equipment that must eventually occur.
United in 2015 opted to lease up to 25 current generation Airbus A319 narrowbodies. Favourable lease rates (due to valuations falling with forthcoming deliveries of new generation A320neos) and lower fuel prices are making used aircraft attractive in some situations. But United also recently placed an order for 40 new current generation Boeing 737-700s to replace some of the operations of its regional partners. The company is in the process of shrinking its 50 seat regional jet fleet, which stood at 259 at YE2015, and is projected to fall by 16 aircraft during 2016.
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American opts to carry a higher liquidity balance to cover its higher ratios
During the last couple of years American has carried an outsized cash balance. At the end of 3Q2015 its liquidity levels were USD11.5 billion, which was 27.4% of its trailing 12M revenues.
Throughout the time American has retained higher liquidity levels than its US peers, it has fielded questions about how it intends to use that cash as investors have become more vocal about reaping rewards during the last few years. American’s standard answer was it needed a larger cash balance to ensure its merger integration with US Airways went smoothly. The two companies integrated their passenger service and reservations systems in late 2015, which required ample resources and investment.
American ended 2015 with USD8.7 billion in liquidity, which executives admitted was more than necessary to run the airline. The airline has concluded that given its leverage levels, it is necessary to retain a higher liquidity level than its peers. United, which has stated a goal of retaining liquidity levels of USD5 billion to USD6 billion, ended 2015 with total liquidity of USD6.5 billion.
American has declared plans to maintain a minimum USD6.5 billion liquidity level for the foreseeable future due to its higher leverage levels. At YE2015 its debt to equity was 2.39 compared with 0.82 for Delta, according to data from the Wall Street Journal. Data for United was not available, but its leverage has trended lower than American’s.
American’s expectation is that its net debt to EBITA will peak in 2016 and decline as the airline’s capital expenditures decline.
American concludes it is more prudent to exploit lower interest rates and have higher leverage
American expects that its annual aircraft Capex will fall from USD4.5 billion in 2016 and 2017 to USD3 billion in 2018. Non aircraft capital expenditures will fall to USD800 million in 2018 from USD1.2 billion annually in 2017 and 2018.
In early 2016 American CEO Doug Parker reiterated the company’s philosophy that it wanted to have a robust cash balance to withstand any large shock to its business. For now, American believes it is more prudent to take advantage of interest rates around 4% to finance aircraft rather than use cash for aircraft.
Mr Parker believes the right path for American to take is holding a higher level of cash than its peers “to offset the fact we’re going to have less collateral in terms of aircraft because we’re going to be financing them”.
American has paid more than USD3 billion higher interest debt since its merger with US Airways. The company tends to discuss debt reduction targets less than United and Delta, but obviously has worked to reduce its high interest debt. At YE2015 American’s long term interest debt was USD18.3 billion compared with USD6.5 billion for Delta (according to data from MarketWatch. YE2015 totals for United were unavailable. Its long term debt at the end of 3Q2015 was USD10.7 billion)
The higher debt loads American is choosing to shoulder in order to take advantage of low interest rates could be a factor in the company’s stock valuation suffering in 2015. Another element driving down the valuation was the airline’s declaration that it would match LCC and ULCC fares; but the airline is working to create new fare families to debut in 2016 that should allow American to refine its revenue management to better compete with low competitors.
See related report: American Airlines’ flawless merger ignored by Wall Street. 2016 should provide a stronger performance
United in 2015 prepaid USD1.2 billion of its debt and eliminated all high interest prepayable debt. At the beginning of 2016, the company concluded it would not continue to prepay debt at the levels it had done in the past. During 2016 the airline plans to finance some, but not all, of its aircraft deliveries. United plans to take delivery of 14 737s, five 787-9s, one 777-300ER, nine of the aforementioned used A319s and 40 Embraer 175 regional jets.
By opting to finance some of its aircraft deliveries in 2016, United will have leftover cash. It has already stated it will complete a USD3 billion share buyback programme earlier than anticipated.
United has stated it was working toward a goal of achieving investment grade status. American, too, obviously monitors its credit ratings; but Mr Parker also highlighted the company is presently borrowing at investment grade rates. “We care about ratings of course, we work well with the agencies, we just have a different view, I think, than some of our competitors about what the right way to manage, what the right leverage amounts are and it doesn’t make sense to us at this point” said Mr Parker.
The large three US airlines opt for approaches to achieve similar financial goals
American, Delta and United are all at varying stages of meeting their balance sheet and debt goals, and have different approaches in their views of debt management and liquidity levels.
Delta deserves credit for attaining its investment grade goals, and its large US global network rivals are also working toward reaching that achievement. But for now it seems American is more focused on accessing favourable rates available for aircraft financing, while United continues to adopt a hybrid path of American and Delta, opting for some used aircraft while working to capitalise on some of the favourable financing currently available.
The overriding theme each airline hopes to implore to investors is a prudent approach to capital management while sustaining shareholder returns. Valuations in the short term will show how investors view the methods American, Delta and United are adopting to maintain balance sheet strength and debt management.