Fitch Downgrades United Airlines' IDR to 'B+'; Outlook Stable
Fitch Ratings has downgraded United Airlines' Issuer Default Rating to 'B+' from 'BB-' and revised the Outlook to Stable. The pace of air traffic recovery combined with pressure on the balance sheet will make it difficult for United to achieve credit metrics that support the 'BB-' rating before 2023, prompting the one-notch downgrade to 'B+'. United's balance sheet debt increased by $12.2 billion in 2020, equivalent to approximately 1.5 turns of 2019 EBITDAR. Gross debt may increase further assuming United draws its availability under the government Coronavirus Aid, Relief, and Economic Security (CARES) Act loan. Fitch believes that United's gross leverage could remain near 5x or higher by the end of 2023 which is high for a 'BB' category rating. United will have limited remaining unencumbered assets, leaving the company with reduced financial flexibility compared to prior to the pandemic.
However, United Airlines managed the crisis effectively despite its network having more exposure to international markets that were heavily impacted by the virus. Fitch views the downside risks to United's rating as decreasing, driving the Stable Outlook.
KEY RATING DRIVERS
Airline traffic has recovered more slowly than Fitch's prior expectations through 1Q21. Global outbreaks of COVID caused a reimposition of travel restrictions and for leisure travel to be discouraged. U.S. traffic and bookings have improved materially in recent weeks around spring break, leading to rising passenger counts in March, but overall performance in 1Q21 remains weak.
Fitch's prior forecasts had anticipated that at this point in the crisis, traffic would be down by approximately 40%-45% compared to 2019 levels. While passenger counts are improving to 30%- 40% on peak travel days, rolling seven-day averages remain 50% or more below 2019 levels. Traffic as measured by RPMs will be worse than passenger counts due to the lack of long-haul travel. 2Q21 and beyond may be more promising, with several carriers reporting stronger bookings. For example, American reported that bookings in recent weeks have been only 20% below 2019 levels, the largest improvement since the start of the pandemic.
Traffic Rebound Expected but Uncertainties Remain: Fitch anticipates a fairly robust rebound, particular in leisure and VFR traffic, once traveler confidence improves driven by a great deal of pent up demand. Recent surveys conducted by IATA and Oliver Wyman indicate that a majority of respondents expect to travel as much or more once the pandemic is over compared to pre-pandemic level, with most respondents also indicating a desire to prioritize travel in the future.
Fitch also believes that the economic impacts of the pandemic have been disproportionately weighted toward lower income households. Higher earners, who have a higher propensity to travel, have been less impacted, and may help to drive the rebound in travel later this year. Although the successful development of COVID vaccines has driven an improvement to Fitch's sector outlook, serious uncertainties remain. There is a possibility that new variants of the coronavirus could prolong the epidemic and delay a recovery in travel. Travel restrictions will also likely limit long-haul travel recovery, and the pandemic's impact on lucrative business travel remains uncertain.
Improved Cash Burn: United recently announced that it expects core cash flow to turn positive in March based on the recent uptick in bookings, and to remain positive assuming the booking trajectory continues. United's definition of core cash flow excludes debt principal payments, capex and certain one-time items and so does not reflect all cash inflows and outflows. Nonetheless, the turn to positive represents a meaningful improvement after burning cash for nearly a full year.
Material Cost Cuts: Permanent changes to the airline's cost structure will be key to returning to pre-pandemic levels of profitability. United announced on its first quarter earnings call that it will permanently reduce annual operating costs by $2 billion and expects to exceed 2019 EBITDA margins by 2023. Fitch's forecast is more conservative. The agency does not anticipate a return to 2019 level margins until 2024 driven by a slow rebound in demand. Expense reduction comes through a permanently lower level of management head count, reduced number of regional partners and renegotiated agreements with suppliers.
Capital spending: United expects gross capex to total $4.4 billion in 2021 and it has capital commitments for nearly $3 billion in both 2022 and 2023. The company has stated that it will not take delivery of new aircraft unless they are fully financed, so capital spending is not expected to be a major net drain on cash. However, the company's ability to reduce its gross debt balance will be limited over the next two years. United's fleet is older than its network peers with an average age of 16 years vs. 13.5 for Delta and 10.8 for American, resulting in relatively high spending requirements at United.
Fitch uses a bespoke approach to recovery ratings for issuers rated in the 'B' category as opposed to a generic uplift approach for 'BB' category issuers. Fitch's recovery analysis assumes that United would be reorganized as a going concern in bankruptcy rather than liquidated. Fitch has assumed a 10% administrative claim. The going concern (GC) EBITDA estimate reflects Fitch's view of a sustainable, post-reorganization EBITDA level upon which the agency bases the enterprise valuation. Fitch uses a GC EBITDA estimate of $5.5 billion and a 5.5x multiple, generating an estimated GC enterprise value (EV) of $27.3 billion after an estimated 10% in administrative claims. This analysis yields a recovery rating of 'RR2' for senior secured creditors, reflecting the possibility that recovery for secured parties could be diluted given the amount of senior debt raised through the downturn. Likewise, United's unsecured recovery rating of 'RR6' reflects the large amount of secured debt in United's capital structure.
Enhanced Equipment Trust Certificate (EETC) Ratings: Subordinated tranche ratings of United's EETC transactions may be impacted by the downgrade of United's IDR. Fitch will be reviewing United's EETC ratings in the coming weeks.
United's 'B+' rating remains two notches above American and three notches below Delta. The rating differential is driven, in part, by Fitch's expectation that United's leverage metrics post-pandemic will remain favorable compared to American's, but still too high to support a rating in the 'BB' category.
--Airline traffic (RPMs) remains 45% or more below 2019 levels in 2021, only fully recovering to 2019 levels by 2024. Domestic and leisure travel are likely to rebound more quickly. Fitch believes that leisure travel could be back to 2019 levels on a run rate basis some time in 2023;
--Fitch's models assume jet fuel prices of approximately $1.60/gallon in 2021, rising to $1.80/gallon in 2023. Actual jet fuel prices have risen above these levels in recent weeks, with spot prices hovering around $1.75. Into-plane prices, including taxes, are modestly higher. Incorporating higher fuel prices into Fitch's models would drive modestly lower margins and greater cash burn in 2021 and 2022, but Fitch believes that the impact by the end of the forecast period would be less minimal as demand normalizes and the airlines are able to raise ticket prices.
--Fitch expects revenue per available seat mile (RASM) for the industry to remain below 2019 levels through the forecast period driven by intense competition.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
--Increasing evidence of a sustainable recovery in air travel;
--Adjusted debt/EBITDAR trending towards 4x;
--FFO fixed-charge towards 2.5x;
--Neutral to positive sustained FCF.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
--Prolonged downturn in air traffic persisting through 2021;
--Adjusted debt/EBITDAR sustained above 5x;
--FFO fixed charge coverage sustained below 1.5x;
--EBITDAR margins deteriorating into the low double-digit range;
--Persistently negative or negligible FCF.
BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
LIQUIDITY AND DEBT STRUCTURE
Solid Liquidity: Risks for United are mitigated by a solid liquidity balance. Fitch believes that, given a rebound in traffic in 2H21, United may be able to end the year with $17 billion in liquidity. The company raised roughly $27 billion in 2020 through a combination of debt, equity, and government grants, ending the year with $12.7 billion in available liquidity excluding $7 billion in available loans under the CARES Act. Fitch's models assume that United will draw on its CARES Act loan. Liquidity was bolstered in 1Q21 through United's $600 million subordinated EETC tranche issuance, and another $2.6 billion in funds received through the second round of the government's Payroll Support Program (PSP2). United is likely to receive a similar amount in the third round of payroll support that was included in President Biden's coronavirus relief package.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg