Fitch: Airline Buybacks Present Incremental Credit Risk

NEW YORK—(BUSINESS WIRE)—New buyback programs in the Airline Industry could affect expected improvements in credit profiles if not managed prudently, according to Fitch Ratings. American Airlines (American [B+/Stable]) and United Airlines (United [B/Positive]) Thursday both announced plans to return cash to shareholders.

We believe that if shareholder focused cash deployment should come at the expense of leverage reduction and healthy liquidity balances, expected improvements to the credit profiles of United and American could be delayed. Fitch does not anticipate an impact to either company’s ratings in the near term.

American’s plan to return cash to shareholders is more aggressive than originally anticipated by Fitch. However, risks around shareholder focused cash deployments are mitigated by its accompanying plan to prepay debt, buyout a significant number of aircraft leases, and to make a sizable contribution to the company’s underfunded pension plan. Fitch notes that size of American’s planned debt prepayment and pension contributions are greater than its planned distributions to shareholders, representing a managed approach to capital deployment.

American announced a $1.0 billion share repurchase program to be completed by year-end 2015 along with a $0.10/share quarterly dividend to be paid out in the third quarter on July 24 in its second quarter earnings release. The current dividend is equivalent to roughly $300 million annually. American also announced plans to prepay a total of $1.8 billion in debt from the completion of the merger through the end of 2014 and to spend $1.0 billion on aircraft purchases that were previously leased. Of the debt prepayment, $900 million is expected to represent a permanent debt reduction whereas the remainder may be refinanced. The company is also contributing $600 million to its pension plans over and above its $120 million minimum required contribution for 2014.

American’s decision to return cash to shareholders represents incremental credit risk given the uncertainties remaining in the merger integration process. The American/US Airways merger was finalized less than a year ago and key items such as merging the two reservation systems and achieving joint collective bargaining agreements are still to be completed. Unanticipated integration problems could affect earnings and cash flows, which would be made worse by American’s cash commitments to shareholders.

Fitch notes that American already has sizable upcoming capital requirements as it updates its fleet over the coming years. The company has 457 mainline aircraft on order and anticipates gross capital spending in excess of $5.0 billion per year for the next several years. These risks are partially offset by American’s sizable liquidity balance including $9.5 billion balance of unrestricted cash and equivalents and $1.0 billion undrawn revolver.

Fitch also notes that American’s initial dividend is relatively modest in size and it is accompanied by record operating performance and significant cash generation in the first six months of the year. Fitch expects the dividend and repurchase program to be manageable if American continues to exhibit margin and cash flow improvement as it has since the merger.

United also announced the initiation of a $1.0 billion repurchase program. Like American, United also has sizable upcoming capital commitments as it takes delivery of new aircraft and the share repurchases could pressure cash balances if not managed prudently. Unlike American, United’s 2010 merger with Continental Airlines is mostly complete. United also has a less aggressive time frame, planning to pay out $1.0 billion in the next three years compared to American’s goal to complete its $1.0 billion program by the end of 2015.

Additional information is available on www.fitchratings.com.