Fitch Upgrades Delta to 'BB-'; Outlook Positive

CHICAGO—(BUSINESS WIRE)—Fitch Ratings has upgraded Delta Air Line’s IDR to ‘BB-’. Fitch has also upgraded Delta’s Seattle project bonds to ‘BB-’ from ‘B+’ and assigned ratings of ‘BB+’ to Delta’s 2012 secured credit facility. The Rating Outlook is Positive.

The ratings upgrade reflects significant improvements to Delta’s balance sheet, continued solid operating performance, and successful efforts to combat operating cost inflation. Delta’s ability to consistently generate positive FCF even in a high fuel price environment is a key consideration in upgrading the ratings. Delta also benefits from good labor relations including a largely non-unionized workforce, and from a sizeable NOL balance which should allow the company to pay minimal cash taxes for the foreseeable future.

The ratings are supported by underlying improvements in the airline industry including consolidation among the legacy carriers and capacity constraint, which have led to an improved risk profile and better profitability for the industry as a whole.

The Positive Outlook reflects Fitch’s view that Delta’s credit profile will continue to improve over the intermediate term. Delta continues to emphasize debt reduction, free cash flow, and return on invested capital as key priorities. Barring an unexpected economic downturn, Fitch expects that credit metrics could trend towards levels that put the company in line with ‘BB’ category credits.

Rating concerns are primarily reflective of risks inherent in the airline industry. Cyclicality, exposure to exogenous shocks (i.e. war, terrorism, etc.), a high fixed cost base, and sensitivity to global oil prices remain constraining factors on the ratings. The industry is also highly competitive despite consolidation among the major airlines. Competition could become tougher in the future as United and American fully benefit from their recent mergers, and as low cost carriers such as JetBlue and Spirit continue to grow.

The ratings also reflect the industry’s high degree of operating leverage. Fitch notes that credit metrics may deteriorate quickly in a stress scenario due to a high fixed cost base, and the sensitivity of air travel demand to an economic downturn.

Delta’s large pension deficit remains a credit concern, though positive asset returns and incremental pension funding have helped to mitigate the risk over the past year. Delta’s unfunded pension balance stands at $10.1 billion at year end 2013, down from $13.3 billion a year prior.

Improving Credit Metrics: Credit metrics at Delta have improved markedly in recent years and Fitch expects further progress going forward. Fitch calculates Delta’s adjusted debt/EBITDAR at 3.2x as of year-end 2013, which is down from over 9x at year end 2009. Adjusted leverage is now notably lower than the majority of the company’s North American peers.

Fitch believes that Delta’s improved credit profile puts it in a much stronger position to weather future market downturns. Delta intends to further reduce debt in the near-term, setting a net adjusted debt target of $7 billion to be reached by year end 2015, after having reached its previous net debt target of $10 billion in the third quarter of 2013. Fitch views this goal as achievable given the company’s capacity to produce free cash flow, and track record of bringing down debt since the previous recession.

Healthy Operating Results: Operating margins also continue to expand, reflecting consistent RASM growth and managed cost pressures. Delta has led the industry in PRASM growth since fully completing its integration of Northwest with results driven by its competitive route network and an improving share of corporate travel.

Fitch believes that operating margins have room for further expansion in coming years as Delta works to revamp its regional jet fleet and its operations in New York continue to mature. Fitch also expects continued modest macroeconomic growth in 2014, positive trends in travel demand, and capacity discipline across the industry, which will foster a healthy operating environment. Business travel trends are particularly robust, which is important given Delta’s increased focus on growing its share of lucrative corporate travelers.

Margin expansion is also driven by Delta’s successful efforts to control cost inflation. Cost per available seat mile (CASM) ex-fuel was up by a modest 2% in 2013 despite a 6% increase in salaries and related costs. Lower maintenance has acted as the primary offset as Delta has been able to avoid heavy maintenance checks on the small regional jets (RJ’s) that it intends to retire in coming years. Delta also has the advantage of maintaining an in-house maintenance operation with a non-unionized work force that allows the company to keep costs down despite operating an older fleet of aircraft.

Going forward, maintenance costs are unlikely to decline as they did in 2013. However, wage/salary growth should be more modest following the large increases in pilot wages experienced in 2012 and 2013, making Delta’s goal of keeping ex-fuel unit cost inflation below 2%/year achievable.

FCF and Financial Flexibility: Fitch expects FCF at Delta to remain strong in the coming years driven by improved margins and lower interest charges, with fuel prices remaining a possible wild card. Delta has now produced positive FCF in each of the past five years. The capacity to consistently produce positive FCF, particularly in a sustained high fuel price environment, is a key consideration in the decision to upgrade the ratings to the ‘BB’ category. Fitch forecasts 2014 FCF to be in the range of $1.5 – $2.0 billion.

Large but Manageable Cash Obligations: Delta expects capital expenditures to total $2.3 billion in 2014 compared to nearly $2.6 in 2013. Thereafter, spending is expected to be in the $2.0-$2.5 billion range, the majority of which will consist of new aircraft deliveries as Delta takes 737-900ERs, A330-300s starting in 2015 and A321s starting in 2016.

Debt maturities range from $1.0 to $1.4 billion annually over the next three years. Although cash obligations are sizeable, Fitch expects Delta to have sufficient cash from operations, cash on hand, and access to capital markets to cover upcoming obligations.

Fitch also expects Delta to manage its dividend and share repurchase programs prudently, though shareholder friendly activities could present a credit concern in the future if they were pursued at the expense of a healthy balance sheet. Delta paid out $100 million in dividends in 2013 after initiating its dividend in May of 2013. At the current rate dividend payments will total roughly $200 million in 2014, though the announcement of a moderate dividend increase in the first half of the year would not be unexpected.

Delta completed $250 million of share repurchases in 2013 and expects to buy back another $250 million by June of this year, which will fulfill Delta’s original buyback capacity nearly 2 years ahead of schedule. Although the time frame for the initial round of share repurchases was accelerated ahead of Fitch’s original expectations the program has not impacted Delta’s credit profile.

Delta Air Lines Pass Through Certificates 2007-1: In its review of Delta’s ratings, Fitch has also affirmed the ratings for the company’s 2007-1 series class A certificates at ‘BBB+’. Fitch’s senior tranche EETC ratings are primarily based on a top down analysis of the collateral, and were not affected by the upgrade to Delta’s IDR.

RATING SENSITIVITIES

Future developments that may, individually or collectively, lead to a positive rating action include:

—Continued debt reduction with adjusted debt/EBITDAR being sustained below 3x and FFO adjusted leverage below 3.25×.

—Sustained free cash flow margins of 4 – 5% of revenue.

—Generating consistent operating margins at or above current levels.

A negative rating action is not anticipated at this time.

However future actions that may individually or collectively lead to a negative rating action include:

—Adjusted Leverage sustained above 4x (FFO adjusted leverage above 4.5x). Fitch notes that a temporary spike above 4x in the case of a recession would not necessarily trigger a negative action.

—Increased operating costs that are not adequately matched by higher ticket prices, causing EBITDA margins to fall and remain below 10%.

—A substantial increase in dividends or stock repurchases that comes at the expense of a healthy balance sheet.

An unexpected and protracted drop in the demand for air travel.

Fitch has taken the following rating actions:

Delta Air Lines, Inc

-IDR upgraded to ’BB’ from ‘B+’;

—$1.2 billion senior secured revolving credit facility due 2016 affirmed at ‘BB+’;

—$1.4 billion senior secured term loan due 2017 affirmed at ‘BB+’.

Delta Air Lines 2007-1 Pass Through Trust:

—DAL 2007-1 class A certificates affirmed at ‘BBB+’.

Industrial Development Corporation (IDC) of the Port of Seattle special facilities revenue refunding bonds, series 2012

(Delta Air Lines, Inc. Project):

—$66 million due April 1, 2030 affirmed at ‘B+’.

Fitch has assigned the following ratings:

—$450 million senior secured revolving credit facility due 2017 ‘BB+’;

—$1.1 billion senior secured term loan B-1 due 2018 ‘BB+’;

—$400 million senior secured term loan B-2 due 2016 ‘BB+’.

Additional information is available at ‘www.fitchratings.com’

Applicable Criteria and Related Research:

—‘Corporate Rating Methodology’ (Aug. 5, 2013);

—‘Recovery Ratings and Notching Criteria for Nonfinancial Corporate Issuers’ (Nov. 19, 2013);

—‘Rating Aircraft Enhanced Equipment Trust Certificates’ (Sept. 12, 2013).

Applicable Criteria and Related Research:

Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715139

Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=721836

Rating Aircraft Enhanced Equipment Trust Certificates

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=717763