Fitch Rates Ryanair's Proposed Notes 'BBB+(EXP)'
The notes, which will be guaranteed by Ryanair Holdings plc (RYA), are part of Ryanair Limited's EUR3bn euro medium-term note programme. The proceeds of the notes will be used for general corporate purposes, including funding Ryanair's upcoming aircraft deliveries, which will support its fleet expansion and help maintain a low average fleet age.
The assignment of the final rating is contingent on the receipt of final documents conforming to information already reviewed.
The notes' rating is aligned with RYA's Long-term Issuer Default Rating (IDR) of 'BBB+' despite potential subordination to RYA's approximately EUR2.8bn of secured debt. Factors supporting the alignment of the unsecured ratings with the Long-term IDR, as opposed to notching down, include the company's strong overall credit profile, the value of the enterprise relative to the outstanding debt, an unencumbered asset to unsecured debt test, and the potential residual market value of encumbered assets.
The issuance will continue RYA's shift to unsecured debt from secured debt, which began in June 2014 with the issuance of EUR850m of unsecured medium-term notes.
It is atypical for an investment-grade issuer to have a capital structure including such a high level of secured debt and encumbered assets. For RYA this occurred mainly due to the inexpensive financing available through Export-Import Bank of the United States (Ex-Im) guaranteed loans. As Ex-Im funding has become less cost-efficient for strong credits such as RYA, it is likely that future funding will lead to a substantial increase in unencumbered assets, further underpinning the alignment of the unsecured rating with RYA's 'BBB+' IDR.
KEY RATING DRIVERS
RYA's low cost advantage and substantial liquidity are key drivers of its rating. The company's high margins, significant cash generation, and financial flexibility further differentiate RYA from most airline peers. RYA's solid capacity for meeting its financial commitments is also supported by the company's fairly flexible cost structure, low break-even load factor, and robust hedging programmes for fuel and currencies.
The company's low fleet age, fleet commonality and other elements of it business model also support the ratings. RYA's financial metrics are generally strong for the rating, with the exception of gross leverage, but this is offset by low net leverage metrics driven by the company's large cash position.
Overall, RYA's conservative and simplified business model tempers the impact of the financial leverage and operating leverage that are characteristic of the airline industry. The business model is designed to achieve industry-low costs and mitigate some of the key risks in the sector. The company's financial strength, including strong cash liquidity, is a key element of this low-cost/reduced-risk strategy. RYA's leading cost position, liquidity, high margins and significant cash generation give it the ability to withstand the inevitable shocks that periodically hit the airline industry, as well as fending off competitive threats.
Key rating risks include significant cash distributions to shareholders; some recent changes to parts of the business model, mainly in the areas of customer service and distribution; and potential yield weakness if competitors use lower fuel costs to fund fare cuts. Ryanair's revenue profile is also more seasonal than most of the airlines in Fitch's portfolio. Competitive pressures are a persistent challenge, including expansion plans of various low-cost/hybrid airlines, such as easyJet plc and Norwegian Air Shuttle ASA and a gradual unbundling trend at the legacy carriers.
The company's growth plan and related capital expenditures over the next five years is also an item to watch, as is potential longer-term exposure to fuel price levels and currency exchange rates. Larger changes to the company's business model, such as an expansion into the long-haul market (unless credit ring-fenced in a separate entity from RYA), could also be a rating risk. Other risks for the general airline industry are also concerns, including economic downturns, debt market conditions, fuel price shocks, war and terrorism, disease pandemics, and environmental factors such as volcano ash clouds.
RYA's performance in the past year has been ahead of Fitch's forecasts, but this has been partly offset by the announcement of a share repurchase programme earlier than Fitch had expected. Through the first three quarters of FY15 RYA's revenues rose nearly 11%, while margins increased five points. Fitch conservatively forecasted flat revenues and a modest margin decline for FY15. RYA's free cash flow for the first nine months of FY15 improved to EUR315m compared with EUR44m in the same period of FY14, despite higher capex. Although capex should continue to rise in 4QFY15, Fitch expects RYA should be able to meet or exceed the EUR539m FCF generated in FY14.
Fitch expects capex will rise to approximately EUR600m in FY15 compared with EUR506m in FY14, then capex should increase noticeably for several years from FY16. Fitch previously expected capital spending would peak in FY17 or FY18, but the new order for up to 200 Boeing 737 MAX 200 aircraft will extend this by several years. Fitch continues to forecast Ryanair will be able to maintain positive FCF throughout this period of heavy capital spending, although FY19 FCF could be low as both the existing aircraft order for 180 737-800 planes and the new MAX 200 order will drive spending in that year. If cash flow or liquidity came under pressure, Fitch expects Ryanair would temporarily reduce cash deployment to shareholders.
Ryanair has distributed a substantial amount of cash to shareholders over the past six years, and Fitch expects this will continue over the next few years assuming no material disruptions to Ryanair's business. The company indicates that shareholder distributions are subject to continued profitability, the economic environment, capital expenditure, fuel prices, yields and shareholder approval. The company issued a EUR520m special dividend on 27 February 2015, which is incorporated into Fitch's cash flow forecasts.
The company also announced a EUR400m share repurchase plan to be executed over six months starting in February. While Fitch's forecasts included substantial shareholder returns, this share repurchase programme was implemented earlier than expected, increasing the risk that overall FY16 shareholder cash deployment could exceed Fitch's expectations if an additional repurchase or dividend programme is announced later in FY16.
Fuel and currency volatility is a key issue in the global airline sector. RYA continues to address this volatility to a greater extent than its peers, with both fuel and key currencies (USD/EUR) hedged 90% for both FY15 and FY16. Capex is fully hedged through September 2017. While its hedging policy provides the company with cost certainty, RYA faces a risk that its peers with fewer or no hedges will be able to use the fuel price windfall to lower fares. The strong US dollar partly offsets this risk, but we will monitor fare pressure in FY16.
Ryanair has recently made some modifications to its business model, and others are in progress. Its goal is to increase its customer focus while keeping its low-fare focus, lifting load factors, and modestly raising average fares. Fitch believes many are common-sense moves, and the net cost appears modest. To date, Fitch considers most of these modifications a success, and if the momentum continues, financial performance could be further boosted over the next two years.
Liquidity at the end of the 3QFY14 was EUR4.1bn of cash, which is 75% of LTM revenues, by far the strongest level in Fitch's airline portfolio. With EUR3.7bn of debt, RYA remained in a net cash position. With 4Q FCF partly offsetting the special dividend, Fitch expects RYA should remain in a net cash position at fiscal year-end. Fitch also expects the company's liquidity will decline as aircraft deliveries ramp up, but the company should still have one of the strongest liquidity positions in the industry. Liquidity could rise further depending on the value of RYA's stake in Aer Lingus.
Key credit metrics have improved so far in FY15. Leverage (both adjusted debt to EBITDAR and FFO adjusted leverage) have declined to approximately 3.1x in the LTM compared to 3.6-3.7x for FY14. This decline is driven by the strong sales and margin performance despite higher debt levels. LTM FFO fixed charge coverage has risen to 7.4x from 5.9x in FY14.
Fitch's key assumptions within our rating case for RYA include:
- Capex will increase noticeably from FY16.
- Positive FCF is possible throughout the aircraft delivery period if there are no material shocks to the European aviation sector.
- Substantial shareholder cash deployment will continue over the next few years. We anticipate that Ryanair will be able to fund shareholder distributions with only modest increases in debt and will slow or eliminate distributions in the event of an economic downturn or disruption to the airline industry.
- Flat net leverage margins.
Future developments that could lead to negative rating action on RYA include:
- Adverse changes in RYA's liquidity strategy, unless cash is used to reduce debt, or in other financial and treasury policies.
- EBITDAR margins consistently below 19%.
- FFO fixed charge coverage consistently in the 4.5x-5.0x range or lower.
- FFO net adjusted leverage consistently above 1.0x.
- Long-haul expansion, unless housed in a credit separate from RYA.
- Revisions to the company's M&A strategy.
The IDR has limited upside potential because of the inherent risks in the airline industry and the company's shareholder distribution policies.
Fitch currently rates RYA and Ryanair Limited as follows:
- Long-term IDR 'BBB+'; Outlook Stable
- Senior unsecured debt 'BBB+'