Fitch Rates Southwest's Unsecured Notes 'BBB+(EXP)'
OREANDA-NEWS. Fitch Ratings has assigned a rating of 'BBB+(EXP)' to Southwest Airline's (LUV) proposed $500 million note issuance.
The notes will feature a five year tenor and will rank equally with Southwest's existing unsecured debt. The funds will be used for general corporate purposes. Including the new debt issuance, Fitch expects Southwest's total adjusted debt/EBITDAR to be approximately 1.8x at year end 2015, which is consistent with the company's 'BBB+' rating, and is among the lowest of any airline globally. Fitch continues to expect Southwest's total leverage to remain stable or trend slightly lower over the near-to-intermediate term.
KEY RATING DRIVERS
Solid Financial Results:
Southwest has exhibited solid performance by many measures through the first part of 2015 and over the last several years in general. Fitch expects LUV to continue to perform well financially for the foreseeable future, with operating margins remaining well above levels generated in recent years, continued low leverage, and solid free cash generation.
Current Rate of Growth Not a Near-Term Concern:
Fitch views Southwest's current growth plans to be prudent, given where and how the company is increasing capacity. Above industry average capacity growth could be seen as a negative over the longer term if it is not supported by demand or if it were detrimental to unit revenues. LUV plans to grow 2015 ASMs by around 7% followed by another 5%-6% in 2016.
The company's recent growth has been driven primarily by attractive opportunities presented by the repeal of the Wright Amendment in Dallas, the acquisition of slots at DCA and LaGuardia, and expansion into international markets. A majority of 2016's expected growth is simply carry-over from new flying that was put into place in mid-to-late 2015. 'Stage and gauge', i.e. flying larger, denser aircraft over longer distances will be another major growth driver. Growth of this type tends to come at low incremental costs and can often be accretive to margins even if it has a negative impact on unit revenues.
Increased Shareholder Friendly Cash Deployment:
Fitch does not view Southwest's increased shareholder returns to be a material concern at this time particularly given the strength of Southwest's balance sheet and its track record of producing free cash flow (FCF). LUV also views its share repurchase program as discretionary, and could scale back repurchases if it was needed to preserve cash. Shareholder returns would be more concerning if management's strategy were to change and repurchases/dividends were pursued at the expense of the company's balance sheet.
Solid Free Cash Flow:
Southwest's ability to consistently generate significant FCF is one of the factors that sets the company apart from its industry peers. Fitch expects Southwest to continue to generate steadily positive FCF for the intermediate term despite relatively high capital expenditures, particularly in 2016-2017 when aircraft deliveries will be heavy, and despite Fitch's expectations that dividends will likely continue to increase. Fitch expects FCF generation in 2015 to reach $1.1 billion-$1.4 billion, compared to $1.02 billion in 2014.
Primary rating concerns include industry risks that are typical for any airline, including cyclicality, high levels of operating leverage, exposure to exogenous events, fluctuating fuel prices, and macroeconomic concerns. The industry remains highly leveraged to the overall macroeconomic environment. A future downturn could significantly impact the demand for air travel resulting in lower yields and load factors and higher unit costs. Southwest faces some technological risk in the intermediate term as it transitions away from its current domestic reservations system over the next few years. Poor implementation of technological changes has created severe operational disruptions for airlines in the past. Shareholder focused cash utilization could present a concern if it were pursued at the expense of the company's balance sheet. Concerns also include increased competition both from LUV's large network rivals that are now financially healthier than they have been in the past, and from rapidly growing low cost carriers.
Fitch's key assumptions within the rating case for Southwest include:
--Mid single digit capacity growth through the forecast period;
--Continued stable/slow growth in demand for U.S. domestic travel;
--Low-single digit RASM decline in 2015 followed by flat unit revenues thereafter;
--Conservative fuel price assumption which includes crude oil approaching $80/barrel in 2016 and rising incrementally thereafter.
Fitch views the rating as having limited upside potential in the near term due to the inherent cyclicality and volatility in the airline industry.
Fitch does not expect to take a negative rating action in the near term. However, a negative action could be driven by an exogenous shock that causes demand for air travel to drop significantly or a fuel shock that is not offset by rising yields. A negative action could also be driven by a change in management strategy favoring shareholder returns at the expense of a healthy balance sheet. Fitch could consider a downgrade if adjusted debt/EBITDAR were to rise and be sustained above 2.5x, if FCF margins were to decline below 1%-2% on a sustained basis, or if funds from operations (FFO) fixed charge coverage were to fall below 4x on a sustained basis.
FULL LIST OF RATING ACTIONS
Fitch has assigned the following ratings:
Southwest Airlines Co.
--$500 million senior unsecured notes due 2020 'BBB+(EXP)'.
Fitch currently rates Southwest as follows:
--Issuer Default Rating (IDR) 'BBB+';
--Senior unsecured debt 'BBB+';
--$1 billion unsecured revolving credit facility expiring 2018 'BBB+';
--Secured term loans due 2019 and 2020 'A-'.