Fitch Publishes British Airways Plc's 'BB+' Rating; Outlook Positive
OREANDA-NEWS. Fitch Ratings has published British Airways Plc's (BA) Long-term Issuer Default Rating of 'BB+' with a Positive Outlook.
BA's rating is supported by its extensively diversified route network, strong hub position at Heathrow, strong position on the cash flow generative routes to the US and rigorous cost management. We rate BA on a standalone basis.
The Positive Outlook mainly reflects the company's on-going improvement of credit metrics. It is also driven by our expectations that the company will continue to pursue a prudent financial policy despite its parent company's (International Airlines Group; IAG) acquisition-focused growth and planned dividend payments.
KEY RATING DRIVERS
Steady Improvements to Credit Metrics
BA's strong financial performance is driven by its strong market and hub position, rigorous cost control and structural changes to the cost base implemented ahead of other European legacy network carriers as well as disciplined capacity growth and lower fuel prices.
We forecast that BA will achieve its financial target of operating profit of GBP1.3bn in 2015 and its medium-term financial target of an operating profit margin in the range of 10%-14% over 2016-2020. We expect its funds from operations (FFO) adjusted gross leverage to decline to around 3x in 2015 from 3.7x in 2014 and further decline towards 2.5x by 2017 and FFO fixed charge cover to increase to about 6x in 2015 from 5.3x in 2014 and fluctuate around 7x over 2016-2019. This is despite our assumptions that BA will have to pay dividends to support IAG's dividend distributions and acquisition debt repayment.
The Positive Outlook is driven by our expectations of further improvement of BA's credit metrics over 2015-2019 and its adherence to a prudent financial policy. BA's ability to sustain its strong financial profile and maintain financial discipline, despite the acquisition-oriented business model of IAG, is key not only to its positive rating momentum but also to rating it on a standalone basis. The Positive Outlook also assumes the cash pension payments to be set by the 2015 valuation to remain in line with our current expectations.
Aer Lingus' Acquisition Credit Neutral
We expect the acquisition of Irish Aer Lingus by IAG to have a neutral financial impact, excluding synergies, on BA as its credit metrics are strong enough to absorb any financial implications of this acquisition. BA's current exposure to the acquisition funding is limited to a EUR400m five-year loan it provided to AERL Holding Limited, IAG's subsidiary, which made the acquisition. However, IAG will have to rely on cash flows generated from dividend payments from its operating companies to repay its loans. Although IAG's dividend policy will apply to all its subsidiary airlines, BA is by far the largest and most profitable airline in the group and will be the key contributor to the dividends flow to IAG.
Extensively Diversified Route Network
BA's strong business profile is underpinned by scale and diversity of its route network with over 400 destinations worldwide (including joint business agreements and code share agreements), its strong presence on key profitable routes (primarily North America) as well as the company's position as the third-largest European airline based on revenue passenger-kilometres (RPK) and the UK's largest international airline. BA falls only behind Air France-KLM and Lufthansa based on RPK among its European peers.
North American Market is Key
One of the competitive advantages of BA is its significant and growing transatlantic network, which is a key contributor to the company's cash flow generation. BA is well placed to capitalise on the UK's strong cultural and financial ties to the US to withstand the competition on this lucrative market. While the intensification of competition on the North American market may put pressure on the yields, it is unlikely to significantly impair BA's position, since its strong presence on this destination is underpinned by NY-London status as world financial centres. The Atlantic Joint Business (AJB) agreement with American Airlines should also support BA's positioning in this region. The share of the AJB in the North Atlantic seat capacity rose to 26% in 2014 from 22% in 2013, surpassing the share of the transatlantic joint venture between Air France-KLM, Delta and Alitalia, which is approaching 25%.
Leading Position in a Global Hub
BA's strong hub position at Heathrow is key to its competitiveness and successful implementation of long-haul strategy. Around 90 airlines operate at Heathrow, which is the largest airport in Europe and the fourth-largest in the world in terms of passenger traffic for the 12 months ending April 2015. BA's exclusive occupancy of Terminal 5 in 2008 provided it with more flexibility for daily operations and planning and resulted in more efficient operational performance. By mid-October 2015, BA had shifted its operations into two terminals - Terminal 3, which is the main Heathrow base for oneworld alliance where BA is a member, and its flagship Terminal 5. The company expects the consolidation to two terminals to improve efficiencies and aircraft utilisation.
Better Managed Costs Than Peers
BA has significantly improved its cost structure and tackled the legacy issues ahead of other European network carriers, establishing a platform for profitable growth. As a result, the company has been leading its European peers on cost metrics. Its unit costs (CASK) are much lower than those of Air France-KLM or Lufthansa. It still has a weaker cost position compared to emerging market carriers (eg Aeroflot or Turkish Airlines) but its unit revenue (PRASK) is higher supporting its profitability.
High Cash Pension Payments
BA is subject to significant cash pension payments in line with the UK funded defined benefit pension schemes. The deficit payment plans are agreed with the trustee of each pension scheme every three years based on the actuarial valuation. We account for cash pension payments as part of FFO calculation in the cash flow projections. Therefore, the pension-related cash payments have a direct impact on the company's FFO-based leverage.
Rating on a Standalone Basis
In accordance with our Parent and Subsidiary Rating Linkage methodology, Fitch rates BA, wholly-owned by IAG, on a standalone basis as we assess the legal and operational ties between IAG and BA as moderate. This reflects IAG's principle for standalone management of its operating entities. In BA's financing, there are no cross-default provisions to other IAG-owned entities. There are no cross guarantees among the entities in IAG and no centralised treasury with independent debt management at subsidiary airlines. In addition, BA has an independent board of directors.
Fitch's key assumptions within the rating case for BA include:
- Oil price of USD55/bbl for 2015, USD60/bbl for 2016 and USD70/bbl thereafter
- RPK growth at about 2% CAGR over 2015-2019
-Dividends of 25% of net income as well as additional distributions to IAG to help it repay acquisition loans
-Capex in line with the company's guidance
-Yields decline in 2015-2016
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
-Sustained FFO gross adjusted leverage trending towards 2.5x and below and FFO fixed charge cover above 5x.
-EBIT margin above 10%, positive free cash flow.
-Disciplined financial and dividend policy.
-Adherence to the standalone principle by IAG in regard to the financial management of its operating entities.
Negative: The Outlook is Positive and Fitch therefore does not anticipate events leading to a downgrade. Future developments that may nonetheless, individually or collectively, lead to negative rating action include:
-Intensive capex, generous dividend payments or rise in fuel costs resulting in negative free cash flow through the cycle and credit metrics' deterioration.
-FFO gross adjusted leverage above 3.5x and FFO fixed charge cover below 4x on a sustained basis.
-Tighter links with IAG Group (for example, cross guarantees or fully integrated balance sheet).
BA has a good liquidity position. Its cash position of GBP2.5bn at end-2014 along with a revolving credit facility of GBP1.1bn due 2022 and committed undrawn credit lines of GBP1.5bn (as of 30 September 2015) are more than sufficient to cover the company's maturities of GBP428m in 2015 and GBP746m in 2016. The debt maturity profile is well balanced with a manageable spike in 2016 due to GBP250m bonds maturity. Assuming a 25% dividend playout ratio, we expect BA to generate positive free cash flow on average over 2015-2019.
FX and Fuel Price Hedging
BA is exposed to currency risk as about half of its revenue is generated in GBP whereas about half of its debt is in USD and only over a quarter of total debt is in GBP. Fuel payments and capex are mostly USD-denominated. The company uses forward contracts and currency options as part of FX hedging.
BA also implements a fuel hedging policy to address fuel price volatility. Fuel hedging is carried out with no collateralisation or margin call requirements. The company uses swaps and collars. As 88% of BA's fuel consumption was hedged in 1Q15 declining to 59% in 4Q15, the drop in oil prices will start having a more pronounced impact from 2016.
British Airways 2013-1 Certificates
Fitch will review the ratings for British Airways Pass Through Trusts Series 2013-1 Class A and B Certificates within the next few days.