Capital Markets

Airline Credit Ratings Lose Altitude

Standard & Poor's drops American, United, and Northwest a notch apiece as heavy losses are expected to continue.
Stephen TaubJuly 25, 2008

On Friday Standard & Poor’s downgraded the debt ratings of three major U.S. airlines, citing expected losses and reduced cash flow caused by high fuel prices.

The credit-rating agency warned that the negative outlook reflects its concern that a potential continuation of heavy losses could erode liquidity at AMR and its subsidiary American Airlines Inc., UAL Corp. and its United Airlines Inc., and Northwest Airlines Corp. and its Northwest Airlines Inc.

The credit ratings of AMR and American were lowered to “B-” from “B.” The debt also was removed from CreditWatch, where it had been placed with negative implications on May 22. The outlook is now negative.

S&P expects AMR to report losses this year exceeding $2 billion before charges for asset write-downs and gains on sale of assets, because of very high and volatile fuel prices, credit analyst Philip Baggaley said in a report.

AMR reported a net loss of $1.45 billion (including $55 million of employee-severance costs and a $1.1 billion charge to write down the value of its MD80 and Embraer RJ-135 fleets) in the second quarter.

Although S&P acknowledges that American is accelerating fleet modernization to replace fuel-thirsty MD80s with new B737-800s, it warned that this will take a long time. “Ratings…reflect participation in the competitive, cyclical, and capital-intensive airline industry; a heavy debt and retiree obligation burden; and substantial capital spending needs to modernize the airline’s fleet,” S&P added.

S&P lowered its ratings on UAL and United to “B-” from “B.” As with American the debt was removed from CreditWatch, where it had been placed with negative implications May 22.

The rating agency said UAL currently has adequate near-term liquidity, with $2.9 billion of unrestricted cash and short-term investments at June 30, 2008, and subsequent actions that have raised significant added liquidity. “But we expect heavy losses,” added Baggaley, which he estimates could be well above $1 billion (not including charges for writing down the value of goodwill and other assets) this year. He expects further, albeit reduced, losses in 2009.

The analyst acknowledged that United, like its peers, is shrinking its domestic operations and grounding older aircraft to trim its losses. This, along with capacity reductions by other airlines, should improve the balance of supply and demand somewhat, particularly in the U.S. domestic market, allowing United to raise its fares further, he added.

“However, this effort will face headwinds in the form of a weak U.S. economy, and we do not expect that the higher fares will be sufficient to avoid a heavy loss this year and reduced, but still substantial, deficit in 2009 if fuel prices remain very high,” S&P warned.

S&P lowered its ratings on Northwest Airlines to “B” from “B+,” and removed the ratings from CreditWatch, where they had been placed with negative implications April 15. The outlook is negative.

Baggaley said he expects Northwest to report a loss this year, which could exceed $500 million before charges for goodwill and asset write-downs.

In April Northwest agreed to a merger with Delta Air Lines, which is expected to be completed by year-end.

Meanwhile, the price of oil has fallen about $20 in the past two weeks, and some Wall Street experts are saying they expect the decline to continue.