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.
Rating Concerns:
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.
KEY ASSUMPTIONS
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.
RATING SENSITIVITIES
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-'.
Date of Relevant Rating Committee: Oct. 29, 2015.
Additional information is available on www.fitchratings.com.
Additional Disclosures
Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=993305
Endorsement Policy
https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31
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