Fitch Affirms Southwest Airlines at 'A'; Outlook Stable
CHICAGO--(BUSINESS WIRE)--Nov. 8, 2005--Fitch Ratings has affirmed the issuer default rating of 'A' for Southwest Airlines Co. (NYSE:LUV). Fitch has also affirmed Southwest's senior unsecured rating of 'A' and the $600 million unsecured credit facility rating of 'A'. Southwest's 'A' senior unsecured rating applies to approximately $1.3 billion of outstanding debt. The Rating Outlook for Southwest remains Stable.
Southwest's ratings reflect the low-fare carrier's proven capacity to deliver strong margins and sufficient levels of operating cash flow to meet high aircraft capital spending commitments without driving leverage significantly higher. During a period of unprecedented turmoil in the U.S. airline industry over the past four years, Southwest has remained profitable in every quarter, growing available seat mile (ASM) capacity, and maintaining strong market share as many of its legacy airline competitors restructured operations and reduced scheduled capacity. An excellent fuel hedging position remains a primary factor explaining the difference in operating performance between Southwest and the other low-cost carriers (e.g. JetBlue, AirTran, and reorganized US Airways). This competitive advantage will continue in 2006, when Southwest has over 70% of expected fuel purchases capped at an average crude oil price of $36 per barrel. This puts the airline in an excellent position to weather an extended high fuel price environment that will likely drive other industry structure changes during 2006. The carrier's fuel hedge coverage falls to over 55% of expected purchases at approximately $37 per barrel in 2007.
Given its strong credit profile and flexible fleet growth plans, Southwest remains the primary beneficiary of the financial collapse of the U.S. legacy carriers. The Chapter 11 filings of Delta and Northwest in September have launched a new round of schedule reductions that will ripple through domestic markets in 2006 and beyond. As the restructuring legacy carriers redeploy ASMs away from hyper-competitive domestic markets to higher yielding international routes, Southwest and the other domestically focused low-cost carriers are likely to realize disproportionate passenger yield and revenue per ASM improvements over the next several quarters. In a prolonged high fuel cost scenario, further domestic schedule cuts by legacy carriers should support an improving domestic supply-demand balance, allowing top-line growth to offset much of the unit cost pressure that would be experienced at Southwest in 2006. The airline's nonfuel cost per ASM levels are expected to remain under control over the next two years, assuming no major contract pay rate changes occur in a new pilot agreement. The pilot agreement becomes amendable in September 2006.
Southwest's operating model has been built upon a consistently competitive cost structure, with good asset utilization, and labor productivity at its core. As the restructured legacy carriers drive unit operating costs down to a level closer to that of Southwest, pressures to avoid labor cost creep will intensify over the next few years. Fitch believes that this represents the biggest longer-term threat to Southwest's financial profile as it seeks to exploit profitable growth opportunities at a time when very high energy costs and domestic overcapacity are putting pressure on operating margins. With ex-fuel cost per ASM still well below that of the restructured legacy carriers, Southwest remains in the best position to grow profitably in a robust air travel demand environment.
The carrier has announced plans to grow ASM capacity in the range of 8% during 2006, with new markets served from recently opened cities (Philadelphia, Pittsburgh, and Fort Myers). In addition, service will be launched at Denver in early 2006. Southwest is scheduled to take delivery of 33 new Boeing 737-700 jets in 2006 and a similar number likely will enter service in 2007 (27 firm orders now in place for that year). Large aircraft capital commitments are expected to consume most cash flow from operations. Still, Southwest continues to build its owned and unencumbered fleet -- totaling approximately 345 aircraft as of Sept. 30. As the size of the unencumbered fleet expands and other aircraft come off of lease, asset protection for unsecured noteholders continues to improve, and lease-adjusted leverage declines. The airline stands poised to delever somewhat over the next two years with the maturity of $614 million of aircraft-backed secured notes by November 2006.
In light of the substantial cash cushion on Southwest's balance sheet, the carrier is in a position to pay down the 2006 debt maturity while allowing cash balances to fall somewhat over the next few quarters. The large $2.6 billion cash and short-term investments balance at Sept. 30 reflects in part the inflow of cash collateral from fuel hedge counterparties that are required to post security on energy derivative contracts where Southwest is substantially in the money. The $865 million increase in accrued fuel hedge deposit liabilities for the first nine months of 2005 represents an anomalous source of operating cash flow that will likely be unwound as cash collateral postings stabilize or fall away over the next few quarters.
The roll-off of fuel hedge positions that begins next year raises the risk that a long-term increase in Southwest's unit costs will occur if no meaningful pull-back in energy prices takes place in the next few years. However, Southwest's strong credit profile and liquidity ensure that it will be well positioned to expand fuel hedge coverage out to the end of the decade in the event that spot and forward contract prices decline substantially.
Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, www.fitchratings.com
CHICAGO--(BUSINESS WIRE)--Nov. 8, 2005--Fitch Ratings has affirmed the issuer default rating of 'A' for Southwest Airlines Co. (NYSE:LUV). Fitch has also affirmed Southwest's senior unsecured rating of 'A' and the $600 million unsecured credit facility rating of 'A'. Southwest's 'A' senior unsecured rating applies to approximately $1.3 billion of outstanding debt. The Rating Outlook for Southwest remains Stable.
Southwest's ratings reflect the low-fare carrier's proven capacity to deliver strong margins and sufficient levels of operating cash flow to meet high aircraft capital spending commitments without driving leverage significantly higher. During a period of unprecedented turmoil in the U.S. airline industry over the past four years, Southwest has remained profitable in every quarter, growing available seat mile (ASM) capacity, and maintaining strong market share as many of its legacy airline competitors restructured operations and reduced scheduled capacity. An excellent fuel hedging position remains a primary factor explaining the difference in operating performance between Southwest and the other low-cost carriers (e.g. JetBlue, AirTran, and reorganized US Airways). This competitive advantage will continue in 2006, when Southwest has over 70% of expected fuel purchases capped at an average crude oil price of $36 per barrel. This puts the airline in an excellent position to weather an extended high fuel price environment that will likely drive other industry structure changes during 2006. The carrier's fuel hedge coverage falls to over 55% of expected purchases at approximately $37 per barrel in 2007.
Given its strong credit profile and flexible fleet growth plans, Southwest remains the primary beneficiary of the financial collapse of the U.S. legacy carriers. The Chapter 11 filings of Delta and Northwest in September have launched a new round of schedule reductions that will ripple through domestic markets in 2006 and beyond. As the restructuring legacy carriers redeploy ASMs away from hyper-competitive domestic markets to higher yielding international routes, Southwest and the other domestically focused low-cost carriers are likely to realize disproportionate passenger yield and revenue per ASM improvements over the next several quarters. In a prolonged high fuel cost scenario, further domestic schedule cuts by legacy carriers should support an improving domestic supply-demand balance, allowing top-line growth to offset much of the unit cost pressure that would be experienced at Southwest in 2006. The airline's nonfuel cost per ASM levels are expected to remain under control over the next two years, assuming no major contract pay rate changes occur in a new pilot agreement. The pilot agreement becomes amendable in September 2006.
Southwest's operating model has been built upon a consistently competitive cost structure, with good asset utilization, and labor productivity at its core. As the restructured legacy carriers drive unit operating costs down to a level closer to that of Southwest, pressures to avoid labor cost creep will intensify over the next few years. Fitch believes that this represents the biggest longer-term threat to Southwest's financial profile as it seeks to exploit profitable growth opportunities at a time when very high energy costs and domestic overcapacity are putting pressure on operating margins. With ex-fuel cost per ASM still well below that of the restructured legacy carriers, Southwest remains in the best position to grow profitably in a robust air travel demand environment.
The carrier has announced plans to grow ASM capacity in the range of 8% during 2006, with new markets served from recently opened cities (Philadelphia, Pittsburgh, and Fort Myers). In addition, service will be launched at Denver in early 2006. Southwest is scheduled to take delivery of 33 new Boeing 737-700 jets in 2006 and a similar number likely will enter service in 2007 (27 firm orders now in place for that year). Large aircraft capital commitments are expected to consume most cash flow from operations. Still, Southwest continues to build its owned and unencumbered fleet -- totaling approximately 345 aircraft as of Sept. 30. As the size of the unencumbered fleet expands and other aircraft come off of lease, asset protection for unsecured noteholders continues to improve, and lease-adjusted leverage declines. The airline stands poised to delever somewhat over the next two years with the maturity of $614 million of aircraft-backed secured notes by November 2006.
In light of the substantial cash cushion on Southwest's balance sheet, the carrier is in a position to pay down the 2006 debt maturity while allowing cash balances to fall somewhat over the next few quarters. The large $2.6 billion cash and short-term investments balance at Sept. 30 reflects in part the inflow of cash collateral from fuel hedge counterparties that are required to post security on energy derivative contracts where Southwest is substantially in the money. The $865 million increase in accrued fuel hedge deposit liabilities for the first nine months of 2005 represents an anomalous source of operating cash flow that will likely be unwound as cash collateral postings stabilize or fall away over the next few quarters.
The roll-off of fuel hedge positions that begins next year raises the risk that a long-term increase in Southwest's unit costs will occur if no meaningful pull-back in energy prices takes place in the next few years. However, Southwest's strong credit profile and liquidity ensure that it will be well positioned to expand fuel hedge coverage out to the end of the decade in the event that spot and forward contract prices decline substantially.
Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, www.fitchratings.com
