Fitch Ratings has affirmed Delta Air Lines' (Delta) ratings at 'BB+'. The Rating Outlook is Negative.
The Rating Outlook is largely driven by spiking jet fuel prices and potential knock-on macroeconomic effects. Higher input costs along with remaining uncertainties around the pace of business and international travel may make it difficult for Delta to bring leverage below its negative rating sensitivity in the next 1-2 years. The Negative Outlook also reflects continued risk that persistently high jet fuel costs may pressure cash flows and necessitate increased borrowing compared to prior forecasts.
Delta's 'BB+' rating is supported by rebounding passenger traffic, the company's pre-pandemic track record of generating solid free cash flows, better than average operating margins, and management commitment toward maintaining a strong balance sheet.
Fitch expects higher fuel costs to drive lower margins and cash flows in 2022 compared to prior expectations. The magnitude of the impact on credit will depend on how long crude oil prices remain volatile. Fitch expects the industry to adapt more easily to Brent prices in the $100-$120 range, particularly as pent-up demand gives the airlines pricing power. Fuel and airfare have historically maintained a positive correlation, and current average fares remain well below peak levels seen during prior periods of high oil prices.
However, the ability to offset higher costs may be limited if crude prices are sustained at or above levels seen in prior peaks, as higher ticket prices and potential macroeconomic effects reduce demand. In a scenario in which Brent crude prices rise and remain materially above $120/barrel Fitch would anticipate a potential multi-year lag in airline profit margins returning to pre-pandemic levels, pressuring credit profiles across the industry.
Fitch expects a continued improvement in passenger traffic in 2022 driven by pent up demand and progress towards COVID reaching an endemic stage. Fitch's base expectations are for North American traffic in 2022 to remain 20% below 2019 levels, though that estimate may prove conservative based on current TSA passenger counts and reports of strong booking activity for the summer travel season. Business travel remains more of an unknown, though with an increasing number of business returning to the office, Fitch expects a healthy uptick through the second half of the year.
Domestic and near-international leisure travel continue to show the most strength, providing US airlines with a relative advantage international competitor who are more reliant on international travel. Long-haul international remains the most impacted segment driven by patchwork travel restrictions. Fitch expects international to improve for the summer season as travel restrictions ease, particularly in the trans-Atlantic market.
Fitch's base case, which incorporates moderating crude oil prices in 2023, anticipates adjusted debt/EBITDAR remaining slightly above Fitch's negative rating sensitivity through 2023 and trending lower thereafter. A slower than expected rebound in air traffic combined with higher jet fuel prices and other inflationary pressures have driven forecasted metrics to remain modestly outside of prior expectations. Although leverage remains high, Delta's 'BB+' rating remains supported by management's commitment to reach a net debt balance of $15 billion by 2024 (from $20.6 billion at YE 2021) and to reach a leverage target of 2x-3x.
Delta's gross on-balance sheet debt stood at $27.1 billion at YE 2021, down from $35.1 billion at its peak in 2020. Delta is taking a more aggressive approach toward paying down debt, and reducing its high liquidity balance compared to peers. Fitch expects the company to pay for upcoming aircraft deliveries with cash and avoid refinancing upcoming maturities. Delta's approach has a mixed impact on the company's credit profile. Quickly reducing total debt balances will unencumber assets and reduce interest costs. However, Fitch views a healthy liquidity balance as important downside protection.
Fitch expects heavy capital spending to drive negative FCF in 2022. Recovering passenger traffic and moderating capital spending should allow FCF to turn positive in 2023, aiding the company's efforts to de-lever its balance sheet. Fitch expects FCF in the -$2.5-3.5 billion range in 2022 turning to +$1 billion-$2 billion next year, though our forecasts are sensitive to fuel prices. Cash generation this year remains limited by the ongoing recovery as we expect top line revenue to remain roughly 15% below 2019 levels. Delta expects capital spending to reach $6 billion this year as it catches up on aircraft deliveries that were deferred during the pandemic.
Delta's pension plans were 92% funded at YE 2021, and fully funded on a Pension Protection Act basis. Delta has no required contributions for 2022. Delta's underfunded pension plan had represented a material overhang in prior years and the improved funded status removes the drag on the company's cash flow.
Delta's 'BB+' rating remains higher than its two major network competitors, United (B+) and American (B-). The rating differential is driven in part by Fitch's expectations for Delta to maintain leverage metrics favourable to its peers in the years following the pandemic, along with its strong history of margin and FCF generation relative to its major competitors. Fitch also views Delta's financial flexibility as materially stronger than American's but similar to United's based on current liquidity and remaining unencumbered assets.