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Fitch Affirms Delta Following Northwest Merger Announcement; Outlook to Negative
2:44 PM EDT April 15, 2008
CHICAGO--(BUSINESS WIRE)--
Fitch Ratings has affirmed the debt ratings of Delta Air Lines, Inc. (NYSE: DAL) following today's announcement that Delta has agreed to merge with Northwest Airlines Corp. (NYSE: NWA), subject to approval by the two airlines' shareholders and the U.S. Department of Justice (DOJ). Delta's ratings were affirmed as follows:
--Issuer Default Rating (IDR) at 'B'; --First-lien senior secured credit facilities at 'BB/RR1'; --Second-lien secured credit facility (Term Loan B) at 'B/RR4'. The issue ratings apply to $2.5 billion of committed credit facilities. The Rating Outlook for Delta has been revised to Negative from Stable.
The affirmation reflects Fitch's view that the proposed transaction is likely to drive a combined post-merger credit profile that is similar to that of a stand-alone Delta. However, a successful completion of the merger is by no means a certainty in light of potential opposition from organized labor and Congress. This uncertainty, together with potential concerns raised by the DOJ in a lengthy antitrust review, increases execution risk and diverts management attention at a time of increasing stress in the U.S. airline operating environment. The Negative Outlook reflects Fitch's opinion that extreme fuel cost pressure and slower unit revenue growth rates in a U.S. recession will materially weaken Delta's credit profile over the next year-whether or not the Delta-Northwest merger is ultimately closed.
The merged carrier will face substantial fixed financing obligations over the next several years in an industry operating environment that will remain difficult as the U.S. economy heads into recession. However, should the merger receive regulatory approval, the Delta-Northwest combination would likely drive some material revenue synergies related primarily to fleet optimization and greater revenue per available seat mile (RASM) premiums linked to the creation of a broadly diversified and deep global route network. Notably, the realization of full revenue synergies would not be complete until 2012 as fleet and schedule optimization benefits are pursued largely in the absence of broad-based available seat mile (ASM) capacity reduction.
Importantly, Delta management noted on this morning's investor call that no hub closures are contemplated in connection with the merger, raising the question of how much domestic capacity could actually be removed post-closing. Delta and Northwest have each announced plans to pull back 2008 domestic capacity (10% reduction at Delta and 5% at Northwest) in response to accelerating jet fuel cost pressure since the start of the year. If no significant domestic capacity rationalization is envisioned beyond 2008, it may be very difficult for the combined Delta-Northwest to drive the type of RASM improvements necessary to offset intensifying fuel cost pressure.
No material pull-backs in energy prices are assumed by Delta management in its merger plan. This fact, together with Delta's revenue synergy target ($700 million run rate) would appear to limit any opportunities to drive substantially positive free cash flow beyond 2008. With large numbers of firm aircraft deliveries keeping capital spending high, and with significant scheduled debt maturities at both carriers, an extended industry downturn could drive combined Delta-Northwest operating losses and negative free cash flow in 2009. This in turn could force the merged carrier to seek new sources of capital next year if current combined liquidity levels (approximately $7 billion) are to be maintained. Given the currently constrained nature of debt capital markets, there is little certainty about the availability of external capital post-closing.
On the cost side, increasing pay rates linked to the tentative agreement with Delta pilots (and other labor deals likely to follow) will pressure non-fuel unit operating costs. Delta management, however, does see an opportunity to realize $300 million to $400 million in cost synergies net of new labor contract changes. Savings linked to the elimination of redundant operations appear to be broadly attainable. Still these savings could be offset in large part by higher unit labor rates and productivity penalties if integrated contracts (particularly for the pilots) are not finalized at the time of the merger. Delta has identified as much as $1 billion of cash merger transition costs, which will likely be front-loaded in the 2008-2009 time period. If a quick agreement with Northwest pilots is to be reached, moreover, labor cost pressures could increase beyond planned levels.
The current 'B' IDR for a stand-alone Delta reflects the high levels of debt that remain on Delta's balance sheet even after the Chapter 11 restructuring, reduced but still heavy cash obligations over the next several years and the company's exposure to demand and fuel price shocks in an industry that remains highly vulnerable to changes in the macroeconomic environment. With domestic unit revenue growth expected to slow throughout 2008 and jet fuel prices at record levels, intense margin pressure will persist. The airline's March plan to cut domestic capacity and 2,000 jobs this year is unlikely to offset the heavy cost pressure linked to $110-plus per barrel crude oil in 2008. With some weakeninng of air travel demand and RASM trends likely to appear by summer, therefore, Fitch expects full year 2008 cash flow and liquidity results to fall well short of bankruptcy exit plan assumptions for the stand-alone Delta.
Delta's post-reorganization capital structure was streamlined as a result of pre-petition debt and lease rejection in Chapter 11. Recovery expectations for the first-lien revolver and term loan are superior to those of the second lien term loan. Recovery expectations for first-lien lenders are excellent, reflecting a deep collateral pool consisting of aircraft, engines, spare parts and other assets, as well as a tight covenant package protecting lenders via fixed charge coverage, minimum liquidity and collateral coverage tests. Taking into account the credit facilities, aircraft-backed EETC obligations and private mortgage agreements, Delta has virtually no unencumbered assets remaining to support additional borrowing if liquidity conditions tighten further.
Secured financing for firm aircraft deliveries (including Boeing 777-200s, Boeing 737 NGs and CRJ-900 regional jets) will need to be secured if Delta's international growth strategy and fleet overhaul are to be completed. Similarly, on the Northwest side, future mainline and regional jet deliveries must be financed, since aircraft capital spending won't be funded from operating cash flow in either a stand-alone or post-merger case.
A downgrade to 'B-' for the IDR could follow later in the year if operating trends in the industry continue to worsen in response to rising jet fuel costs and a fragile demand environment. With respect to the merger transition process, Fitch will remain focused primarily on the risks related to labor opposition at Northwest, where ALPA-represented pilots have made it clear that a quick intergration of pilot contracts is not likely. Labor opposition at Northwest, if prolonged, could complicate the task of realizing full merger synergies if the deal gains necessary regulatory approvals.
Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, www.fitchratings.com. Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site. The ratings above have been initiated by Fitch as a service to investors. The issuer did not participate in the rating process other than through the medium of its public disclosure.
Source: Fitch Ratings
2:44 PM EDT April 15, 2008
CHICAGO--(BUSINESS WIRE)--
Fitch Ratings has affirmed the debt ratings of Delta Air Lines, Inc. (NYSE: DAL) following today's announcement that Delta has agreed to merge with Northwest Airlines Corp. (NYSE: NWA), subject to approval by the two airlines' shareholders and the U.S. Department of Justice (DOJ). Delta's ratings were affirmed as follows:
--Issuer Default Rating (IDR) at 'B'; --First-lien senior secured credit facilities at 'BB/RR1'; --Second-lien secured credit facility (Term Loan B) at 'B/RR4'. The issue ratings apply to $2.5 billion of committed credit facilities. The Rating Outlook for Delta has been revised to Negative from Stable.
The affirmation reflects Fitch's view that the proposed transaction is likely to drive a combined post-merger credit profile that is similar to that of a stand-alone Delta. However, a successful completion of the merger is by no means a certainty in light of potential opposition from organized labor and Congress. This uncertainty, together with potential concerns raised by the DOJ in a lengthy antitrust review, increases execution risk and diverts management attention at a time of increasing stress in the U.S. airline operating environment. The Negative Outlook reflects Fitch's opinion that extreme fuel cost pressure and slower unit revenue growth rates in a U.S. recession will materially weaken Delta's credit profile over the next year-whether or not the Delta-Northwest merger is ultimately closed.
The merged carrier will face substantial fixed financing obligations over the next several years in an industry operating environment that will remain difficult as the U.S. economy heads into recession. However, should the merger receive regulatory approval, the Delta-Northwest combination would likely drive some material revenue synergies related primarily to fleet optimization and greater revenue per available seat mile (RASM) premiums linked to the creation of a broadly diversified and deep global route network. Notably, the realization of full revenue synergies would not be complete until 2012 as fleet and schedule optimization benefits are pursued largely in the absence of broad-based available seat mile (ASM) capacity reduction.
Importantly, Delta management noted on this morning's investor call that no hub closures are contemplated in connection with the merger, raising the question of how much domestic capacity could actually be removed post-closing. Delta and Northwest have each announced plans to pull back 2008 domestic capacity (10% reduction at Delta and 5% at Northwest) in response to accelerating jet fuel cost pressure since the start of the year. If no significant domestic capacity rationalization is envisioned beyond 2008, it may be very difficult for the combined Delta-Northwest to drive the type of RASM improvements necessary to offset intensifying fuel cost pressure.
No material pull-backs in energy prices are assumed by Delta management in its merger plan. This fact, together with Delta's revenue synergy target ($700 million run rate) would appear to limit any opportunities to drive substantially positive free cash flow beyond 2008. With large numbers of firm aircraft deliveries keeping capital spending high, and with significant scheduled debt maturities at both carriers, an extended industry downturn could drive combined Delta-Northwest operating losses and negative free cash flow in 2009. This in turn could force the merged carrier to seek new sources of capital next year if current combined liquidity levels (approximately $7 billion) are to be maintained. Given the currently constrained nature of debt capital markets, there is little certainty about the availability of external capital post-closing.
On the cost side, increasing pay rates linked to the tentative agreement with Delta pilots (and other labor deals likely to follow) will pressure non-fuel unit operating costs. Delta management, however, does see an opportunity to realize $300 million to $400 million in cost synergies net of new labor contract changes. Savings linked to the elimination of redundant operations appear to be broadly attainable. Still these savings could be offset in large part by higher unit labor rates and productivity penalties if integrated contracts (particularly for the pilots) are not finalized at the time of the merger. Delta has identified as much as $1 billion of cash merger transition costs, which will likely be front-loaded in the 2008-2009 time period. If a quick agreement with Northwest pilots is to be reached, moreover, labor cost pressures could increase beyond planned levels.
The current 'B' IDR for a stand-alone Delta reflects the high levels of debt that remain on Delta's balance sheet even after the Chapter 11 restructuring, reduced but still heavy cash obligations over the next several years and the company's exposure to demand and fuel price shocks in an industry that remains highly vulnerable to changes in the macroeconomic environment. With domestic unit revenue growth expected to slow throughout 2008 and jet fuel prices at record levels, intense margin pressure will persist. The airline's March plan to cut domestic capacity and 2,000 jobs this year is unlikely to offset the heavy cost pressure linked to $110-plus per barrel crude oil in 2008. With some weakeninng of air travel demand and RASM trends likely to appear by summer, therefore, Fitch expects full year 2008 cash flow and liquidity results to fall well short of bankruptcy exit plan assumptions for the stand-alone Delta.
Delta's post-reorganization capital structure was streamlined as a result of pre-petition debt and lease rejection in Chapter 11. Recovery expectations for the first-lien revolver and term loan are superior to those of the second lien term loan. Recovery expectations for first-lien lenders are excellent, reflecting a deep collateral pool consisting of aircraft, engines, spare parts and other assets, as well as a tight covenant package protecting lenders via fixed charge coverage, minimum liquidity and collateral coverage tests. Taking into account the credit facilities, aircraft-backed EETC obligations and private mortgage agreements, Delta has virtually no unencumbered assets remaining to support additional borrowing if liquidity conditions tighten further.
Secured financing for firm aircraft deliveries (including Boeing 777-200s, Boeing 737 NGs and CRJ-900 regional jets) will need to be secured if Delta's international growth strategy and fleet overhaul are to be completed. Similarly, on the Northwest side, future mainline and regional jet deliveries must be financed, since aircraft capital spending won't be funded from operating cash flow in either a stand-alone or post-merger case.
A downgrade to 'B-' for the IDR could follow later in the year if operating trends in the industry continue to worsen in response to rising jet fuel costs and a fragile demand environment. With respect to the merger transition process, Fitch will remain focused primarily on the risks related to labor opposition at Northwest, where ALPA-represented pilots have made it clear that a quick intergration of pilot contracts is not likely. Labor opposition at Northwest, if prolonged, could complicate the task of realizing full merger synergies if the deal gains necessary regulatory approvals.
Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, www.fitchratings.com. Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site. The ratings above have been initiated by Fitch as a service to investors. The issuer did not participate in the rating process other than through the medium of its public disclosure.
Source: Fitch Ratings
