*NEW* Financial Ratings
New perspective on airline ratings.
(Please click here to see relevant tables.)
Michael Duff reveals how his newly launched airline ratings on The Airline Analyst compare with those of the ratings agencies.
With liquidity issues continuing to constrain long-term lending by banks and the new aircraft sector understanding pricing about to increase the cost of export credits, many commentators are predicting that 2013 will finally be the year of the capital markets for airlines outside of the US.
Among the reasons cited by airlines to explain their historic reluctance to tap the capital markets (though cheap export credit and bank loans might have been the real reasons) has been the requirement of obtaining a rating. They do not want to lose control of their credit standing and they do not want to submit to the due diligence and disclosure necessary to obtain a rating. There has also been a perception that the rating outcome was too unpredictable and not transparent enough.
The rated universe of airlines is only 16 strong (including AMR), nine of them from North America. Will airlines finally undergo this process and what ratings might they expect?
To help answer these questions, and in response to requests from clients, The Airline Analyst (TAA) has developed and will launch at the 15th Annual Airfinance Conference Dublin on January 23, its TAA Financial Ratings service covering airlines followed by The Airline Analyst. The TAA Financial Ratings universe totals about 120 passenger airlines, and will increase as we add cargo and charter carriers.
Our goals in developing this service are to:
* develop a transparent no-black-box methodology that could produce comparative ratings of the intrinsic financial strength of the world’s airlines;
* produce results that could be reconciled with the ratings agencies, so that they can be used to help predict baseline credit ratings;
* be able to apply the methodology equally to all airlines; and
* use the most up-to-date information available for each airline, so that financial ratings always incorporate recent financial results and trends.
TAA Financial Ratings are based on a single numerical score assessing five factors - similar to those of the ratings agencies: average fleet age, operating margin, coverage, liquidity and leverage. The single numeric score is then mapped to ratings from AAA to CC. Credit ratings, of course, also take other factors into consideration, such as application of a sovereign ceiling, business risk profile, strategy, management, labour relations, pension deficits, diversity of revenues, size and government support. Some divergences can, therefore, be expected from the TAA Financial Ratings.
The TAA Financial Ratings incorporate the most recent latest 12-month (LTM) data and, accordingly, are likely to be more volatile than public ratings, which the agencies often appear reluctant to change. A consequence of this is that TAA Financial Ratings may prove a leading indicator of rating actions by the ratings agencies.
In addition to LTM data, we provide data and ratings for the two previous 12-month periods (LTM-1 and LTM-2). This has the advantage of revealing trends in ratings over the three most recent periods.
To validate the TAA Financial Ratings methodology we have analysed our results and compared them with those of the 16 airlines covered by the ratings agencies. For 10 of these airlines, the TAA Financial Ratings were within zero and two notches of the existing public ratings. (see Table 1)
As expected, there are also some outliers. Three are the smaller US airlines - jetBlue (four notches higher), Allegiant (seven notches) and Alaska Airlines (six notches). Allegiant and Alaska have strong credit metrics but are publicly rated at the BB- level. We attribute these variances to adjustment by the ratings agencies for perceived business risk. Their relatively small size compared with the US majors and niche markets focus are likely to be factors behind the differences.
Among the comments from the ratings agencies about Alaska was S&P's: "A relatively small participant in the cyclical and price-competitive US airline industry." Though it did also acknowledge in July 2012: "Our expectation that... recent strong cash-flow generation and debt reduction will continue, resulting in improved credit metrics." This would suggest an upgrade is quite likely in 2013.
Our rating was also noticeably higher for Delta (DAL), for which we are two and three notches higher. Again, this can be reconciled. Fitch said in June 2012: "Some of DAL's operating and credit metrics are currently suggestive of a BB rating but the improvement in its credit profile is fairly recent." The TAA Financial Ratings already incorporates this improvement.
Among the non-North American airlines, Gol is the only significant outlier. Our rating of CCC- is lower than its B+/B3/B- public ratings as a result of the recent decline in three of the four financial metrics assessed by TAA Financial Ratings, the exception being the carrier's still strong liquidity.
Moody’s acknowledged the decline in April 2012 when it observed: "The stable outlook reflects the company's strong liquidity, manageable debt maturities over the next three years, the positive impact from the pending acquisition of WebJet and the expectation that the domestic industry will appropriately manage capacity to sustain growth in yields."
However, Moody’s added: "We expect earnings and cash flows to remain under pressure in the near term, which will limit the deleveraging process and operating margins recovery."
Our ratings for Air New Zealand and SAS are one or two notches lower than their public ratings, which again can be reconciled because the ratings agencies acknowledge having incorporated implicit government support in their ratings.
For the TAA universe as a whole, the distribution of ratings is as shown in the chart. As would be expected, the ratings are heavily skewed towards the weaker ratings, with a median rating of B. The top-rated airlines are Ryanair and Jazeera Airways at AA-, followed by Copa, Skymark and Japan Airlines at A+.
The next group, at A, includes Air Arabia, Allegiant, Aer Lingus and Singapore Airlines. AirAsia, Alaska Airlines, WestJet and Luxair make the list at A-. An additional 11 airlines make the investment-grade cut-off of BBB- or above, including All Nippon, easyJet, Cebu Pacific and Turkish Airlines. Notable airlines rated just below the BBB- level based on most recent LTM data include Qantas, British Airways, Emirates and Cathay Pacific. Among the Chinese majors, Air China scored highest at BB, with China Southern and China Eastern following at BB- and B+, respectively.
Of the 111 airlines whose ratings are available for the three most recent LTM periods, 35 showed improvement in their TAA Financial Ratings, 57 showed deterioration and 19 were unchanged. This points to a weakening of the overall credit strength of the global airline industry because airlines faced weak economic conditions, high fuel prices and poor cargo demand. The median rating declined from B+ to B over the period.
A clear lead for most improved TAA Financial Ratings over the three most recent LTM periods is Jazeera Airways. It is followed by Skymark, Spirit, KLM, Asiana, Alitalia and Aer Lingus. The number of full grades improvement is shown in Table 2. Table 3 shows the underlying ratios for Jazeera behind this improvement.
The surprise candidate for greatest deterioration in an airline?s financial rating was Indigo, closely followed by PAL Holdings, Tiger Airways, SpiceJet and South African Airways (see Table 4). Of the existing rated universe, Gol was the biggest faller. Indigo's rating declined as a result of the difficult market conditions in India, which led to deterioration in all four of the ratios we assessed (see Table 5).
Greatest likelihood of upgrade by ratings agencies
Based on the largest positive differences between the TAA Financial Ratings and the existing public ratings, the most obvious candidates for upgrade are Alaska Airlines and Delta Air Lines.
Greatest likelihood of downgrade by ratings agencies
Conversely, the negative differences between the ratings suggest that Gol is the most vulnerable to a downgrade in its existing public ratings, followed by Qantas.
The weakest ratings
Forty-one airlines are rated CCC+ or worse by TAA Financial Ratings, of which 24 are rated CC. The characteristics of these airlines, which include notables such as Flybe, Royal Jordanian, Air Malta, Air France, Air Berlin, South African Airways and Transaero Airlines, are weak operating margins, coverage at or below 1x, variable liquidity and high leverage. Some are in the midst of, or facing, restructuring and government bailouts, and others are likely to follow.
The complete data set
Subscribe to the TAA Financial Ratings service to see the full list of ratings and the detailed methodology. TAA Financial Ratings will be updated four times a year based on the rolling latest 12-month data. The ratings will, therefore, always reflect an airline?s latest financials and trends.
Please contact Harry Sakhrani at firstname.lastname@example.org or call +852 2842 6975 for more information about how to subscribe to The Airline Analyst and TAA Financial Ratings.
Data sources: The Airline Analyst (for financial information) and ATDB.aero (for average fleet age)