Fitch Upgrades AMR & American Airlines' IDRs to 'B-'; Outlook Stable
Fitch Ratings has upgraded the debt ratings of AMR Corp. and its principal operating subsidiary American Airlines, Inc. as follows:
AMR
--Issuer Default Rating (IDR) to 'B-' from 'CCC';
--Senior Unsecured Debt to 'CCC'/RR6' from 'CC'/RR6'.
American Airlines
--Issuer Default Rating (IDR) to 'B-' from 'CCC';
--Secured Bank Credit Facility to 'BB-/RR1' from 'B'/RR1'.
The Rating Outlook for both AMR and American is Stable.
The upgrade reflects recent progress made by AMR in its effort to de-lever a badly-damaged balance sheet, as well as improved free cash flow generation prospects moving into 2007. In addition, the carrier's liquidity position has been bolstered in 2006 as a result of better operating results, a pull-back in growth-related capital spending and the issuance of $400 million in new equity. AMR ended the September quarter with total cash and short-term investments of $5.5 billion, of which $464 million was restricted. This compares with total cash and short-term investments of $4.3 billion at year-end (YE) 2005.
In light of AMR's strengthened cash position, Fitch believes that the risk of a near-term liquidity crisis -- even in the event of a heavy demand and/or fuel price shock -- has been reduced dramatically. While recognizing the diminished risk of liquidity pressures, the 'B-' IDR captures the high degree of financial risk linked to AMR's very heavy debt and lease loads, substantial near-term cash obligations, as well as the U.S. airline industry's unique vulnerability to external shocks.
AMR management has repeatedly signaled its intention to focus on balance sheet repair as a core objective in the airline's long-term strategic turnaround plan. Significant progress toward debt reduction is likely to be made through the remainder of this year and into 2007 if operating trends remain strong. AMR is on track to fund $1.2 billion of scheduled debt maturities this year, and another $1.4 billion in maturities can be met comfortably in 2007 even if operating margins come under modest pressure next year. With little growth in consolidated available seat mile (ASM) capacity expected during 2007, capital spending should remain quite low by historical standards. This, in turn, should allow AMR to fund scheduled debt payments and required pension contributions next year without eroding its improved liquidity position substantially. AMR has re-purchased $128 million of debt securities above and beyond scheduled maturities so far in 2006, and management has indicated that additional re-purchases of this kind could continue in the future.
High and volatile jet fuel prices continue to represent a significant risk factor for AMR. Prior to September, extreme cost pressure was being felt as a result of spikes in jet fuel prices. The 20% pull-back in crude oil and refined product prices over the past two months provides additional support for margin improvement moving into 2007. With fuel accounting for 32% of total operating expenses in the third quarter, the impact of a steep drop in fuel costs will be felt immediately. AMR now forecasts fourth quarter jet fuel prices of $1.85 per gallon, compared with an actual price paid of $2.16 per gallon in the third quarter. Approximately 33% of 2006 fuel consumption has been hedged at average crude oil prices of $66 per barrel. A $1 per barrel change in the price of crude oil translates into approximately $80 million of consolidated cash flow for AMR.
Over the last year, more restrained industry capacity growth and robust air travel demand patterns have combined to drive a passenger unit revenue recovery for U.S. airlines, and AMR has benefited accordingly. Third quarter revenue per available seat mile (RASM) performance remained strong in spite of some weakness in bookings in response to the increased security measures announced on Aug. 10. Third quarter mainline RASM increased by 7.7% on a capacity decrease of 2.4%. Management noted on Oct. 18 that fourth quarter bookings are up modestly year over year. AMR's cautious approach to capacity management in light of high fuel prices should support 2007 unit revenue trends, provided global economic growth remains relatively strong. Fitch believes that the small number of anticipated 2007 aircraft deliveries for U.S. airlines has set the stage for continued industry capacity discipline next year.
The passage of pension funding reform legislation by Congress in August represented an important step forward for AMR in managing the level of future cash contributions to its under-funded defined benefit pension plans. Special provisions for airlines in the bill will allow AMR to meet its under-funded liability over a ten-year period. This removes the risk of sharply higher required cash contributions (in excess of $1 billion for 2007) under the old funding rules. Although AMR faces an additional pension funding burden relative to United and US Airways (both of which have terminated their defined benefit plans through Chapter 11), the new funding rules should make it possible for AMR to avoid the need to seek a freeze or any other substantial plan modifications. As of YE 2005, AMR's defined benefit plans were under-funded by $3.2 billion on a projected benefit obligation (PBO) basis. Cash pension contributions for 2006 totaled $233 million through Oct. 18, and the company now expects 2007 cash funding to total approximately $360 million.
The resolution of the pension issue should improve prospects for continued labor-management collaboration on productivity initiatives as the carrier moves closer to the 2008 amendable dates for all of its contracts with unionized employees. Efforts to boost productivity through process improvement throughout the airline have been critical in AMR's effort to drive non-fuel unit costs lower. Future progress in this regard will be essential if AMR is to narrow labor cost gaps with low-cost carriers and the two legacy carriers (Delta and Northwest) currently restructuring under Chapter 11 protection.
Fitch's Recovery Ratings (RR), introduced in 2005, are a relative indicator of creditor recovery on a given obligation in the event of a default. A broad overview of Fitch's RR methodology as it relates to specific sectors, including a Case Study webcast, can be found at www.fitchratings.com/recovery.
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