The rating is supported by ALK's low leverage, solid financial flexibility, and strong operating margins. Healthy cash balances, a sizeable base of unencumbered assets, and the ability to generate free cash flow support ALK's ability to meet its financial commitments.
Expected performance through a downturn or a period of competitive pressure is also an important factor in the rating. Fitch believes that ALK is much better positioned to operate through future downturns while maintaining adequate credit protection than it was in the past. Fitch's expectations are based on the significant improvements in ALK's balance sheet and cost structure as well as the broadening of the airline's route network since the last recession. Fitch believes that ALK's margins, cash generation and liquidity provide significant downside protection.
ALK's rating is also supported by its leading market share in the
Fitch currently has a positive fundamental view of the
Fitch's primary concerns center on the intensifying competitive environment in ALK's key market of
Other concerns include increasing cash returns to shareholders, ALK's small size and geographic concentration compared to its competitors, and the cyclicality and exposure to exogenous shocks that are typical of the airline industry.
Key Rating Drivers:
ALK has made significant strides to improve its cost structure over the past decade. The company now operates with a unit cost advantage compared to the large network carriers.
Fitch expects ALK's unit costs in 2014 to be roughly flat with the year prior with increased IT costs representing the primary headwind. Longer-term, Fitch expects unit costs to continue to decline incrementally as new fuel efficient 737-900ERs replace ALK's older 737-400s. Other initiatives such as reconfiguring the existing narrowbody fleet with slimline seats and densifying cabin layouts are also likely to push unit costs lower.
Fitch considers ALK's low cost structure to be a competitive advantage over its larger network rivals, allowing the company to compete head-to-head by offering low fares, while still maintaining adequate operating margins.
High Operating Margins:
ALK has generated EBITDAR margins in the low to mid 20% range for the past five years, which stands well above most of its North American peers. ALK operates as a full service carrier, maintaining a first class cabin on its mainline fleet and generating a fair amount of business travel, allowing it to generate unit revenues close to those generated by the network carriers, but with a significantly lower cost structure.
Competition with Delta/Geographic Concentration:
Competing with Delta is likely to be challenging due to the size difference of the two airlines. For comparison, the
Fitch expects ALK will be able to weather the increase in competition without a material impact to its credit profile. Fitch believes that ALK's low cost structure, greater frequencies to key markets out of
Significant Financial Flexibility:
ALK ended the first quarter of 2014 with a cash and equivalents balance of
Upcoming debt maturities are also manageable, averaging around
Fitch considers ALK's sizeable base of unencumbered assets to be a key consideration supporting its financial flexibility. ALK has paid for all of its new aircraft deliveries over the past several years with cash, which sets the company apart from much of its peer group. As a result, ALK now has 66 aircraft that are fully unencumbered by debt, mostly consisting of newer delivery 737-800s and 737-900ERs. Fitch considers these to be high quality assets that could be leveraged to raise cash even in a difficult or unfavorable debt market.
Positive Free Cash Flow:
Fitch expects ALK to continue generating positive FCF for the foreseeable future.
ALK produced positive FCF in 2013 despite the initiation of a dividend. Although Fitch expects the company to steadily increase the dividend going forward (depending on operating performance), dividend payments are not expected to materially impact FCF. Cash flows are also supported by the fully funded pensions, which will translate to lower cash contributions in the future. ALK also has a sizeable share repurchase program in place, which it can pull back on should cash flows deteriorate.
Modest Debt Levels, Solid Credit Metrics:
Total on balance sheet debt as of
Importantly, ALK's improved balance sheet leaves it in a much better position to weather future industry downturns. Its adjusted leverage was higher than 5x heading in to 2008 and spiked above 7.5x when fuel prices were at their highest. Improvements in ALK's balance sheet make it unlikely that credit metrics would degrade to that degree when the industry faces another downturn.
Performance in a Stress Scenario:
Fitch's rating for ALK incorporates expectations that the company will be able to maintain its 'BBB-' rating in a temporary stress scenario. It is notable among the North American airlines that ALK managed through both the 2001-2003 and 2008-2009 downturns without filing for bankruptcy protection. Credit metrics did suffer during the most recent recession, with adjusted leverage spiking above 7x and free cash flow turning sharply negative in 2007 and 2008 (though this was partially due to heavy aircraft deliveries at the time).
However, ALK was proactive in reducing costs, cutting its head count sharply, and in reallocating capacity to more profitable markets. As a result, its performance rebounded sharply in 2009. The company has had a solid operating history since that time, producing consistently positive results.
Fully Funded Pension:
As of year-end 2013 ALK's defined benefit plans were slightly overfunded, compared to an underfunded position of
Returning Cash to Shareholders:
ALK's focus on increasing returns to shareholders represents a concern, though Fitch expects the company to manage dividends and share repurchases within the limits of its internal cash generation. ALK initiated a dividend in July of 2013 at
ALK also recently announced its largest ever share repurchase authorization (
Future actions that may individually or collectively cause Fitch to take a negative rating action include:
--Increasing competitive pressure causing EBITDAR margins to fall and remain below 20%;
--Gross adjusted leverage rising and remaining above 3.0x (FFO adjusted leverage above 3.3x);
--Significant loss of market share in ALK's key city of
--Persistently negative free cash flow;
--Liquidity (including revolver availability) falling to 15% of LTM revenue or lower;
--The rating could also be negatively impacted if ALK were to merge with or be acquired by a lower rated airline.
Fitch does not expect to take a positive rating action in the foreseeable future. Fitch views ALK's credit profile as somewhat constrained at its current level due to its geographic concentration in the
Additional information is available at 'www.fitchratings.com'
--'Corporate Rating Methodology' (
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage
Source: Fitch Ratings
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