–Issuer Default Rating (IDR) was dropped to ‘CCC’ from ‘B-‘;
–Secured term loan rating was reduced to ‘B/RR1’ From ‘BB-/RR1’;
–Senior unsecured rating was reduced to ‘CC/RR6’ from ‘CCC/RR6’.
Fitch’s ratings apply to approximately $1.7 billion in outstanding debt.
“The downgrade follows the unprecedented spike in crude oil and jet fuel costs that continues to erode margins and operating cash flow generation for LCC and all of its competitors in the U.S. airline industry. Given the dramatic rise in energy prices, Fitch believes that the potential for a liquidity squeeze in early 2009 has increased significantly. Assuming no dramatic pull-back in jet fuel prices later in the year and increasing softness in domestic air travel demand as the U.S. economic slowdown continues, Fitch believes that LCC’s unrestricted liquidity could decline toward the covenant level in its secured term loan facility by early next year. The ‘CCC’ IDR reflects the growing likelihood of a constrained liquidity position, as well as LCC’s limited flexibility in raising additional cash through asset sales or new financings.
Because LCC’s average length of haul tends to be shorter than that of the other legacy carriers, the airline’s financial results are relatively more sensitive to swings in the price of jet fuel. Each 10-cent change in the average price of jet fuel for LCC drives approximately $120 million of annual mainline operating costs. While the carrier has hedged a considerable portion of expected 2008 fuel consumption, an increase in the full-year 2008 average jet fuel price to $3.30 per gallon from $2.20 per gallon in 2007 would result in approximately $1.2 billion of mainline expense pressure from fuel alone this year. With current jet fuel spot prices near $4.00 per gallon, a quick reversal in fuel prices would be necessary if LCC is to avoid an erosion of its cash position by Q109.
On the revenue side, industry fare initiatives aimed at offsetting the intense fuel pressure will likely boost yields on reduced domestic capacity, particularly after August as legacy carriers reduce their domestic schedules. Corresponding adjustments in domestic capacity will be somewhat constrained at LCC in 2008, however, by pilot contract fleet and aircraft utilization minimums that could reduce the airline’s near-term flexibility in dealing with a worsening revenue and fuel environment. In 2009, LCC is expected to have more flexibility to reduce capacity, if needed.”
The rating agency also said that it could further downgrade the airline’s debt into the junk category if weak revenue growth increases and fuel trends continue upward.
According to Fitch, this could increase the likelihood that the airline will breach its term loan liquidity covenant. The agency also added, “Any significant increases in credit card processor holdbacks linked to adverse operating developments could further limit LCC’s financial flexibility and prompt an additional downgrade.”
Ticker: (NYSE: LCC)