S&P Lifts Outlook on Delta Air Lines (DAL) to Positive; Ratings Affirmed

September 2, 2016 11:26 AM EDT

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S&P Global Ratings said it affirmed its ratings on Delta Air Lines Inc. (NYSE: DAL), including affirming its 'BB+' corporate credit rating, and revised the outlook to positive from stable.

The outlook revision is based on Delta's consistent strong operating results, with an adjusted EBITDA margin of 28% for the 12 months ended June 30, 2016, highest among large hub-and-spoke airlines rated by us globally. We could raise our ratings if Delta is able to maintain margins at or close to this level in spite of pricing pressures and our expectation of somewhat higher fuel costs and rising labor costs. Delta's credit measures remain solid, with a funds flow-to-debt ratio of 37.6% for the 12 months ended June 30, 2016, and a debt-to-EBITDA metric of 2.2x. However, we do not foresee near-term improvement, because declining interest rates are likely to cause an increase in Delta's already sizable pension deficit (which we include in our adjusted debt calculation). Also, Delta has gradually shifted an increasing portion of its free cash flow to dividends and share buybacks, after paying down balance sheet debt significantly over the past five years.

"Despite some pricing pressure and potential rising labor costs, we expect Delta to continue to generate solid earnings and cash flow, with funds flow to debt remaining in the low-30% area," said S&P Global Ratings Philip Baggaley.

We could raise our ratings on Delta if continued strong margins and returns lead us to reassess the company's operating efficiency and overall business risk profile, based on an extended track record of operating profitability, and if funds from operations to debt remains above 30%. Although less likely, we could also raise ratings if the company's credit measures improve more rapidly than we expect, with a funds flow-to-debt ratio consistently in excess of 45% and a free cash flow-to-debt ratio of more than 25%. This could occur because of a combination of stronger-than-expected earnings, debt reduction, and a material shrinkage of the airline's retiree liabilities due to higher interest rates, excess funding of employee pensions, and strong pension fund asset performance.

We could revise the outlook to stable if Delta's operating profitability deteriorates from current strong levels due to adverse industry or company-specific trends, such as pressure on pricing combined with rising fuel and labor costs. That could cause us to conclude that there is no basis for a favorable reassessment of Delta's operating efficiency and business risk profile and that the current rating is therefore not likely to improve over the near term.

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