Fitch Rates Southwest's Unsecured Notes 'BBB+(EXP)'

CHICAGO--(BUSINESS WIRE)-- Fitch Ratings has assigned an expected rating of 'BBB+(EXP)' to Southwest Airline's proposed $300 million note issuance.

The notes will feature a 10-year tenor and will rank equally with Southwest's existing unsecured debt. The funds will be used for general corporate purposes. Including the new debt issuance, Fitch expects Southwest's total adjusted debt/EBITDAR to be approximately 1.6x at year-end 2016, which is consistent with the company's 'BBB+' rating, and is among the lowest of any airline globally. Fitch continues to expect Southwest's total leverage to remain stable over the near- to intermediate-term.

KEY RATING DRIVERS

Southwest's corporate rating is supported by its solid financial flexibility, strong balance sheet, history of generating positive free cash flows and its position as one of the largest air carriers in the U.S. Southwest's credit metrics continue to support the 'BBB+' rating.

Southwest has exhibited solid performance by many measures through the first nine months of 2016 and over the last several years in general. Fitch expects LUV to continue to perform well financially for the foreseeable future, though margins are likely to contract going forward due to the confluence of rising labor costs, higher jet fuel prices, and soft unit revenues. Despite the various headwinds Fitch expects Southwest's profitability to remain above levels seen prior to 2014 for the foreseeable future.

Southwest's capacity growth has been well above industry average over the past two years, but is expected to moderate in 2017 and 2018. LUV has stated that its 2017 year-over-year capacity growth will be approximately 3.5% compared to the 5%-6% it expects to add in 2016. Roughly 2% of Southwest's expected 2017 growth is expected to be domestic with the remainder coming from international markets. Fitch views Southwest's slowing capacity as prudent given the current macroeconomic environment and on-going unit revenue pressures. Moderating growth plans both at Southwest and among U.S. competitors should lead to improved unit revenue trends over the near- to intermediate-term.

Southwest's investment-grade ratings are supported by the company's substantial financial flexibility. As of the end of the third quarter, LUV maintained a cash balance of $3.4 billion, augmented by a $1 billion revolver. Total liquidity, including revolver capacity, totalled 22% of LTM revenue, which is above average for the industry. Southwest also maintains a sizeable pool of unencumbered assets which should support its access to the capital markets even in a future recession. Fitch expects Southwest to generate sufficient cash flow over the next several years to continue to fund its aircraft deliveries without accessing the debt markets, adding to its existing pool of high-quality, unencumbered assets.

KEY ASSUMPTIONS

Key assumptions in Fitch's rating case include:

--Capacity growth in the low- to mid-single digits through the forecast period;

--Continued moderate economic growth in the U.S. over the near term, translating into stable demand for air travel;

--Jet fuel prices of roughly $55/barrel on average for 2017, increasing to approximately $65/barrel by the end of the forecast period;

RATING SENSITIVITIES

Fitch views the rating as having limited near-term upside potential due to the inherent cyclicality and volatility in the airline industry.

Fitch does not expect to take a negative rating action in the near term. However, a negative action could be driven by an exogenous shock that causes demand for air travel to drop significantly or a fuel shock that is not offset by rising yields. A negative action could also be driven by a change in management strategy favoring shareholder returns at the expense of a healthy balance sheet.

Fitch could consider a downgrade if adjusted debt/EBITDAR were to rise and be sustained above 2.5x, if free cash flow margins were to decline below 1%-2% on a sustained basis, or if FFO fixed-charge coverage were to fall below 4x on a sustained basis.

FULL LIST OF RATING ACTIONS

Fitch has assigned the following ratings:

Southwest Airlines Co.

--$300 million senior unsecured notes due 2026 'BBB+(EXP)'.

Fitch currently rates Southwest as follows:

--Issuer Default Rating (IDR) 'BBB+';

--Senior unsecured debt 'BBB+';

--$1 billion unsecured revolving credit facility expiring 2021 'BBB+';

--Secured term loans due 2019 and 2020 'A-'.

Date of Relevant Rating Committee: Oct. 29, 2015.

Additional information is available on www.fitchratings.com.

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage - Effective from 17 August 2015 to 27 September 2016 (pub. 17 Aug 2015)

https://www.fitchratings.com/site/re/869362

Additional Disclosures

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1014142

Endorsement Policy

https://www.fitchratings.com/regulatory

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View source version on businesswire.com: http://www.businesswire.com/news/home/20161101006356/en/

Fitch Ratings
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or
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or
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Source: Fitch Ratings

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