Credit Rating Lowered, Forecast Ugly
Fitch Ratings has assigned a 'B'
rating to the $300 million in senior unsecured notes issued by
Northwest Airlines. The notes carry a coupon rate of 10% and mature
in 2009. The Rating Outlook for Northwest is Negative.
The unsecured rating and the negative rating outlook reflect
Northwest's heavy debt load, high level of cash obligations over
the next few years and the lack of progress toward the achievement
of lower contract pay rates for unionized employees that would
bring the carrier's unit labor costs in line with its restructured
network carrier rivals. If competitive deals on amendable labor
contracts are reached, Northwest should be in a position to deliver
unit operating expenses at the low end of the network airline peer
group. However, progress toward this goal has been slow. As a
result, Northwest faces another year of marginal profitability and
cash flow results in spite of an improving industry revenue
environment.
Northwest continues to struggle with unit operating expenses
that remain above the new competitive cost benchmark being
established by the restructured network carriers--American and
United. Although management reiterated its hope on Jan. 23 that the
airline's unit labor cost premium could ultimately be erased, there
is no expectation that new collective bargaining agreements with
the pilots or ground workers can be reached quickly. Negotiations
with the Air Line Pilots Association (ALPA) have been underway
since last summer, when the pilot agreement became amendable, and
the company has been in talks with its ground employees' union (the
International Association of Machinists and Aerospace Workers)
since late 2002.
Liquidity remains a source of
relative credit strength, given the airline industry's ongoing
exposure to external demand and fuel price shocks. A year-end 2003
unrestricted cash balance of $2.8 billion allowed Northwest to
retain the strongest ratio of unrestricted cash to annual revenues
among the U.S. network carriers. The strong cash balance was
supported by asset sales completed in 2003 (including stakes in
computer reservations company Worldspan and online travel companies
Orbitz and Hotwire). An IPO of Northwest's Pinnacle regional
airline unit provided liquidity for Northwest's defined benefit
pension plans, which were funded in part during 2003 through a
contribution of Pinnacle stock.
A solid liquidity buffer will remain critical in light of the
cash flow pressures that Northwest faces in 2004 and 2005.
Scheduled debt maturities total more than $600 million this year
and $1.4 billion (including $975 million of secured credit
facilities) in 2005. Cash pension funding will also represent a
major drain on operating cash flow, but some required funding may
be deferred if Congress acts quickly to cut so-called deficit
reduction contributions (DRC) made to underfunded airline pension
plans. The Senate voted yesterday to approve a deferral of most
airline DRC payments in 2004 and 2005. Northwest management on Jan.
23 noted that 2004 cash funding of pension plans would not exceed
the accrued pension expense on the income statement of $450
million.
Following Northwest's recent asset sales, few unencumbered
assets are available to generate cash. Northwest has now issued
debt on an unsecured basis (including $300 million in convertible
bonds issued last fall) on three separate occasions over the past
year. Continued access to the capital markets is allowing Northwest
to counter the cash flow pressures posed by debt maturities and
required cash pension funding this year. Some of the liquidity
benefits, however, are being offset by the high coupon rate for the
current offering, which will drive higher interest expense.
In addition to strong cash balances,
Northwest's credit position is supported by better revenue
fundamentals than those seen by the other network carriers.
Passenger unit revenue (revenue per available seat mile) grew by
12% in the fourth quarter--outpacing the rest of the industry by a
comfortable margin. The unit revenue improvement derived not only
from strong load factors (up 3 points system-wide versus the
prior-year period), but also from better pricing.
Passenger yields improved by 7% in the fourth quarter, in part
reflecting Northwest's discipline in adding back scheduled capacity
more slowly than the rest of the industry. The carrier's unit
revenue premium to the rest of the industry widened year-over-year,
reflecting more limited exposure to rapidly growing low-cost
carriers in the Heartland markets where Northwest maintains a
strong unit revenue position. Strengthening trans-Pacific,
trans-Atlantic and cargo demand has also supported Northwest's
relatively strong unit revenue performance.
Besides the risk of slow progress on the labor front, Northwest
and the entire U.S. industry face a high level of fuel price risk
this year that could undermine operating results and offset some of
the expected revenue improvement. Northwest has no fuel hedges in
place, and forecasts a full-year 2004 jet fuel price of 85 to 95
cents per gallon.
FMI: www.nwa.com