How the top five US network carriers are now positioned October 2009

Delta is one of the best–positioned US legacies, having successfully implemented the merger with Northwest (after both restructured in Chapter 11). First, the airline has financially outperformed its peers in recent quarters and is expected to post a narrower loss than the other large carriers for 2009. This reflects the extensive cost cuts in bankruptcy as well as the merger synergies, which are expected to boost this year’s results by $500m.

Second, Delta has had ample cash reserves – the result of the opportunities to raise significant liquidity as part of the Chapter 11 exits and the merger. At the end of June the company had $5.4bn in unrestricted cash and available credit facilities, or 16% of trailing 12–month revenues.

But Delta also has an extremely heavy burden of debt and lease obligations. Fitch Ratings noted in June that the airline had $5bn in debt coming due through the end of 2011. The agency downgraded Delta’s credit ratings, citing a steady erosion of cash balances that “threatens Delta’s ability to comfortably meet heavy fixed obligations”.

So in September Delta understandably grabbed the opportunity to refinance. The airline originally intended to issue $1.5bn of first–lien bank and capital market debt to take care of Northwest’s Chapter 11 exit facility and other 2010 debt maturities. But investor demand was so strong that Delta was able to boost the first–lien offering by $250m and add a $600m second–lien tranche on the same collateral.

The total of $2.1bn raised consisted of $750m of 9.5% senior secured first–lien notes due 2014, $600m of 11.75% senior secured second–lien notes due 2015, a $500m revolving credit facility and a $250m term loan.

The transactions took care of more than 40% of Delta’s 2010 debt maturities and generated $600m in incremental cash. As a result, Delta expected to have $5.6bn in unrestricted liquidity, or 17.7% of trailing 12- month revenues, at the end of September.

In addition to having more manageable debt maturities in 2010, Delta also benefits from having relatively light aircraft commitments next year and from having committed financing in place for all near–term deliveries.

On the negative side, Delta still has a heavy overall debt burden and few unencumbered assets remaining to support additional borrowing. But its longer–term prospects are generally regarded as promising, because the combined network will make it well positioned to benefit from global economic recovery.

AMR needed to raise funds because its liquidity position deteriorated sharply last winter. Its unrestricted cash reserves were only $2.8bn at the end of June – 13% of trailing 12–month revenues. This was the lowest amount since the airline’s 2003 reorganisation and brush with bankruptcy.

The main problem has been significant near–term debt and capital lease maturities, even though AMR has significantly reduced its debt since 2002. Current maturities of debt and capital leases were $1.2bn as of June 30th. Also, AMR has an onerous pension burden (because it avoided Chapter 11), one of the highest labour costs in the industry and higher costs associated with a very mature fleet.

American kicked off the September liquidity- raising with the massive GE and Citibank deals. The $1bn FF–mile sale will be treated as a loan for accounting purposes (8.3% interest rate). AMR will “repay” the loan using FF–miles in equal monthly instalments in 2012–2016. A week later, AMR raised $830m in aggregate net proceeds from public stock and convertible senior note offerings (each contributing $400m–plus). Both offerings were significantly increased in size, reflecting strong demand from investors.

And finally, AMR launched a $450m private bond offering to refinance $432m of its bank debt. The three–year notes have a 10.5% interest rate and are secured by the same 141 aircraft that backed the bank facility (757s, 767s and MD–80s).

The $4.2bn in new liquidity and financings raised in the past month was in addition to some $1.3bn in secured aircraft financings AMR completed earlier this year.

The latest fund–raising has dramatically improved AMR’s liquidity position. In JP Morgan’s estimates, the airline will end the year with unrestricted cash of $4.1bn – a very healthy 20.8% of revenues. And, having pre–funded a substantial portion of upcoming debt maturities, next year’s debt and capital lease payments will be a relatively modest $867m, compared to this year’s $2.3bn.

Unlike its peers, American still has significant unencumbered assets that could be used to raise additional funds. The airline estimates those assets at $2bn, down from $3.7bn in June, though it is not clear if all of them are easily marketable.

In conjunction with the liquidity moves, American announced a modest new network restructuring for next summer, aimed at eliminating unprofitable flying. And of course, American is maintaining a disciplined approach to capacity addition. Next year its mainline capacity is slated to inch up by only 1%.

The latest transactions and network plans are all the more beneficial because there should be minimal overall negative impact on costs. One analyst noted that the network retooling efforts would offset the additional interest expense. Of course, not all of the transactions added to debt, and the share offering strengthened the company’s balance sheet. AMR has already averted a potential ratings downgrade from Moody’s, which in late September changed the ratings outlook from “negative” to “stable”.

In recent months, there has been much speculation that United, in particular, could face liquidity pressures this winter. UAL is expected to incur the legacy sector’s steepest loss this year, reflecting its extensive global route system and greatest exposure to the premium sector. UAL also has heavy debt and capital lease obligations that add up to $1.7bn between April 2009 and the end of 2010.

UAL’s current liquidity position is actually not that bad. The airline was expected to maintain its unrestricted cash balance at around $2.6bn (15.4% of trailing 12–month revenues) at the end of September, thanks to $300m of financings, asset sales and other liquidity initiatives completed in the third quarter. The cash raised included $154m proceeds from the sale of senior notes backed by aircraft spare parts in late June. UAL was also in full compliance with its credit facility covenants on September 30th.

But the key concern with UAL is the potentially large amount of additional cash that needs to be raised to meet the substantial upcoming debt and capital lease payments if the recession lingers on.

The $1.1bn of new financings in early October represented a very significant first step in giving UAL more breathing room this winter. The $659m proceeds from the EETC offering will repay at par the $568m debt in the 2001 EETC and provide $90m to boost the cash position. The deal will reduce UAL’s 2010 debt repayments by $215m and 2011 payments by $100m.

The EETC financing has an interest rate of 10.4% and a final distribution date of November 2016. S&P described the 31–aircraft collateral as “mixed in attractiveness”, but the deal was structured in such a way to increase the likelihood that United would continue to pay on the certificates in bankruptcy.

The public stock and convertible note offerings, which raised $424m in net proceeds, were evidently well received. The convertible note offering was increased in size from $175m to $300m. In JP Morgan’s estimates, UAL will now end the year with cash reserves of an adequate 16.1% of annual revenues.

United’s CEO Glenn Tilton said recently that the airline could decide by year–end whether to make the major new aircraft order it began considering in the spring. In part because of its ageing fleet, the airline is handicapped by one of the highest operating costs in the industry.

When global economic recovery gets under way, United could be the biggest beneficiary among the US airlines. It could stage an amazing transformation from the likeliest bankruptcy candidate to an over–performer.

US Airways had a difficult 2008 and saw its unrestricted cash position dwindle to just 10.2% of annual revenues at year–end. However, the airline has been performing better financially than its legacy peers this year and has relatively light debt maturities in the near term, so there are no real liquidity concerns. In May US Airways raised $234m from common stock and convertible debt offerings, which helped to boost unrestricted cash to $1.7bn (15.2% of annual revenues) at the end of June.

On the negative side, US Airways has few unencumbered assets it could borrow against, so it relies heavily on equity offerings. It was quick to take advantage of last month’s favourable market conditions, raising $137.3m in net proceeds through a common share offering that closed on September 28th.

Separately, US Airways also amended its credit card agreement with Barclays to temporarily lower the minimum unrestricted cash requirement from $1.5bn to $1.35bn.

So US Airways is not in danger, but it needs to juggle a bit to avoid violating covenants and could benefit from further cash infusions. The airline is performing better than its legacy peers mainly because of its domestic focus (better pricing environment, more opportunity to collect ancillary revenues, Southwest’s historic capacity cuts, etc).

Continental is one of the healthiest US carriers. Its unrestricted cash balance has remained remarkably stable over the years and through the turmoil in recent quarters, fluctuating only in the $2.5 to $2.8bn range (17–20% of annual revenues). Its June 30th unrestricted cash balance was $2.8bn (20.2% of annual revenues), and year–end reserves are again expected to exceed 20% of revenues.

Continental was not active in the bank or capital markets in September. It raised about $158m from equity issuance in July. Earlier that month, it completed a $390m EETC (with an attractive 9% coupon compared to the 12- 13% others were paying) and obtained new bank loans to finance 737–900ER deliveries.

The airline does have a substantial debt and lease burden stemming from fleet modernisation since the mid–1990s. But exemplary cash management, consistently superior operating margins and a nicely balanced global network inspire confidence. It is currently focused on staging a smooth transition from SkyTeam to Star alliance in the last week of October.