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Fitch Ratings has affirmed the debt ratings of Southwest Airlines
Co. (Southwest), and has revised Southwest's Rating Outlook to
Negative from Stable following the company's announcement that it is
launching a new $500 million share repurchase program to be completed
over the next three months.
Fitch has affirmed the ratings for Southwest Airlines as follows:
--Issuer Default Rating (IDR) at 'A';
--Senior Unsecured Debt at 'A';
--Bank Credit Facility at 'A'.
The change in the Rating Outlook reflects Fitch's expectation that
the increase in share repurchase activity in a somewhat softer
operating environment will drive debt levels modestly higher over the
next six to twelve months. Southwest completed $1 billion of share
buybacks under two separate authorizations made during 2006, and has
repurchased approximately $223 million under a $300 million repurchase
program initiated in the first quarter of this year.
The step-up in repurchase activity makes a modest increase in
leverage much more likely during 2007, reversing a trend toward debt
reduction that has been ongoing since 2002. Management now appears
more focused on the need to boost equity returns -- partially through
increased leverage -- in light of growing evidence that 2007 revenue
and earnings growth will fall short of expectations.
First quarter unit revenue performance at Southwest was weak,
mirroring softness in domestic revenue per available seat mile (RASM)
seen across the U.S. airline industry. Weak revenue patterns appear to
be extending into Q2, reflected in the 4-point load factor decline
reported by Southwest in April. The company is actively considering
the development of new revenue sources to offset rising fuel cost
pressure over the next few years. Expanded code share agreements, new
cargo revenue initiatives and better yield management are some of the
programs now under review by the airline.
Liquidity remains strong, with $1.9 billion of cash on the balance
sheet at the end of the first quarter. In addition, Southwest has an
undrawn $600 million revolving credit facility. The airline's base of
unencumbered aircraft has grown steadily this decade as virtually all
new deliveries have been funded out of internally generated cash flow.
For 2007, projected capital spending of about $1.5 billion is being
driven by the delivery of 39 Boeing 737-700 aircraft (37 new and 2
used). This is expected to drive available seat mile growth of 8% for
the full year. As yet, no adjustments have been made to the airline's
capacity growth plans as a result of the weaker revenue environment.
Total balance sheet debt levels have fallen in recent years, and
management has consistently stated its opposition to a large increase
in debt levels linked to a leveraged recapitalization or LBO. However,
increased reliance on share repurchases to boost shareholder returns
may represent a capital structure policy shift that could lead to
increased tolerance for modestly higher leverage over the next several
years.
A commitment to the management of fuel price risk through a
multi-year fuel hedging program has contributed to Southwest's
substantial unit cost advantage versus other U.S. carriers in recent
years, but diminished hedge protection is pressuring costs in 2007.
Ex-fuel unit operating costs are being managed effectively, but
Southwest faced average jet fuel prices that were 12% higher year over
year during Q1.
A downgrade to 'A-' would likely follow within the next few months
if the company decides to move forward more aggressively with
additional debt-financed share repurchases, signaling a shift in its
philosophy of capital structure management in a challenging industry
operating environment expected to persist over the next few years.
Fitch's rating definitions and the terms of use of such ratings
are available on the agency's public site, www.fitchratings.com.
Published ratings, criteria and methodologies are available from this
site, at all times. Fitch's code of conduct, confidentiality,
conflicts of interest, affiliate firewall, compliance and other
relevant policies and procedures are also available from the 'Code of
Conduct' section of this site.
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