Fitch Ratings has downgraded Spirit Airlines' Long-Term Issuer Default Rating (IDR) to 'CCC' from 'B-'. Fitch has also downgraded Spirit IP Cayman Ltd.'s and Spirit Loyalty Cayman Ltd.'s senior secured debt to 'B-'/'RR2' from 'BB-'/'RR1'.

Fitch has not taken rating actions on Spirit's outstanding EETC debt. The EETCs will be reviewed in the coming days.

The downgrades follow Spirit's first quarter earnings announcement and guidance that illustrates ongoing profitability weakness. Fitch believes there is a heightened risk that a pending refinancing of Spirit's 2025 loyalty bonds and 2026 convertible notes may constitute a distressed debt exchange. Overcapacity in Spirit's key Latin American markets and other leisure destinations is driving continued unit revenue pressures, limiting top-line growth and driving Spirit's guidance for operating margins to remain negative in the second quarter.

Operating risks are heightened by the lack of visibility around A320 NEO engine availability beyond 2024. Fitch expects Spirit's financial metrics to remain well outside of levels supportive of a 'B-' rating at least through 2024 and likely 2025.

Rating concerns are partly tempered by recent liquidity enhancing items such as Spirit's compensation agreement with Pratt & Whitney and its decision to defer aircraft deliveries and furlough pilots.

Key Rating Drivers

Diminishing Financial Flexibility: Fitch believes Spirit's financial flexibility is diminishing as profitability remains elusive and recent forward guidance is unlikely to restore investor confidence, limiting the company's refinancing options. The company needs to address the September 2025 maturity of its $1.1 billion 8% bonds. Refinancing may be difficult given current market sentiment, with the bonds currently trading at a steep discount. Spirit has publicly stated that it has engaged in discussions with its loyalty bondholders and convertible note holders and expects a resolution this summer.

Liquidity remains adequate in the very near term, though the company continues to burn cash. Spirit reported a cash and short-term investments balance of $898 million at Q1 2024. Although cash is down from $985 million at YE, the company retains adequate liquidity to fund near-term operating needs. Spirit also had $300 million available under its revolving credit facility, though the revolver contains a $450 million minimum liquidity covenant.

Recent developments, including Spirit's compensation agreement with Pratt & Whitney and its decision to defer deliveries and furlough pilots, support near-term liquidity. The company recently announced it expects to end the year with roughly $1.2 billion in liquidity, inclusive of its revolver. The company also expects to generate operating cash flow in the second half of the year. Fitch's forecast is modestly lower at around $1.1 billion.

Profit Headwinds: Following Spirit's updated guidance, Fitch no longer expects margin improvement this year from low levels produced in 2023. Fitch expects Spirit's margins to remain negative in the upper single digits at the EBIT level in 2024, compared to a -7.1% margin produced in 2023. Spirit faces headwinds toward improving its profitability, including engine availability issues, overcapacity in certain leisure markets, and intense competition. Macroeconomic pressures on Spirit's cost-conscious customer base may also limit Spirit's near-term recovery.

Spirit is pursuing cost-cutting measures, but still faces unit cost headwinds given limits on the company's capacity growth from limits to aircraft availability. Spirit also gave early indications of pending strategic changes to improve its brand image and bolster unit revenues. Fitch views these as positive steps, as Spirit's current brand image limits its appeal to certain travelers. However, such changes will take time to implement and pose certain execution risks.

Modestly Negative Near-Term FCF: Fitch expects Spirit's FCF to be modestly negative in 2024, driven by weak operating margins, though the forecast is slightly improved from its prior review due to lower capital spending. 2024 cash flows will be aided by the company's order deferral with Airbus. Because of a change in pre-delivery deposit payments, Spirit now expects its net capital spending to be minimal for 2024. The deferral with Airbus will also limit capital spending in 2025 and 2026, although Fitch expects cash flows to be pressured in those years as profitability remains well below historical levels.

Weak Leverage, Coverage Metrics: Fitch expects Spirit's leverage and fixed charge coverage metrics to remain weak in 2024 and 2025, at levels that reflect the 'CCC' rating. Fitch's base case anticipates that EBITDAR leverage will likely remain above 10x through 2024, with potential to improve thereafter, assuming improvement off of current trough levels of profitability. EBITDAR fixed charge coverage may end 2024 around below 1x, indicative of Spirit's limited financial flexibility.

Pratt & Whitney Engine Issues: Aircraft availability remains one of Spirit's primary headwinds. Spirit reports that geared-turbofan (GTF) engine inspection issues will take an average of 25 of its aircraft out of service through 2024, rising to 40 aircraft by the end of the year. Capacity should be flat for the year, compared to Spirit's typical mid-teens growth rate. Visibility into engine availability is limited beyond 2024, adding a layer of uncertainty to Fitch's forecast, as it is difficult to predict Spirit's ability to add capacity.

The company estimates that as many as 70 aircraft could be out of service in 2025. Such uncertainty also drives complexity into network planning and hiring decisions for the year. Spirit currently operates a fleet of 207 aircraft. The A320 NEO family aircraft supported by the GTF engines represent the most efficient planes in Spirit's fleet, and the grounding of such a material portion of these planes constitutes a material headwind.

Derivation Summary

Spirit's 'CCC' rating is below member of its North American peer group reflecting the company's near-term refinancing risks and pressured profitability.

Key Assumptions

Fitch's base case incorporates flat capacity growth in 2024 followed by modestly declining capacity in 2025;

Fitch expects modestly higher unit revenues to be modestly lower in 2024, followed by improvement thereafter driven by capacity limitations and various revenue initiatives;

Jet fuel is assumed at $2.80/gallon through the forecast;

Fitch expects Spirit to refinance its 2025 and 2026 debt maturities in 2024.

Fitch assumes that Spirit receives $150 million in compensation from Pratt & Whitney in 2024.

Recovery Analysis

Fitch's recovery analysis assumes Spirit would be reorganized as a going concern (GC) in bankruptcy rather than liquidated. The analysis incorporates a going-concern EBITDA estimate of $220 million and a 5x multiple.

Fitch's GC EBITDA estimate of $220 million is a downward revision from prior estimates and reflects Spirit's recent track record of operating losses and uncertainty around its turnaround plans. The GC EBITDA assumption is below levels generated through the pandemic downturn and forecast EBITDA for 2024. Fitch believes that pandemic period profits through 2023 are temporarily depressed due to a confluence of factors but profits may continue to be constrained by intense competition and rising costs.

The choice of this multiple considered the following factors:

Historical bankruptcy case study exit multiples for peer companies ranged from 3.1x to 6.8x.

Spirit's 5x multiple is at the mid-point of the range, which given the company's potential growth over time, is offset by profitability and competitive headwinds.

The value available to holders of the loyalty program assets is dependent upon the size of Spirit's loyalty member base and associated cash flows. Actions that cause loyalty cash flows to decline, including a shrinking footprint, asset sales, etc. may cause the value available to the loyalty program debt to decrease which could impact the recovery rating over time.

RATING SENSITIVITIES

Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade

Successful refinancing of Spirit's 2025 and 2026 bonds;

EBITDAR fixed-charge coverage sustained above 1x;

Demonstrated progress towards improving cash flow while maintaining adequate liquidity

Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade

Near-term failure to articulate refinancing plans for the 2025 maturities, or an increasing likelihood that Spirit may pursue a DDE;

Cash and revolver availability declining towards $500 million and/or the decreasing likelihood of ability to access contingent liquidity options.

Liquidity and Debt Structure

Declining Liquidity: As of March 31, 2024, Spirit had cash and cash equivalents of $764.8 million plus $133.6 million in short-term investments. The company has full availability under its $300 million revolving credit facility though the facility matures in September 2025 and has a minimum liquidity covenant of $450 million. Spirit's short-term investments consist of U.S. treasury and government agency securities with maturities of less than 12 months.

Spirit's total liquidity (cash plus short-term investments) has come down over the past year driven by operating cash outflows and debt repayment. Fitch considers Spirit's liquidity adequate in the very near-term. However, continued cash burn absent other capital injections could drive liquidity concerns over the course of the next year.

Issuer Profile

Spirit Airlines, Inc. is a Florida-based ultra-low cost air carrier.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.

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