oWe expect International Consolidated Airlines Group, S.A. (IAG) will report a substantial operating cash flow (OCF) deficit in 2020, due to a steeper decline in air passenger traffic of up to 70% versus 2019 from COVID-19 under our revised base case.
oThe measures IAG is taking to counterbalance the plunge in revenue include containing costs, adjusting capacity, and bolstering its capital structure (including completing a capital increase of EUR2.74 billion in gross proceeds). We think these will be insufficient to offset the effects of the pandemic on its credit metrics in 2020.
oHowever, assuming a vaccine or effective treatment for COVID-19 becomes widely available in the second half of 2021 and restores passenger confidence in flying, we expect the group's OCF will turn positive in 2021, and support credit metrics improving to a level consistent with the current rating.
oWe are therefore affirming our 'BB' ratings on IAG and its unsecured debt.
oThe negative outlook reflects our view that IAG's financial metrics will be under considerable pressure in coming quarters due to difficult trading conditions. Additionally, there is high uncertainty regarding the pandemic and economic recession, and their impact on air traffic demand and IAG's financial position and liquidity.
FRANKFURT (S&P Global Ratings) Sept. 21, 2020--S&P Global Ratings today took the rating actions listed above.
Although IAG is cutting costs, executing operating-efficiency initiatives, and drastically reducing capacity, among other measures, and should benefit from a lower fuel bill (forecast at EUR3.2 billion-EUR3.3 billion in 2020 versus EUR6.0 billion in 2019), we think these factors will be insufficient to counterbalance the collapse in revenue in 2020. Our fuel cost forecast includes losses from ineffective fuel hedges, which we treat as operating expenses and that were caused by lower fuel prices, and an over-hedged fuel position after a significant cut in capacity. We estimate that IAG's adjusted EBITDA will be markedly negative in 2020, compared with EUR5.4 billion in 2019. This, aggravated by working capital needs, which could be material because of continued ticket refunds and sluggish forward bookings, will result in significantly negative OCF in 2020. IAG's bookings across Europe started to recover in June, albeit from a nearly complete halt during April and May, but flattened in July. This is consistent with our view of a slow and bumpy recovery continuing, depending on local travel constraints, including quarantine rules or mandatory testing for COVID-19, in particular in IAG's home markets. Furthermore, we anticipate a delayed and sluggish recovery of long-haul bookings on account of travel restrictions to North and South America, as well as corporate traffic, which normally are IAG's most profitable segments. As such, IAG's EBITDA and credit metrics will remain under considerable pressure in the next few quarters. The surge in adjusted debt will be offset to some extent by delays or cuts to capital expenditure (capex) for new planes and other discretionary projects (total spending to EUR2.7 billion in 2020 down from the EUR4.2 billion scheduled before the pandemic), and a capital increase of EUR2.74 billion in gross proceeds. We forecast IAG's S&P Global Ratings-adjusted debt will increase to about EUR12.0 billion by year-end 2020 from about EUR7.4 billion in 2019, but it is well below our May 2020 forecast of EUR15.0 billion. Furthermore, we envisage IAG's operating performance improving in 2021, albeit at slower pace than we projected in May because of our slashed air traffic assumptions, with adjusted EBITDA rising to EUR2.8 billion-EUR2.9 billion (May forecast EUR3.0 billion-EUR3.5 billion). We assume a strong rebound in air traffic in second-half 2021, underpinned by our current view that a vaccine or effective treatment for COVID-19 will become widely available and restore passenger confidence in flying. Our revised base-case supports our unchanged view that adjusted funds from operations (FFO) to debt will rebound to the rating-commensurate level of 15%-20% in 2021, but stay far below the 2019 level of 65%. However, low visibility regarding the pandemic, recessionary trends, and their impact on passenger volumes adds a significant degree of uncertainty to our forecasts. We continue to view IAG as one of the financially strongest groups in the airline industry, with total liquidity of EUR7.1 billion as of Aug. 31, 2020, comprised of EUR5.8 billion of cash and deposits and EUR1.3 billion of undrawn committed general and aircraft facilities maturing beyond 12 months, as adjusted by S&P Global Ratings. Liquidity was further boosted by EUR2.74 billion in gross proceeds from the capital increase IAG completed on Sept. 10, 2020, to a pro forma total liquidity position of about EUR9.84 billion. IAG demonstrates its proactive treasury management, continued access to capital markets, and ability to safeguard liquidity, underpinned by its most recent equity raising. We also acknowledge IAG's determination and flexibility to defer capex for new planes and suspend shareholder remuneration, with a focus on preserving cash and restoring its credit measures.
The negative outlook reflects our view that IAG's financial metrics will be under considerable pressure in the next few quarters due to difficult operating conditions. In addition, there is high uncertainty regarding the pandemic and economic recession, and their impact on air traffic demand and IAG's financial position and liquidity.
We would lower the rating if the recovery of passenger demand is delayed or appears to be structurally weaker than expected, placing further pressure on IAG's credit metrics; and if we expect that adjusted FFO to debt won't recover to at least 12% in 2021. This could occur if the pandemic cannot be contained, resulting in prolonged lockdowns and travel restrictions, or if passengers remain reluctant to book flights.
While we currently don't see liquidity as a near-term risk, we would lower the rating if air traffic does not recover in line with our expectations, external funding becomes unavailable for IAG, and management's proactive efforts to adjust operating costs and capital investments are insufficient to preserve at least adequate liquidity, such that sources of liquidity exceed uses by more than 1.2x in the coming 12 months.
We could also lower the rating if industry fundamentals weaken significantly for a prolonged period, impairing IAG's competitive position and profitability.
To revise the outlook to stable, we would need to be confident that demand is normalizing and the recovery is robust enough to enable IAG to partly restore its financial strength, such that adjusted FFO to debt increases sustainably to at least 12%, alongside a stable liquidity position. We would expect this to be further underpinned by prudent capital spending and shareholder returns.
Related Criteria
oGeneral Criteria: Group Rating Methodology, July 1, 2019
oCriteria | Corporates | General: Corporate Methodology: Ratios And Adjustments, April 1, 2019
oCriteria | Corporates | General: Recovery Rating Criteria For Speculative-Grade Corporate Issuers, Dec. 7, 2016
oCriteria | Corporates | Recovery: Methodology: Jurisdiction Ranking Assessments, Jan. 20, 2016
oCriteria | Corporates | General: Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Dec. 16, 2014
oCriteria | Corporates | Industrials: Key Credit Factors For The Transportation Cyclical Industry, Feb. 12, 2014
oGeneral Criteria: Country Risk Assessment Methodology And Assumptions, Nov. 19, 2013
oCriteria | Corporates | General: Corporate Methodology, Nov. 19, 2013
oGeneral Criteria: Methodology: Industry Risk, Nov. 19, 2013
oGeneral Criteria: Methodology: Management And Governance Credit Factors For Corporate Entities, Nov. 13, 2012
oGeneral Criteria: Principles Of Credit Ratings, Feb. 16, 2011
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