Fitch Ratings has downgraded Spirit Airlines, Inc.'s (Spirit) long-term Issuer Default Rating (IDR) to 'B+' from 'BB-'.

The Rating Outlook is Stable. Fitch has affirmed Spirit's senior secured debt at 'BB+'/'RR1' and assigned a rating of 'BB+'/'RR1' to its proposed senior secured notes

Fitch believes improvement of Spirit's credit metrics to levels that support a 'BB' category rating will be prolonged beyond our prior expectations. Various headwinds including pilot constraints, aircraft delays, and general inflationary pressures contribute to our expectations that Spirit's operating margins will remain well below historical levels at least through 2023. Fitch estimates that total adjusted leverage will remain above our negative sensitivity of 4.75x through 2024.

The 'B+' rating remains supported by Spirit's solid liquidity balance and its low cost structure relative to competitors, which positions the company well to capture price-sensitive consumers in a recessionary environment.

Fitch evaluates Spirit's credit profile on a standalone basis. Spirit has agreed to be acquired by JetBlue, but significant uncertainty remains around the ultimate closing of the transaction. Fitch will evaluate the two companies on a combined basis when the transaction closes.

Key Rating Drivers

Planned Bond Issuance: Spirit plans to issue a new series of senior secured notes as an add-on to its existing 8% loyalty program backed notes due in 2025. Proceeds will be used for general corporate purposes, including building additional liquidity ahead of a potentially volatile operating environment in 2023. Fitch views the additional liquidity as prudent given current macroeconomic uncertainties. However, the issuance raises potential refinancing risk when the loyalty bonds come due in 2025. The company utilized an equity issuance in 2021 to prepay $340 million of the original notes, leaving $510 million outstanding today.

Fitch believes the core nature of the collateral represented by the loyalty program and Spirit Saver$ Club and by the necessity to maintain access to the Spirit brand provide compelling motivation for the airline to affirm its obligations in a bankruptcy scenario. However, the value of the assets largely rests on Spirit continuing as a going concern. Liquidation of the airline would materially impact the collateral values and weaken recovery.

Delayed Improvement in Profitability: Fitch has cut its expectations for Spirit's operating margins in 2022 and 2023, causing credit metrics to remain weak for a 'BB' category rating for longer than previously anticipated. Spirit's aircraft utilization remains significantly below pre-pandemic levels as staffing, training, supply chain, and infrastructure issues all contribute to limits in the airlines' ability to fully utilize its assets. Spirit's average daily aircraft utilization was 10.6 hours in 3Q 2022, down from 12.5 hours in 3Q 2019.

Fitch expects asset utilization and profitability to improve sequentially in 2023, particularly as limited capacity growth by US carriers continues to limit seat supply and support pricing. However, our 2023 forecasts are at risk from increasing macroeconomic pressures, and a sharper than expected downturn in travel demand could pressure metrics further. Fitch expects Spirit to generate modestly negative EBIT margins for 2022 and near breakeven margins in 2023, compared to low-to-mid teens margins generated prior to the pandemic.

Unit Cost Pressures: Cost pressures have hit Spirit harder than most U.S. carriers. Fitch expects the company's non-fuel costs to be up in the low 20% range over 2019 levels while many network airlines are anticipating mid-teen increases. Spirit's low cost structure remains a competitive advantage. Cost Per Available Seat Mile excluding fuel (CASM-ex) is more than 30% below its closest competitor, allowing the company to stimulate demand with low fares. However, Spirit's low cost structure partially relies on growth and high utilization, which may be limited at least through 2023.

Leisure Demand Remains Strong: In the near term, demand for leisure and visiting friends & relatives (VFR) travel remains strong. Multiple U.S. airlines are reporting solid forward-bookings into the third quarter of 2022 and around the holiday season. Fitch believes that the demand picture is increasingly at risk in 2023 from rising macro pressures. However, our base case remains that demand remains supported by a shift in consumer spending from goods to services, and pent up desire to travel from the pandemic, which should soften the impact to the industry.

Spirit is also well positioned as a low cost/low-fare operator as a weakening economy may drive some amount of 'buying down' from the full-service operators. For the second quarter, Spirit reported traffic that was 11.3% above the same period in 2019 with total revenue per available seat mile up 22.8%.

Aggressive Planned Growth: Spirit maintains an aggressive growth strategy. High levels of planned growth pose some risk if demand were to fall in a recessionary environment. Spirit also faces execution risk related to the pilot shortage and other supply chain constraints. The company reports higher than normal rates of pilot attrition and difficulty hiring new pilots due to attractive rates being offered by other airlines. Staffing shortfalls may lead to continued underutilization of Spirit's assets. The company is currently in negotiations with its pilots' union to address issues with attrition. However, increased pilot pay will also represent a cost headwind.

Spirit's fleet has grown to 184 aircraft up from 145 prior to the pandemic, and the company has another 154 aircraft to be delivered through the end of 2027 including 113 on order with Airbus and another 40 under direct operating leases. Spirit plans to grow capacity in the mid 20% range in 2023.

Negative FCF: Fitch expects FCF to remain negative through 2023 as operating margins remain below historical averages. Spirit plans to use sale-leaseback financing the for the bulk of its aircraft deliveries, limiting its upfront capital expenditures, and potentially allowing FCF to turn positive in 2024. However, aircraft lease expenditures are expected to increase materially through the forecast period, keeping pressure on Spirit's lease adjusted leverage. Fitch expects Spirit's total adjusted leverage to remain above levels that support the 'B+' rating at least through 2023, before trending lower in 2024 and 2025. Adjusted leverage may approach 4x by the end of Fitch's forecast period in 2025.

Key Assumptions

Fitch's base case incorporates capacity and traffic growing by mid-teens percentages in 2023. Fitch's base case is conservative to management's projections, incorporating potentially lower demand due to weakening macroeconomic conditions.

Fitch expects modestly lower yields in 2023 compared to 2022 reflecting economic pressures. Yields are expected to expand modestly beyond 2023.

Jet Fuel is assumed at $3.45/gallon for 2023, declining modestly thereafter.

Recovery Assumptions

Fitch's recovery analysis assumes that Spirit would be reorganized as a going concern (GC) in bankruptcy rather than liquidated. Fitch has assumed a 10% administrative claim. The GC EBITDA estimate reflects Fitch's view of a sustainable, post-reorganization EBITDA level, which is the basis for the enterprise valuation calculation.

Fitch views its GC EBITDA assumption as conservative as it remains below levels generated prior to the COVID downturn, but it incorporates potential structural changes to the industry driven by the pandemic.

Fitch uses a GC EBITDA estimate of $450 million and a 5.5x multiple, generating an estimated GC enterprise value (EV) of $2.5 billion. Fitch's affirmation of the senior secured ratings at 'RR1' assumes that the loyalty program and brand IP collateral account for roughly 50% of the total enterprise value of the company. This valuation is supported in part by the planned increase in Spirit's Brand IP license royalty payment to 5% of total revenue, up from 2% of total revenue previously.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Consummation of the acquisition by JetBlue in a credit conscious manner.

Standalone Spirit Airlines Sensitivities:

Adjusted debt/EBITDAR sustained below 4.5x;

FFO fixed-charge coverage sustained around 2.5x;

Improving operational stability leading FCF to trend towards neutral or higher and EBITDA trending towards pre-pandemic levels.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Completion of the acquisition by JetBlue in a manner leading credit or operating metrics remaining above levels commensurate with the current rating.

Standalone Spirit Airlines Sensitivities:

Adjusted debt/EBITDAR sustained above 5x beyond 2024;

EBITDAR margins sustained in the low double-digit range;

FFO fixed-charged coverage sustained at 1.5x or below;

Liquidity declining toward 10%of LTM revenue.

Best/Worst Case Rating Scenario

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Liquidity and Debt Structure

Sufficient Liquidity: As of Sept. 30, 2022, Spirit had cash and cash equivalents of $953.4 million plus $106.3 million in short-term investments. The company also has full availability under $240 million revolving credit facility which matures in 2024. Total liquidity is equal to 25.5% of Spirit's projected 2022 revenue. Spirit's short-term investments consist of U.S. treasury and government agency securities with maturities of less than 12 months. The pending debt issuance will bring Spirit's total available cash to about $1.5 billion.

While we view Spirit's liquidity position as solid for the rating, the company has pared down its liquidity more quickly compared to other U.S. carriers that have maintained elevated cash levels in the face of an uncertain operating environment. Spirit's total liquidity is roughly 20% above levels held at YE 2019, a much smaller increase than most other airlines. Its liquidity position is smaller relative to its overall size as the company continued to grow during the pandemic. Spirit's active fleet will be a third larger at YE 2022 than it was at YE 2019.

Fitch views Spirit's upcoming debt maturities as manageable given its cash on hand and undrawn revolver. Maturities total $96.2 million for the last six months of 2022, $336.6 million in 2023 and $222.1 million in 2024. Maturities become more material in 2025 when the company's $510 million, 8% secured notes come due.

Issuer Profile

Spirit is a Florida-based ultra low-cost air carrier. It emphasizes very low ticket prices and an unbundled fare structure, with the cost of the ticket only buying a seat on the plane and little else. Non-ticket revenue makes about 50% of Spirit's total revenue.

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

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This 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. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg

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