Delta Gets a Lift on Its Credit Rating

Standard & Poor's looks at the carrier's strategy as it emerges from bankruptcy protection, and raises it to a B credit rating

by Phillip Baggaley From Standard & Poor's RatingsDirect

After a relatively rapid and successful reorganization, Delta Air Lines (DALR) emerged from Chapter 11 bankruptcy proceedings on Apr. 30. (The company has indicated it will seek listing of its new post-bankruptcy common stock on the New York Stock Exchange under the ticker symbol DAL.) Standard & Poor's Ratings Services raised its ratings on Delta, including raising the corporate credit rating to B, with a stable outlook, from D, following the move.

Post-bankruptcy, Delta is left with lower operating costs, improving revenue generation, and a reduced debt load. Still, the airline's credit profile and its B corporate credit rating also continue to reflect risks associated with participation in the price-competitive, cyclical, and capital-intensive airline industry. They also reflect Delta's below-average, albeit improving, revenue generation, and its significant intermediate-term debt and capital spending commitments.

Delta, the third-largest U.S. airline, entered Chapter 11 bankruptcy protection in September, 2005, following the spike in jet fuel prices caused by the Gulf hurricanes. In December, 2006, US Airways Group (LCC; S&P credit rating, B–) proposed a merger with Delta, but withdrew its bid January 31, 2007, after failing to win sufficient support from the Delta creditors' committee.

Reducing Debt and Obligations

Delta has used the bankruptcy process to reduce its exposure to the competitive U.S. domestic market from almost 80% of flying to under 70% (with a further shift forecast), redeploying aircraft to international routes, and returning unneeded planes to lessors and secured creditors. It has also implemented extensive operational changes to achieve $3 billion of profit improvements (reduced costs and enhanced revenues) by the end of 2007; and terminated the pilots' defined-benefit pension plans, relieving the airline of an approximate $3.4 billion deficit (pensions of other employees have been frozen, but not terminated).

As for its balance sheet, Delta has reduced total debt and lease obligations by more than one-third through cancellation of unsecured obligations, elimination of secured debt and leases related to planes removed from the fleet, renegotiation of other secured obligations to reduce debt service, and amortization of debt while in bankruptcy.

Delta's basic operational strategy is to reduce its operating cost to one of the lowest among legacy carriers while narrowing its historical disadvantage in revenue generation. The company had secured substantial labor cost concessions (including $1 billion in annual savings from its pilots) in late 2004 as part of an (ultimately unsuccessful) effort to avoid bankruptcy, and was able to implement further labor cost reductions (partly through headcount reductions) in Chapter 11. Operating costs, measured by cost per available seat mile, have benefited also from various operational changes that have increased aircraft utilization.

Risks from the Economy

Revenue generation, measured by revenue per available seat mile, has improved significantly (20% higher in the first quarter of 2007 than in the like period two years earlier), due to a combination of reducing less profitable domestic operations (the Cincinnati and Salt Lake City hubs, and certain point-to-point flying); an aggressive expansion of international flying, principally to Europe; and benefits from the overall favorable industry pricing environment.

Delta's revenue per available seat mile (RASM) continues to trail the average of its peers, a reflection of its greater concentration in vacation markets (principally Florida) that have significant low-cost competition. But the gap is narrowing—the company estimates that length-of-haul adjusted RASM had reached 95% of its peer group by the first quarter of 2007. Delta achieved its planned $3 billion profit improvement a year ahead of schedule and continues to implement other operational improvements.