Fitch Ratings-London-03 June 2015: Fitch Ratings has assigned Etihad Airways PJSC a Long-term Issuer Default Rating (IDR) of ‘A’ with a Stable Outlook.

Etihad’s ‘A’ rating incorporates strategic and operational links with its sole shareholder – the Emirate of Abu Dhabi (AA/Stable) and is notched down from the Emirate’s rating by three notches.

KEY RATING DRIVERS
Parent and Subsidiary Linkage
Etihad’s ‘A’ rating is notched down from that of its sole direct shareholder the Emirate of Abu Dhabi by three notches as we assess the strategic and operational ties and to a lesser extent, the legal ties between the company and the Emirate as strong, in accordance with Fitch’s Parent and Subsidiary Rating Linkage methodology.

Strategic Links
Etihad’s strategic importance to Abu Dhabi is underpinned by the fact that it is vital for tourism development in Abu Dhabi and is integral to the implementation of the Emirate’s 2030 Vision, which aims at development of non-oil related sectors of the economy, as well as to support Abu Dhabi’s brand internationally. Strategic ties are thus reflected in consistent and tangible commitments made by Abu Dhabi to Etihad in the form of equity injections and a shareholder loan.

Etihad’s contribution (direct and indirect) to Abu Dhabi’s economy was estimated by Oxford Economics at USD15.6bn in 2013 (6% of the country’s 2013 GDP). The group supported 11.9% of non-oil jobs in the country.

Operational Ties
The strength of operational ties is underpinned by Etihad’s role in connecting Abu Dhabi and the UAE domestically and internationally, developing the transportation hub at Abu Dhabi International Airport. Etihad carried over 74% of all the passenger traffic through Abu Dhabi airport in 2014 or 82% if the contribution of Etihad equity airlines is taken into account. In addition, Etihad’s growth is important for providing passenger traffic to the new, Etihad-dedicated terminal under construction at Abu Dhabi airport. Etihad’s Board is appointed by the Amiri Decree. The Board determines the company’s top management.

Limited Legal Links
We assess the legal ties between Etihad and Abu Dhabi to be limited as Etihad does not benefit from cross-default provisions and/or guarantees. The inclusion of any of these provisions would strengthen the linkage and would likely to be positive for the rating.

Network Scale and Diversify Through Partnerships
Formed in 2003, Etihad is a relatively young airline but has managed to establish a global network with the scale and depth similar to that of its more established European and Gulf peers by implementing a growth model combining organic fleet expansion with codeshare partnerships and minority equity investments in other airlines. This has enabled Etihad to reach a sustainable operational scale and diversity at a much faster pace than rivals, and established a platform for more measured future growth. An established network is key to any airline’s success and sustainability because it underpins revenue generation and cost management.

Good Market & Hub Position
One of the key competitive advantages of Etihad compared with European and to some extent US peers is the geographic location of its hub in proximity to the fast-growing travel markets of Asia, Middle East and Africa. Etihad’s more developed route network in these regions gives it a competitive edge over European carriers that are also focusing on connecting the Asian, Middle Eastern and African passenger traffic to Europe and the US. Etihad’s increasing penetration of the US market is also likely to help compared with the European and US rivals.

However, this does not offset the effects of fierce competition among the airlines on these growth destinations and Etihad’s exposure to market changes and yield’s pressure. The three main Gulf carriers benefit from similar geographic locations of their hubs. Etihad is the smallest, but has three competitive advantages over its Gulf peers – US pre-clearance at its Abu Dhabi hub, shorter connecting time and greater domestic access to key markets such as Europe and India, through its airline partnerships.

Unit Revenue Pressured by Rapid Growth
Building a network during a relatively short period of time through rapid expansion while competing with already established Gulf and other carriers led to constant pressure on Etihad’s passenger revenue per available seat-kilometre (PRASK) and yield. Despite expansion-related and competitive pressures, Etihad’s PRASK has remained relatively stable over the past five years.

We believe that the achieved critical network size should enable the company to focus on profitability management capitalising on its scale and brand recognition, as well as on incremental revenue and synergies from its operations with equity partners. The company on its own generated 28% of 2014 passenger revenue from premium class and business travellers accounted for 16% of total passengers carried in 2014 and quality focused leisure travellers for 26% of passenger traffic, all of which provide a solid base for enhanced profitability focus. While this is likely to underpin stronger PRASK and yield performance, in our forecasts we assumed a marginal decline in yields over 2015-2019 due to high competitive pressures and further capacity growth.

Competitive CASK Position
Etihad is favourably positioned on the cost curve compared with the European legacy carriers, which provided a foundation for its extensive growth, despite pressure on unit revenues, and should support its sustained profitability. The company’s unit costs (eg cost per available seat-kilometre (CASK)) are much lower than those of its European rivals but are comparable with those of other emerging market airlines, including Aeroflot (BB-/Stable) and Emirates.

We expect Etihad to retain its cost advantage in the short to medium term, which along with measures on revenue management side should underpin higher margins. Having reached scalability, the company plans to increase its focus on profitability and cost management through network management, fleet optimisation and higher fleet utilisation. The cooperation with equity airline partners may also bring in synergies and cost savings on joint fleet orders, joint procurement (eg ground handling, catering, fuel, etc) and aircraft maintenance and joint staff training, among other things.

Stretched Financials Driven by Expansion and M&A
We view Etihad’s business profile as relatively strong due to its extensive network, strong market position, favourable geographic hub location poised for growth and cost advantage. At the same time, the company’s financial profile is challenged, despite the forecast gradual improvement in credit metrics. As a result, Etihad’s standalone credit profile is lower than the ‘A’ rating, in our view.

Etihad’s credit metrics were negatively impacted in 2013-2014 by the start of the intensive capex phase, acquisitions and continuous pressure on yields. While the company plans to continue heavy investments in fleet expansion, we believe it has reached a more mature stage of its business profile development, which should enable it to focus more on profitable growth. As a result, we expect a gradual improvement in its credit metrics with funds from operations (FFO) gross adjusted leverage declining to slightly below 7x by 2019 and FFO fixed charge cover increasing to above 2x from 2018.

We expect the decline in oil prices to start feeding through the financials from 2016 once the share of fuel consumption hedged at higher prices begins to diminish. The peak of the capex cycle is expected beyond our forecast horizon (after 2022), therefore, the leverage ratios are likely to remain high, despite some improvement.

KEY RATING ASSUMPTIONS
Fitch’s key assumptions within our rating case for the issuer include:
-No dividend payments over 2015-2019
-Capex in line with the company’s forecast
-Significant capacity growth with a relatively stable load factor over 2015-2019
-Marginal decline in yields over 2015-2019
-Oil price of USD65/bbl in 2015 and USD75/bbl in 2016

RATING SENSITIVITIES
Positive: Future developments that could lead to positive rating action include:
-We consider rating upside to be limited in the short term as we perceive the high sector risk as a rating constraint.
-Explicit legal ties (e.g. financial guarantees by the majority shareholder for a large portion of the company’s debt and/or cross default provisions) would be positive for the ratings, but are not considered likely.

Negative: Future developments that could lead to negative rating action include:
-Weakening of the creditworthiness of the sole shareholder – Abu Dhabi – could be negative for Etihad’s ratings, unless we view the links with the parent as stronger.
-Evidence of weaker ties with Abu Dhabi.
-Evidence of unremedied liquidity challenges, such as the inability to cover upcoming 12 months’ financial obligations from cash and committed facilities.

LIQUIDITY AND DEBT STRUCTURE
Adequate Liquidity
We view Etihad’s liquidity position as adequate, but exposed to continued availability of external funding. Its cash position of USD738m at end-2014 along with available credit facilities of USD487m due in 2015 was sufficient to cover short-term maturities of USD615m. The company’s debt maturity profile is well balanced and consists mainly of payments under finance leases. The only bulk repayment is in 2016 as USD1.27bn of revolving credit facilities are falling due in 2016 in addition to annual finance leases payment of USD638m. We expect the company to continue generating negative free cash flow (FCF, including finance leases) due to high capex and thus remain exposed to available external funding. When finance leases are excluded, FCF turns positive from 2017.

The company’s policy is to maintain at least 10% of revenue in total liquidity (including cash and available credit facilities) and at least 5% of turnover in unrestricted cash. The company’s unencumbered assets amounted to USD4.9bn at end-2014, which can also provide an additional source of liquidity.

Most of Etihad’s debt is denominated in USD (91% in 2014) and only about 25% of debt is at fixed rates. The company uses both FX and interest rate hedging. FX risk management policy at Etihad focuses on the forecast net cash flow position in each currency over time.