CHICAGO—(BUSINESS WIRE)—Fitch Ratings has affirmed the Issuer Default Rating for Spirit Airlines, Inc. at ‘BB+’. The Rating Outlook is Stable. Fitch has also affirmed the ratings on Spirit’s 2015-1 series of enhanced equipment trust certificates. A full list of ratings follows the end of this release.

The rating is supported by Spirit’s solid profitability, healthy liquidity, and low cost structure. Spirit’s cost advantage over its peers remains a significant ratings factor as it provides the company a meaningful cushion to operate through potential future economic downturns while maintaining adequate financial health. The company’s 20%+ EBIT margins have put it among the most profitable airlines in the industry for the past five years. Despite significant unit revenue headwinds and Fitch’s expectations that operating margins will decline from highs seen in 2015, Spirit is still expected to generate above average margins throughout our forecast period.

Fitch’s primary rating concerns revolve around the high levels of capital spending required to support Spirit’s growth plans and around increasing competition from the major carriers. Heavy capital spending and higher debt balances combined with top-line revenue pressures stemming from increasing industry competition and low oil prices may cause credit metrics to deteriorate modestly over the near term. Competition is also a particular area of focus for Spirit as the major network carriers are increasingly willing to matching Spirit’s low fares and are introducing various stripped down economy products to better compete with ultra-low cost carriers. Other concerns are typical of the airline industry and include Spirit’s unionized workforce, high degree of operating leverage, exposure to fluctuating fuel prices, and exogenous shocks that could cause demand for travel to drop quickly.

KEY RATING DRIVERS

Solid Profitability Despite Headwinds: Spirit remains one of the most profitable airlines in the industry despite facing serious unit revenue headwinds and increased competitive pressure. Spirit’s EBIT margins increased by 3.1 percentage points in the latest 12 month (LTM) period ended March 31, 2016 to 23.7% due to lower fuel prices. Spirit’s margin premium to the industry average decreased over that time as it faced unit revenue pressures of a greater magnitude than its peers. Nevertheless, Spirit remains highly profitable, and Fitch forecasts that Spirit’s margin advantage over its peers is sustainable over the intermediate term, with larger airlines facing some unit cost headwinds while Spirit has opportunities to maintain or incrementally improve its unit cost basis. A significant unknown in Spirit’s cost structure is its open pilot contract, which became amendable in August 2015. The ratification of a new contract will likely involve meaningful pay increases for Spirit’s pilots, following the trend in the industry. Pay raises may be at least partially offset by work rule changes, the cost benefits from the ongoing upgauging of Spirit’s fleet, and benefits of scale as Spirit expands.

Unit Revenue Weakness is a Near-term Concern: Fitch expects unit revenues to remain pressured at least through the remainder of 2016, following a sharp decline in 2015. Our forecast anticipates that unit revenues will stabilize or improve modestly thereafter based on some of the actions that Spirit is taking, including modifying its schedule in order to run a more reliable operation, and based on expectations that fare actions across the industry may reflect oil prices that have rebounded from recent lows. Should unit revenues remain weaker than what Fitch anticipates, the combination of a smaller top-line and a rising debt balance could cause Spirit’s leverage metrics to rise above levels that support Spirit’s current rating. Revenue pressures over the past year have been driven by a confluence of factors including sharply lower fuel prices, Spirit’s rapid capacity growth, and increasing competition from the major network carriers. The magnitude of Spirit’s RASM decline has been greater than Fitch’s prior expectations.

Mixed Credit Metrics: Spirit currently operates with a small amount of debt on its balance sheet and remains in a net cash position. On an adjusted basis (including operating leases), Fitch calculates Spirit’s total adjusted debt/EBITDAR at 3.4x as of March 31, 2016. While Spirit’s leverage has ticked up slightly over the past year, its position among its peer group has suffered as leverage metrics for much of the rest of the industry improved sharply as fuel prices have fallen and as some airlines have paid down debt. Fitch expects that total adjusted leverage may tick up into the 3.5x-4x range over the next year depending on fuel prices and the unit revenue environment, but over the longer term, leverage is expected to remain near or slightly above current levels.

While Spirit’s leverage is moderate, its coverage metrics are weak compared to some peers because of the company’s heavy use of operating leases. Funds from operations (FFO)/fixed charge coverage as of March 31 was 3.1x, which is up from 2.1x a year ago, but remains weak compared to its peer group. Fitch expects coverage metrics to improve over the next several years due to the benefits of owning some aircraft versus having 100% operating leases. Spirit is also able to negotiate lower aircraft lease rates as it grows in size and as its credit profile improves.

Sustained Negative Free Cash Flow (FCF): Fitch expects Spirit’s FCF to remain negative for the intermediate term as high capital spending is sustained by heavy aircraft deliveries in the coming years. Fitch’s forecast anticipates that FCF will be between 0 and -$200 million annually for the next three years.

EETC Ratings:

The ‘A’ rating on the 2015-1 class A certificates is primarily based on a significant amount of overcollateralization and a high quality pool of underlying assets. Since Fitch initially rated the transaction, loan-to-value ratios have deteriorated slightly compared to our initial expectations; nevertheless, the transaction remains heavily overcollateralized.

The class B certificate rating of ‘BBB+’ is notched up from Spirit’s corporate rating of ‘BB+’. The three notch differential reflects Fitch’s view that the affirmation factor for this pool of aircraft is high, and due to the presence of an 18-month liquidity facility.

KEY ASSUMPTIONS

—Capacity growth sustained in the mid-teens throughout the forecast period.

—Continued moderate economic growth in the U.S. over the near term, translating into stable demand for air travel.

—Jet fuel prices equating to roughly $60/barrel on average for 2017, increasing to approximately $70/barrel by the end of the forecast period.

—High single digit RASM decline in 2016 followed by low growth thereafter.

RATING SENSITIVITIES

Factors that could individually or collectively cause Fitch to take a positive rating action include:

—Total adjusted debt/EBITDAR falling below 3x on a sustained basis (debt/EBITDAR as of March 31, 2016: 3.4x).

—FCF trending towards positive.

—FFO fixed charge coverage ratio sustained at or above 3×.

Factors that could individually or collectively cause Fitch to take a negative rating action include:

—Total adjusted debt/EBITDAR rising towards 4x on a sustained basis.

—Liquidity as a percentage of LTM revenue falling below 20% on a sustained basis (as of March 31, 2016: 41%).

—Material weakness in revenue or a sharp uptick in costs resulting in EBIT margins sustained below 12% (as of March 31, 2016: 23.8%).

—Difficulties managing planned capacity growth which cause Fitch to make material negative revisions to its financial projections.

LIQUIDITY

Financial Flexibility Remains Solid: As of March 31, 2016, Spirit had a cash and equivalents balance of $902 million, equal to 41.3% of LTM revenue. Spirit’s cash equivalents consist of highly liquid money market funds. The company also maintains two lines of credit totaling $66.6 million. The credit lines consist of an $18.6 million line related to corporate credit cards which the company uses for interrupted trip expenses, crew hotels, etc., and a $48 million line available for both physical fuel delivery and jet fuel derivatives. As of March 31, 2016, the company had drawn $9.8 million on the former and $7.4 million on the latter. The company also maintains $25.2 million in unsecured standby letter of credit (LOC) facilities, as of March 31, the company had $14.2 million in outstanding LOCs under this facility. Spirit’s financial flexibility is supported by the absence of significant near-term debt maturities and the fact that it has no pension obligations. It’s recent purchase of two airbus A319s off of operating leases and the possibility that it may purchase more in the near term also starts to build Spirit’s unencumbered asset base.

FULL LIST OF RATING ACTIONS

Fitch has affirmed the following ratings:

Spirit Airlines, Inc.

—Issuer Default Rating at ‘BB+’.

Spirit Airlines Pass Through Trust Certificates, Series 2015-1

—Class A certificates at ‘A’;

—Class B certificates at ‘BBB+’.

Additional information is available on www.fitchratings.com

Summary of Financial Statement Adjustments

Fitch sets aside a certain amount of cash as ‘not readily available’ to reflect a minimum amount of cash that may be necessary for the company to carry on day-to-day operations and is thus not immediately available for things like debt payments or capital expenditures. Fitch estimates this amount at roughly 10% of LTM revenue.

Applicable Criteria

Corporate Rating Methodology – Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362

Rating Aircraft Enhanced Equipment Trust Certificates (pub. 12 May 2016)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=881329

Additional Disclosures

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https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1009430

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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1009430

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