Fitch Ratings has affirmed Etihad Airways PJSC’s Long-Term Issuer Default Rating (IDR) at ‘A’ with a Stable Outlook and published its senior unsecured rating of ‘A’.

Etihad’s ‘A’ ratings reflect fairly strong strategic and operational links and, to a lesser extent, legal links with the airline’s sole indirect shareholder – the Emirate of Abu Dhabi (AA/Stable). These links are reflected in the IDR being notched down from the Emirate’s rating by three notches.

KEY RATING DRIVERS

Parent and Subsidiary Linkage

Etihad’s ‘A’ IDR is notched down from that of 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.
Etihad’s mandate set in 2006 to establish a commercially viable airline that is also an economic contributor, along with shareholder commitment to support the implementation of this mandate, remains intact, despite a drop in oil prices and a challenging operating environment.

Strategic Links

Etihad’s strategic importance to Abu Dhabi is underpinned by the airline’s vital role in tourism development in Abu Dhabi and in supporting Abu Dhabi’s brand internationally. The airline is also integral to the implementation of the Emirate’s 2030 Vision, which aims at development of non-oil related sectors of the economy. Strategic ties are reflected in consistent and tangible commitments made by Abu Dhabi to Etihad in the form of equity injections and a shareholder loan.
Operational Ties

The strength of operational ties is underpinned by Etihad’s role in connecting Abu Dhabi and the UAE domestically and internationally, in turn developing the transportation hub at Abu Dhabi International Airport. Etihad carried over 75% of all the passenger traffic through Abu Dhabi airport in 2015 or 84% 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 Chairman of the Executive Council of Abu Dhabi. 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 or guarantees. The inclusion of any of these provisions would strengthen the linkage and would likely be positive for the ratings.

Stretched Financials

Etihad underperformed our expectations for 2015 due to challenging market conditions, competitive pressures, fuel hedging losses and weaker yields. We do not expect market recovery in the short term with pressure on yields persisting in 2016-2017. We expect the recovery of the financial profile to be slow with visible improvements only from 2018. Capex will remain sizeable, despite plans to moderate the airline’s investments. As a result, Etihad’s standalone credit profile remains significantly lower than the current ‘A’ rating, in our view.

Growth Moderation in Challenging Environment

We expect substantial moderation in Etihad’s capacity growth over 2016-2020 due to slowing traffic growth as a result of economic slowdown from low oil prices in the Middle East and terrorism threats. This should help the company sustain its load factors in contrast to Emirates or Turkish Airlines (THY) which posted a significant reduction in their load factors due to their continuing material capacity expansion. We expect Etihad’s revenue passenger kilometres (RPK) to grow in line with the market in 2016 and forecast RPK to increase at a 9.2% CAGR over 2015-2020, compared with a 20% CAGR over 2010-2015.

Pressure on Yield to Remain

We expect further pressure on yields in 2016-2017 due to low oil prices, slower traffic growth, capacity growth outstripping demand for Middle Eastern carriers, and focus on transfer traffic, which generates lower yields. The company’s unit revenue underperformed Fitch’s expectations in 2015. We forecast Etihad’s yields in USD cents to decline in 2016-2017 before gradually increasing from 2018.

Competitive Cost Position

Etihad is favourably positioned on the cost curve compared with European legacy carriers, which should support its future profitability. But its unit costs (eg cost per available seat-kilometre (CASK)) are comparable with those of other emerging market airlines, including Aeroflot, Emirates and THY, albeit on the higher side. The company was able to achieve a 4.1% reduction in CASK (excluding fuel costs) in 2015. We expect Etihad to retain its cost advantage in the short- to medium-term, which along with measures on revenue management, should underpin higher margins.

As fuel expenses are the largest cost item (31.8% of 2015 operating costs), Etihad uses a hedging policy to manage its exposure to fuel prices. We do not expect low oil prices to have an impact on the company’s financials in earnest before 2017 when the impact of previous fuel hedges wanes.

Growing Network through Partnerships

Etihad has achieved its operational scale much faster than its Gulf or European competition. Etihad along with its equity partners is the second-largest carrier among the European and Gulf airlines after Lufthansa based on the number of passengers and is the fourth-largest based on RPK.

In addition to achieving a sustainable scale, Etihad reached the breadth and depth of the network in line with that of its more mature peers through eight equity partners and 49 codeshare partners. Etihad fares well compared with European peers based on the geographic diversity of its revenue and RPK and is favourably positioned relative to Emirates and THY, with a more balanced revenue split by geography and a stronger position on Asian and American destinations.

Solid Market & Hub Position

One of the key competitive advantages of Etihad compared with European peers is the proximity of its hub 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 competitiveness is also being boosted by increasing penetration of the US market, 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 on a standalone basis 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.

KEY ASSUMPTIONS

Fitch’s key assumptions within our rating case for the issuer include:

- Capex in line with the company’s forecast

- No dividend payments over 2016-2020

- Decline in yields in USD cents in 2016-2017 with a gradual increase from 2018

- RPK to grow in line with the market in 2016 and at a 9.2% CAGR over 2015-2020

- Oil price of USD42/bbl for 2016, USD45/bbl for 2017, USD55/bbl for 2018 and USD65/bbl thereafter. Fuel hedges as per company’s disclosure to us

RATING SENSITIVITIES

Positive: Rating upside is limited in the short term as we perceive the high sector risk as a rating constraint. However, future developments that may, individually or collectively, lead to positive rating action include:

- Explicit legal ties (e.g. financial guarantees by sole indirect shareholder for a large portion of the company’s debt or cross default provisions), which would be positive for the ratings, but are not considered likely.

Negative: Future developments that may, individually or collectively, lead to negative rating action include:

-Weakening of the creditworthiness of the sole indirect shareholder Abu Dhabi, which 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 un-remedied liquidity challenges, such as the inability to cover upcoming 12 months’ financial obligations from cash and committed facilities.

LIQUIDITY

Etihad liquidity position is subject to external funding being made available. Its cash position was USD366m at end-2015, available credit facilities were USD523m as of August, mostly due in 2016, and the company received USD89m from the notes placement under EA Partners II BV transaction. Short-term maturities were USD1.5bn at end-2015, out of which USD500m were already refinanced. Debt repayments are high in 2016-2018. The maturity profile of Etihad’s finance leases is well balanced. Facilities maturing in 2016 and 2017 are in the process of being refinanced with maturities of over two years.

We expect the company to continue generating negative free cash flow due to high capex and thus remain exposed to external funding being made available.

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 USD6.2bn at end-2015, which can also provide an additional source of liquidity.

FX Exposure

Most of Etihad’s debt is denominated in USD or USD-pegged currencies (91% in 2015). 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.

Senior Unsecured Rating

The senior unsecured rating is aligned with the company’s Long-Term IDR, given adequate unencumbered assets, the value of which remains well above 2x of unsecured debt.

Ends

Contact:
Supervisory Analyst
Angelina Valavina
Senior Director
+44 20 3530 1314
Fitch Ratings Limited
30 North Colonnade
London E14 5GN

Principal Analyst
Raman Singla
Associate Director
+44 20 3530 1728

Committee Chair
Josef Pospisil
Managing Director
+44 20 3530 1287

Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com.

Summary of Financial Statement Adjustments

-Guarantees provided to Jet Airways were added to Etihad’s gross adjusted debt in 2015

-Gain on sale of assets was excluded from EBITDA calculation in 2015

Additional information is available on www.fitchratings.com. For regulatory purposes in various jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this issuer; the principal analyst is deemed to be the secondary.