Fitch Ratings-London-15 March 2017: Fitch Ratings has upgraded British Airways Plc’s (BA) Long-Term Issuer Default Rating (IDR) to ‘BBB-’ from ‘BB+’. The Outlook is Stable.

The upgrade is supported by BA’s strong credit metrics and adherence to prudent financial policy including cost control. The rating also reflects the company’s extensively diversified route network, strong hub position at Heathrow and strong position on the cash flow-generative routes to the US. We rate BA on a standalone basis.

KEY RATING DRIVERS
Financials Drive Rating Upgrade: The rating upgrade reflects Fitch’s expectation that the company will report a strong financial performance over the medium term despite political and economic uncertainty and the implementation of a disciplined financial policy. Although we have revised down our EBITDA forecasts for BA, we expect it to be one of a very few EMEA airlines generating positive free cash flow (FCF) over 2016-2020. We anticipate that funds from operations (FFO) gross adjusted leverage will trend towards 2.5x and that the cash position will remain high with FFO net adjusted leverage falling below 2x in 2017.

BA remains the key contributor to its parent International Airlines Group’s (IAG) cash flows. BA has the flexibility to pay dividends up to 35% of its net income without incurring additional pension payments. BA’s adherence to prudent financial policy and cost control is key to its standalone rating.

Brexit Vote Absorbed; Uncertainty Remains: We believe that the immediate impact of the UK Brexit referendum, which led to lower corporate travel demand and significant sterling depreciation, has already been absorbed by BA’s credit metrics in 2016. Despite lower-than-expected EBIT in 2016, the company’s financial ratios remained strong. BA plans to address the uncertain operating environment through more disciplined capacity growth, capex moderation and an even stronger focus on cost optimisation. The company’s FX exposure is well balanced, which along with active FX hedging limits the impact of the weak pound on BA’s financials. Its geographical diversity should also help BA weather the uncertainty and cash-flow volatility following the Brexit vote.

Heathrow as a Global Hub: BA’s strong hub position at Heathrow is key to its competitiveness and successful implementation of long-haul strategy. Heathrow is the largest airport in Europe and the sixth largest in the world in terms of passenger traffic in 2015. It is also the largest European hub for transatlantic travel. BA is the leading airline in its Heathrow hub with about 53% of Heathrow slots. Although BA operates some flights from other airports in London, its main hub is Heathrow, which is underpinned by the airport’s favourable location, good transportation links to London and relatively large capacity suitable for hubbing activities.

Diversified Network; North America Key: BA’s strong business profile is underpinned by: the scale and diversity of its route network, with over 400 destinations worldwide (including joint business agreements and code share agreements); its strong presence on key profitable routes (primarily North America); and the company’s position as the third-largest European airline based on revenue-passenger-kilometres.

One of BA’s competitive advantages is its significant transatlantic network, which is a key contributor to the company’s cash flow generation. BA is well placed to capitalise on the UK’s strong cultural and financial ties to the US to withstand the competition in this lucrative market.

Cost Control in Focus: BA continues its rigorous cost management and plans to implement Plan4 over 2016-2020, which aims at non-fuel cost reduction during this period. We expect the cost control measures to become the driver of the company’s profitability in the short-to-medium term in the environment of political and economic uncertainty. BA has been leading its European peers on cost metrics and is comparable to US carriers.

Rating on a Standalone Basis: Fitch rates BA on a standalone basis as we assess the legal and operational ties between IAG and BA as moderate. This reflects IAG’s principle of the standalone management of its operating entities. In BA’s financing, there are no cross-default provisions to other IAG-owned entities. There are no cross-guarantees among the entities in IAG, with independent debt management at subsidiary airlines. In addition, BA has an independent board of directors.

DERIVATION SUMMARY
BA’s ‘BBB-’ rating is supported by its strong business and financial profiles. BA’s business profile compares well with those of Delta Air Lines (BBB-/Stable), Alaska Air Group Inc. (BBB-/Stable), Air France-KLM, Lufthansa and American Airlines Group, Inc. (BB-/Stable) due to BA’s extensively diversified route network, strong hub position at Heathrow, strong position on the cash flow-generative routes to the US, and rigorous cost management. BA’s financial profile is comparable to that of other ‘BBB-’ rated airlines due to BA’s reduced leverage, strong coverage metrics and expected positive FCF generation.

KEY ASSUMPTIONS
Fitch’s key assumptions within our rating case for the issuer include:
- Capacity expansion at an average 2% per annum over 2016-2020
- UK GDP growth of 1.8% in 2016, 1.5% in 2017 and 1.3% afterwards
- Dividend payout ratio of 35%
- Cash pension payment of GBP300m per year over 2016-2020
- Decline in yields in USD cents in 2016-2017 and relatively flat afterwards

RATING SENSITIVITIES
Future Developments That May, Individually or Collectively, Lead to Positive Rating Action
- Sustained positive FCF generation
- FFO gross adjusted leverage below 2.5x and FFO net adjusted leverage below 1.5x on a sustained basis with FFO fixed charge cover comfortably above 5x
- Disciplined financial and dividend policy and adherence by IAG to the principle of the standalone financial management of its operating entities

Future Developments That May, Individually or Collectively, Lead to Negative Rating Action
- Intensive capex, generous dividend payments, drop in yields or traffic resulting in negative FCF through the cycle and a deterioration in credit metrics
- FFO gross adjusted leverage above 3x, FFO net adjusted leverage above 2.0x and FFO fixed charge cover below 5x on a sustained basis
- Tighter links with the IAG group (for example, cross-guarantees or fully integrated balance sheet)

LIQUIDITY
BA has a strong liquidity position. Its cash position of GBP2.5bn at end-2016 and committed undrawn credit lines of GBP2.0bn (as of October 2016) are more than sufficient to cover the company’s maturities of GBP721m in 2017 and GBP632m in 2018. The credit facilities are due in 2021-2022. The debt maturity profile is well balanced. Assuming a 35% dividend payout ratio, we expect BA to generate positive FCF over 2016-2020.