Fitch affirms Southwest ratings

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Fitch Ratings has affirmed the ratings for Southwest Airlines at 'BBB'. The investment upgrade is reflected by the budget carrier’s solid free cash flow, declining leverage, substantial financial flexibility, and large base of unencumbered assets, says the rating agency in a research note.

The rating outlook is stable.

Southwest's ability to consistently generate significant free cash flow is one of the factors that sets the company apart from its industry peers, says Fitch. In the 12 months ended 30 June, 2013, Southwest generated $873 million in free cash flow, despite relatively heavy capital spending.

“Free cash flow has been consistently positive since 2008 when the industry was going through the worst of the recession. Over the next several years, Fitch expects free cash flow to be pressured by heavy capital spending as the company continues to renew its fleet, by increased dividend payments announced in May, and by the remaining share buybacks under the company's $1.5 billion repurchase authorization. However, free cash flow is expected to remain steadily positive through the near to intermediate term.”

Fitch notes that since the beginning of the year, Southwest has paid down $220 million in balance sheet debt and plans to pay down roughly another $100 million by year-end.

Southwest's ended the second quarter with a cash balance of $3.4 billion, augmented by an upsized $1 billion revolver facility which has a five-year term.

“Total liquidity, including revolver capacity, totalled 25.5% of LTM revenue, which is among the highest in the industry,” comments Fitch.

The rating agency says that unlike most other North American carriers, Southwest also maintains a significant pool of unencumbered assets which should support its access to the capital markets even in a future recession. “Unencumbered assets at the end of 2012 totalled $6.8 billion. Fitch expects Southwest to generate sufficient cash flow over the next several years to continue to fund its aircraft deliveries without accessing the debt markets, adding to its existing pool of high-quality, unencumbered assets.”

The rating agency rated Southwest’s issuer default rating (IDR) at 'BBB', the senior unsecured debt at 'BBB', the $1 billion unsecured revolving credit facility expiring April 2018 at 'BBB' and the secured term loans due 2019 and 2020 at 'BBB+'.