Written by Cameron Caldwell and Rachel Hill (University of Glasgow), Chirag Gupta (NYU Stern)
Edited by Seerat Sandhu (Scripps College), Udhaav Jhunjhunwala (Singapore Management University), Callum Magee (University of Glasgow)
Overview of the Deal
Delta, once again, turned to the capital markets in June to raise $1.25 billion in unsecured, five-year bonds, having previously raised $3.5 billion in April through a sale of five-year secured bonds. This issuance, yielding 7.38%, means Delta has raised an accumulative $10+ billion since the pandemic began.
As the airline industry continues to face massive pressure due to mainly travel restrictions, there are still concerns whether the industry and Delta, will be able to sustain themselves for a potentially long period of operating below capacity and incurring losses. While the unsecured bond classification hinting there's better things to come since their last issuance, fears of a 2nd bankruptcy in 15 years still loom.
Credit rating agencies remain speculative over Delta’s future, with Fitch assigning a BB+ rating to the issuance, signifying its non-investment grade classification and inline with Delta’s corporate rating. However, such classification was expected given the unsecured bond's yield is about 23 times higher than the current interest on a five-year U.S. Treasury note, portraying their risk and potential future junk-rating.
The airline industry has been one of the hardest-hit by COVID-19. Since the pandemic’s effects began on the Western World, airlines have been struggling for liquidity. The border closures emerging in March marked the mass grounding of aeroplanes worldwide. Still, 6 months on, travel restrictions remain in place across large parts of the globe. With an increased transmission rate on planes and the possibility of carrying the virus from air travel, authorities have had no choice but to close borders, grounding aircraft to control the spread of the virus.
Delta offered voluntary redundancies, buyouts and will furlough some staff in November, much like American Airlines and United Airlines, to reduce labour costs in a bid to try and weather the effects of a depleted top line. Many airlines, including Delta, reported significant reductions to their revenue and profits in Q1 and Q2, despite extensive cost cuts, causing some airlines to collapse including Flybe, Virgin Australia and Avianca. However, while other industries are ready to return to business as usual, Delta will likely see both business and leisure air travel likely to be affected for many years to come. This is of significant importance to Delta following quickly after Delta’s need to rebuild their reputation after an emergency fuel dump in January, causing 31 injuries on the ground in Los Angeles.
Delta, under the CARES (Coronavirus Aid, Relief, and Economic Security) Act, had not been able to furlough any of their workers until October as a result of measures to prevent further unemployment filings in the US in obligation to the acceptance of federal aid. Instead, their approach has been to try and preserve as many jobs as possible, through voluntary leave, buyouts, pay cuts and reduced work schedules. However, on October the 1st, many companies announced significant job cuts, including airlines. Since the lifting of restrictions and with US airlines fearing the worst, the main priority over the pandemic has been to raise capital. Southwest Airlines Co. has raised capital through the bond market three times this year, United Airlines have issued further shares and JetBlue is in the stages of marketing a $500 million loan with universal uncertainty over the future of business.
“It would be naive to believe we or anyone for that matter can accurately predict the course of this crisis or the recovery”
J. Scott Kirby, United’s president and incoming Chief Executive
Delta Airlines Inc (NYSE:DAL) is one of the biggest airlines in the United States. Currently ranked 69 on Fortune 500 list, Delta operated over 5,400 flights daily across 325 locations in 52 countries worldwide pre-pandemic. The airline is also a member of the SkyTeam airline alliance along with other prominent airlines like Air France and KLM.
Founded in: 1928
Headquartered in: Atlanta, GA, United States
CEO: Ed Bastian
Number of Employees: 91,000 (2019)
Market Cap: $20.16 billion (As of 28/09/2020)
EV: $33.58 billion
LTM Revenue: $34.06 billion
LTM EBITDA: $3.09 billion
LTM EV/Revenue: 0.99x
LTM EV/EBITDA: 10.87x
Debt Asset Ratio: 0.48x
Figure 1: Current Capital Structure of Delta (Capital IQ)
Figure 2: Bond Details of Delta (Cbonds)
Figure 3: Credit Ratings of Delta (Capital IQ)
Delta experienced a credit revision by Fitch at the beginning of this year, with a downgrade from BBB- to a non-investment grade rating of BB+. The negative outlook has increased with expectations that Delta would face a more substantial hit from COVID-19 than first anticipated. S&P assigned a BB rating in September with a negative outlook, with a more pessimistic approach than Fitch. Moody’s favours Delta slightly more after it assigned an investment-grade rating of Baa3 in January with a stable outlook. Yet, Delta experienced a further degradation with their outlook switching to negative in July. Moreover, after the September issuance of $8 billion, the ratings are likely to be revised along with the potential Moody’s will move to junk status too as Delta's Net debt-to-EBITDA ratio continues to rise.
"Given the combined effects of the pandemic and associated financial impact on the global economy, we continue to believe that it will be more than two years before we see a sustainable recovery"
Ed Bastian, Delta CEO
Projections and Assumptions
Why was this deal done?
Since the outbreak of COVID-19, the airline industry has been under great distress. Without the option to furlough staff until October, Delta had become cash strapped. Having last turned to the bond markets in April for $3.5 billion, Delta determined that further cash is required to fund its liquidity and repay its outstanding debt.
Delta has almost $19 billion in current assets and reported it had 19 months of liquidity at the end of last quarter. However, looking to avoid its second bankruptcy in 15 years, Delta is conscious of upcoming obligations in late 2020/early 2021. Delta had 3 debt maturities before the end of April 2021, totalling $2.375 billion and it is expected funds from this issuance will be used to help satisfy their upcoming obligations. Supporting their liquidity through this issuance to manage upcoming maturities is seen as a credit neutral move.
In 2019, Delta was ranked the number one airline for profitability, as they increased their revenue by 6%. However, with the ongoing impacts of the pandemic, travel restrictions, reduction of both leisure and corporate travel and the collapse of passenger confidence, Delta’s future enters turbulent times. Half of the US’s planes remain out of flight and face a 90% reduction in use. Delta reported a 93% YoY decline in Q2 passenger numbers translating directly to a 91% decline of revenue, forcing Delta to cut their capacity significantly. The international capacity reduction is sitting at over 20%, with domestic over 10% as Delta seeks to protect themself against further risk. Delta is deferring delivery of over 40 Airbus aircraft that were scheduled for arrival at the end of 2020 to better prepare for the slowly increasing capacity as demand for air travel picks up over time.
Alongside the sale of bonds, Delta has aimed to increase cash flow through planned ongoing cost reduction, aided by the crude oil collapse in April, generating an approximate $2 billion cost-saving. Delta achieved a 50% reduction on their outgoings in Q2 with a move to reduce costs and increase their fleet efficiency through the reduction in running (84%) and upkeep costs (90%) of their fleet. With Delta’s stock price dipping over 48% over the last year, it is unclear how Delta can recover in the short-term. Their issuance of unsecured bonds rather than secured notes signifies a root towards their long recovery, and this combined with the fact the bonds were initially marketed with a yield of 8% suggest the general credit market has been improving in recent months. However, still experiencing a relatively large daily cash burn, from both COVID-induced costs and their wider economic impact, revenues are recovering, but nowhere near pre-COVID levels as Delta will likely see losses for the remainder of the year, much like other US airlines.
With very unpredictable rates of recovery expected in the airline industry, it can be hard to consider long-term outcomes. However, one thing for sure is that Delta faces some challenging years ahead. Delta’s low Altman Z score, hitting 0.89, presents the possibility that bankruptcy is not off the table and a further significant drop in revenues would be catastrophic for Delta’s business.
Delta detailed their ‘recovery path’ in July in which they plan a reduction of their aircraft numbers and the retirement of their older, less efficient aircraft over the coming years. Delta will aim to reposition themselves for the increase in short-haul flights as they target a reduction in their fleet and increase their cost-efficiencies. They also want to capitalise on the ability to lower the cost/time scale of construction projects in their terminals aiding the freeing up of cash. Fitch and S&P analysts took into account recovery that wasn’t rebounding to pre-COVID levels until at least 2023 as this recovery is linked to Delta’s customer base returning, increasing revenues and eliminating their negative net cash flow.
Delta’s ability to control its cash flow in the long-run will be crucial. With adjusted net debt up 49% in Q2 YoY, Delta will have some large future obligations in addition to its day-to-day and operating costs.
Financial Ratio Analysis
Figure 4: Financial Ratios of Delta (Capital IQ)
Delta entered negative Return on Equity for LTM Jun-30-2020 (32.3% vs 32.8% for the fiscal year ending Dec-31-2019) as they were hit by restrictions on air travel, resulting in the curtailment of both managerial efficiency and net income
Net Income Margin, Levered Free Cash Flow Margin and Unlevered Free Cash Flow Margin percentages for Delta’s LTM fell negative, despite Delta’s gross margin managing to remain positive. It strongly indicates the serious reduction of cash flow as they enter liquidity issues
The YoY increase of the Total Debt/(EBITDA-CAPEX) with an over 3-fold increase since 2019, and over 6-fold from 2016 bears witness to Delta’s increasing reliance on debt every year, with the increase of the debt simultaneous with the reduction of the denominator
The fall of Delta’s Altman Z score to 0.89 strongly suggests the possibilities of Delta entering bankruptcy within the next 2-fiscal years falling under the 1.81 threshold of financial security indicating Delta sits with great risk
Risks and Uncertainties
Having received 2-term loans, initiated 2-issuances as well as receiving a Care Act loan, Delta hasn’t fallen short of cash in recent months. However, this financing will need to be repaid over time and while Delta’s efforts to gain capital have resulted in a much higher cash balance of around $15 billion at the end of Q2, Delta’s debt balance increased by approximately $13.7 billion as expected. However, net debt has only increased by $4.8 billion signifying Delta’s future to be less risky than first predicted.
From a long-term perspective, Delta’s debt balance could pose a significant risk if the net debt were to continue to increase. With Delta running the risk of having to finance their existing debt maturities with further financing if their cash balance were to dry up over time. The biggest issue will be the interest payments on the debt, rather than the repayment itself since it is due after at least 5-years and will likely be rolled over-dependent on whether or not travel has rebounded before the respective commitments/maturities are due. For now, the increase in net debt is sustainable, and Delta can use cash to de-lever if revenues and cash flows improve.
While in other industries recovery is dependable on a vaccine, the airline industry is more uncertain. The willingness to travel via plane is expected not to rebound instantly with consumer confidence taking a long time to rebuild. Many airlines fear they will not be able to operate with severely less revenue for multiple years if consumer confidence remains low. An extension of travel restrictions or the re-introduction in lockdown measures also poses a significant risk to Delta’s recovery. It is unclear whether Delta and other US airlines could survive another significant drop in travel. While expectations are not predicting a full recovery until 2023, Delta still runs the risk that recovery may take even longer.
Leisure travel has begun to recover, but an equally large market pre-pandemic, business travel, has yet to make any attempts at recovery, mainly due to the fact corporate travel restrictions are preventing employees from travelling for business. Even with the gradual lifting of travel restrictions, corporations will likely take a more gradual approach in respect to international travel, and corporate restrictions could still be in force long after government travel restrictions are lifted.
For years, Delta has battled with the likes of American Airlines, Jet Blue, United Airlines and Southwest Airlines in a market in which Delta excelled. However, competitive advantage is going to be even more crucial in the return of aviation as consumers prioritise airlines over factors which were less prominent pre-pandemic, including plane cleanliness and COVID-19 protection procedures. Delta risks losing customers to competitors if it cannot provide what customers are looking for in a very different era of air travel.
“The airlines certainly need to get back into business but they’re going to be facing a public that’s going to be scared to travel”
Henry Harteveldt, president of Atmosphere Research Group