Delta Air Lines Inc. upgraded to ‘BBB-’ on expectation for stronger-than-forecast credit measures

• S&P Global Ratings expects Delta Air Lines Inc. will generate sustainably stronger credit measures than we previously forecast, supported by its steady margin expansion and increasing revenue.
• In addition, we assume the company will generate material free operating cash flow (FOCF), which it could use for further debt reduction.
• Delta has announced a new, more-conservative leverage target, which we view as signaling management's increased commitment to strengthening its balance sheet.
• Therefore, we raised our issuer credit rating (ICR) on Delta to 'BBB-' from 'BB+'.
• Our issue-level ratings on the company's senior and unsecured debt are now aligned with the ICR, thus we raised our ratings on its enhanced equipment trust certificates (EETCs).
• The stable outlook reflects our expectation that Delta will generate funds from operations (FFO) to debt of about 40% in 2025 on continued favorable passenger demand, which will support increasing revenue, higher margins, and debt reduction.

S&P Global Ratings today took the rating actions listed above.

Delta is well positioned to generate sustainably stronger credit measures.

The company has steadily improved its earnings and cash flow over the past three years and we assume it will exceed the levels it reported in 2019 next year. Delta also reduced its gross debt by about $2 billion year to date through Sept. 30, 2024. We now estimate its FFO to debt will be over 30% this year and about 40% in 2025, which is in line with our previous upgrade trigger. These figures correspond to S&P Global Ratings-adjusted debt to EBITDA of roughly 2x next year.

The improvement in our estimated credit measures for Delta incorporates its recently disclosed guidance, as well as our expectation for continued favorable demand in its core end markets and moderate industry capacity expansion. Our expectations for increased earnings and strong positive FOCF generation, amid a period of relatively stable capital expenditure (capex), underpin the expected improvement, which we anticipate will support incremental debt reduction.

Lastly, the company introduced a new, more-conservative gross leverage target of 1x over the next few years (slightly higher on an S&P Global Ratings-adjusted basis), which we believe is indicates its intention to continue strengthening its balance sheet. In our view, Delta has enhanced its capacity to withstand unexpected earnings weakness linked to historically volatile airline market conditions and preserve credit measures commensurate with its rating.

We believe Delta will remain a key beneficiary of what appears to be a structural shift in passenger travel demand.

The company has materially expanded its premium, loyalty, and international revenue over the past several years, which we assume will continue. Delta has highlighted its goal of generating durable earnings and we believe these segments provide the most upside to its business and profitability. We expect the proportion of the company's revenue that it derives from its main cabin sales, which it estimates will account for 43% of its 2024 revenue, will gradually decline toward 40% as it expands its higher-margin premium, loyalty, and other revenue at above-average levels. Delta's premium seating, which includes four classes above its main cabin (with ascending margin profiles up to its Delta One class), generates high repeat purchases, mainly by less economically sensitive consumers.

Over the next two years, we assume Delta's profitability measures will lead its closest North American airline industry peers. We estimate the company's S&P Global Ratings-adjusted operating margins will be in the 10%-12% range over the next two years--though still below its pre-pandemic average--before trending positively toward its long-term (2027-2029) target in the mid-teens percent area. Delta's SkyMiles loyalty program and co-branded card with American Express have been a notable source of earnings growth and profitability and we expect its contributions will likely further improve. This reflects our assumption of steady consumer demand, as well as the company's updated renumeration target of $10 billion over the next 3-5 years, which is up from over $7 billion in 2024.

Delta will likely generate steady positive FOCF, which we expect it will most likely use for debt reduction.

The company will likely generate steady FOCF, including about $4 billion in 2025, over the next few years. Delta does not face a looming material increase in its aircraft-related capex, which we believe enhances its financial flexibility. We assume management will primarily use its excess FOCF for debt reduction next year, given the company's relatively large debt maturities (approximately $3 billion in 2025) and more-conservative leverage target that likely precludes significant share repurchases and dividends. We believe this FOCF will provide Delta with an ample balance sheet cushion to absorb potential weaker-than-expected earnings stemming from demand pressures, excess industry capacity, or elevated cost inflation. Moreover, we believe there is greater potential upside to the company's credit measures than downside, at least over the next couple of years, which mainly reflects our FOCF estimates.

The stable outlook reflects our expectation Delta will generate credit measures that are firmly in line with the rating, including FFO to debt of just above 40% in 2025. We also estimate the company will improve its S&P Global Ratings-adjusted debt to EBITDA close to 2x by the end of next year. Our forecasts incorporate higher earnings and cash flow on rising passenger volumes and modestly higher unit revenue, which will more than offset its operating cost inflation. Furthermore, we believe the company will continue to use its strong positive FOCF for debt reduction, which will mitigate the risk associated with unexpected adverse shifts in airline market conditions.

We could lower our rating on Delta over the next 12-24 months if we assume its FFO to debt will decline and remain below 30%. Under this scenario, we would anticipate a protracted period of weaker-than-expected passenger demand and airfares or sustained unit-cost pressure that reduce its operating margins, earnings, and cash flow below the levels it reported over the past year. We could also downgrade Delta if it undertakes an unexpected acquisition or shareholder distribution that increases its S&P Global Ratings-adjusted debt.

We could raise our ratings on Delta over the next 12-24 months if we expect its FFO to debt will increase above 45% on a sustained basis. We believe this could occur if the company's earnings and cash flow generation exceed our estimates in 2025, with higher margins and lower S&P Global Ratings-adjusted debt. Under this scenario, we would also expect Delta to prioritize debt reduction over future shareholder returns such that it develops an ample cushion in its credit measures to withstand unexpected airline industry weakness.