S&P Global Ratings: British Airways PLC upgraded to ‘BB+’ on air traffic recovery; outlook stable

• British Airways PLC (BA) announced that it plans to restore capacity to 93% of pre-pandemic (2019) levels this year, from 70% in 2022, to meet the continued recovery in demand for air travel.
• Following BA's capacity guidance, we raised our forecast for BA's air traffic in 2023 and 2024. We also forecast that BA's yields will remain high and its EBITDA margins will improve, resulting in stronger credit ratios.
• We raised our long-term issuer credit rating (ICR) on BA to 'BB+' from 'BB', following the same rating action on its parent International Consolidated Airlines Group S.A. (IAG).
• We also raised our issue ratings by one notch on BA's 2019-1 Class A enhanced equipment trust certificates (EETCs) to 'BBB' (sf) from 'BBB-' (sf), its 2021-1 Class B to 'BBB+' (sf) from 'BBB' (sf), and its 2013-1 and 2021-1 Class A to 'A+' (sf) from 'A' (sf). We raised by two notches its 2020-1 Class B to 'A-' (sf) from 'BBB' (sf).
• The issue ratings on BA's other EETCs are unchanged (see rating list below).
• The stable outlook mirrors that on IAG given the airline's integral relationship with the group.

LONDON (S&P Global Ratings) March 24, 2023--S&P Global Ratings today took the rating actions listed above.

We raised our forecast for BA's air traffic and assume that its yields will remain high and EBITDA margins will improve.

Following BA's capacity guidance for 2023, we raised our forecast for BA's air traffic (revenue passenger kilometers; RPK) to 85%-90% of pre-pandemic levels in 2023 and 95%-100% in 2024, from 67% in 2022. This reflects our view of the still-unsatisfied demand for leisure travel across BA's domestic, European short-haul, and international long-haul routes. We also note the change in consumer behavior to favor experience-based expenditure. We anticipate the premium leisure segment (typically one of BA's most profitable segments) will continue to outperform the other segments. Our forecast also reflects a continued pick up in corporate travel, which started meaningfully in the second half of 2022, albeit still lagging behind the recovery in leisure travel. We also forecast approximately stable or slightly lower passenger yields (passenger revenue per RPK) in 2023-2024 after a strong 17% increase in 2022. We assume that cargo revenue will decline by 10%-15% in 2023 before stabilizing in 2024 and that other revenue, which includes BA Holidays and provision of ground handling and maintenance services, will grow by about 10% per year. In addition, we forecast that BA's adjusted EBITDA margin will significantly improve to 15%-16% in 2023 and 18%-19% in 2024, from 13% in 2022. This primarily reflects lower employee and other non-fuel costs per available seat kilometer (ASK) in 2023, and lower fuel costs per ASK in 2024 based on our forecast of a lower Brent oil price and a stronger pound (see "Our Base-Case Scenario" below).

The continued fleet investment could delay balance-sheet deleveraging, so improvement in BA's credit metrics hinges mostly on air traffic and EBITDA recovery, in our view.

We forecast that higher EBITDA in 2023-2024 will more than offset significant capital expenditure (capex) and lead to stronger credit ratios. We forecast that BA's EBITDA will increase by about 50% to £2 billion-£2.2 billion in 2023 (65%-75% of 2019) and by about 30% to £2.6 billion-£2.8 billion in 2024 (85%-95% of 2019), from £1.43 billion (47% of 2019) in 2022. Accounting for a robust EBITDA-to-cash flow conversion, our base-case stipulates that the airline will generate sufficient operating cash flows to largely counterbalance the impact from the significant capex, which we forecast at £1.8 billion-£2 billion in 2023 and £2.4 billion-£2.6 billion in 2024, from £1.6 billion in 2022. That means we expect that adjusted debt, which amounted to about £7.9 billion as of Dec. 31, 2022, will likely stay largely unchanged at around £8.0 billion over the 2023-2024 investment period, per our forecasts. Boosted by increasing EBITDA, S&P Global Ratings-adjusted funds from operations (FFO) to debt will improve to 16%-21% in 2023 and 22%-27% in 2024, from 12.5% in 2022. This is consistent with a stronger financial risk profile assessment of significance, compared with aggressive previously.

BA's strong market position at London Heathrow airport underpins the expected recovery in EBITDA and credit ratios.

BA continues to hold about 50% of the take-off and landing rights at Heathrow, which has a large, affluent catchment area. BA also benefits from its high-value premium-traffic routes across the North Atlantic, and its above-average profitability: We forecast return on capital will return above 10% this year and rise to about 15% next year.

BA's air traffic recovery could face unexpected setbacks, which is only partly reflected in our base case.

This includes possible operational disruption at Heathrow or other airports. Although this would likely be considerably less severe than in summer 2022, since companies operating at airports have had time to address staff shortages, strike action is a risk, such as the recently announced strikes over Easter by over 1,400 security guards at Heathrow. Another risk is a reduction in consumer spending on holidays amid cost-of-living pressures. We note that the U.K., which typically accounts for about half of BA's revenue, has a weaker macroeconomic outlook than other major European economies. We currently assume that U.K. real GDP will decline by 1% and inflation will be 7% in 2023, while unemployment will increase but remain relatively low at 4.6%. That said, the evidence so far is that U.K. consumers are prioritizing spending on holidays. This is reflected in current forward bookings for Easter as well as the crucial summer holiday season, with visibility supported by earlier bookings than BA has observed in the past.

The stable outlook of BA mirrors that of IAG given the airline's integral relationship with the group.

The stable outlook on IAG reflects our expectation that the recovery in air traffic will continue in 2023, assuming that macroeconomic and/or geopolitical conditions do not deteriorate unexpectedly and sharply. This recovery should allow IAG to sustain adjusted FFO to debt at a rating-commensurate level of above 20% in 2023.

We would lower the rating if IAG's passenger demand fell short of our expectations of an uninterrupted recovery in 2023 or appeared structurally weaker than expected, hindering a consistent EBITDA improvement, and if we do not expect adjusted FFO to debt of at least 20%. This could occur if mounting inflation curbs consumer confidence and travel affordability or if geopolitical tensions escalate.

An unexpectedly large debt-funded acquisition resulting in IAG's credit measures falling short of our guidelines for a prolonged period may also trigger a downgrade.

To raise the rating, we would need to be confident that passenger demand is robust enough to enable IAG to maintain its financial strength, such as adjusted FFO to debt reaching and staying above 30%. This would most likely occur if operating cash flows further improved and were sufficient to offset the significant capex for new planes in 2023 and 2024. We would expect this to be underpinned by a prudent financial policy that prioritizes stronger ratios over shareholder remuneration.

Environmental, Social, And Governance

ESG credit indicators: To: E-3, S-4, G-2; From: E-3, S-5, G-2

We now view social factors as a negative consideration in our credit rating analysis of BA, compared with very negative previously. This reflects our updated forecast that BA's air traffic will return to 85%-90% of pre-pandemic levels in 2023 and 95%-100% in 2024, from 67% in 2022. We forecast that BA's EBITDA will return to 65%-75% of pre-pandemic levels in 2023 and 85%-95% in 2024, from 46% in 2022. We continue to acknowledge that the pandemic highlighted the sensitivity of air traffic to health and safety risks. This was particularly the case for long-haul and business traffic, to which BA has significant exposure.

Environmental factors are a moderately negative consideration, as they are for the broader airline industry, reflecting pressures to reduce greenhouse gas emissions. Tightening environmental regulations for European airlines, particularly those proposed in the EU's "Fit for 55" package, could significantly increase costs under the EU Emissions Trading System, bring in a mandate for minimum sustainable aviation fuel usage, and even introduce a kerosene tax over the medium term. However, BA's fleet will become more fuel efficient with new deliveries of the latest generation planes. BA's fleet is currently somewhat older (average 13 years) than some other network airlines.

Environmental, social, and governance (ESG) credit factors for this change in credit rating/outlook and/or CreditWatch status:

• Health and Safety