Fitch Initiates US Airways Group IDR at 'CCC', Affirms America West Ratings

Business Wire, Sept 30, 2005

CHICAGO -- Fitch Ratings has affirmed the issuer default rating (IDR) of 'CCC' and the senior unsecured rating of 'CC' on the debt obligations of America West Airlines, Inc. (AWA). Fitch has also initiated coverage of US Airways Group, Inc. (NYSE:LCC) with an IDR of 'CCC' and a senior unsecured rating of 'CC'. The recovery ratings for the senior unsecured obligations of both US Airways Group and AWA are 'R6', indicating an expected recovery of less than 10% in a default scenario. In conjunction with these rating actions, Fitch has removed AWA's debt obligations from Rating Watch Negative and established a Negative Outlook on US Airways Group and all rated obligations of US Airways and America West. Fitch's ratings apply to approximately $350 million in unsecured debt obligations.

On Sept. 27, US Airways Group and America West Holdings Corp. completed their merger, with AWA becoming a subsidiary of US Airways Group. The merger marries US Airways' heavy East Coast presence with AWA's strength in the Southwest and West. Due to the complexities of integration, however, the two carriers plan to continue under separate Federal Aviation Administration (FAA) operating certificates for up to two years as they work to create one airline out of two. Although the merger and its related capital infusions likely constituted the only option either carrier had for long-term survival, significant credit concerns remain.

The merger has increased the combined carriers' liquidity considerably, far above the prior individual liquidity positions of either US Airways or AWA. As a result of new equity injections, partner and supplier support, asset sales, and sale-leaseback transactions, US Airways Group has approximately $1.8 billion in unrestricted cash on its balance sheet, equivalent to 18% of the combined carriers' revenues over the last 12 months (LTM) of $9.6 billion. By way of comparison, as of June 30, AWA's unrestricted cash was equivalent to 13% of its LTM revenues, while US Airways unrestricted cash was equal to only 7.9% of its LTM revenues. The improved liquidity cushion established through the transaction makes it unlikely that US Airways will face a renewed cash crisis in 2006, even if fuel prices remain at or above their very high current levels.

US Airways hopes to achieve annual revenue and expense synergies of $600 million as a result of the transaction: $350 million through network optimization, revenue improvements, and Hawaii flying and $250 million through reduced operating expenses. It is likely that the carrier can achieve most of the $250 million in costs savings. The other $350 million in synergies could be more problematic, as achieving those synergies will be dependent, in large part, upon competitive reactions that the carrier cannot control. Revenue synergies, in particular, are notoriously difficult to achieve. On a positive note, however, the carrier could be well positioned to take advantage of the likely improvement in revenues that will arise from the upcoming capacity pull-backs at Delta, Northwest, and FlyI.

Historically, labor integration has been a contentious issue in airline mergers and has in many cases determined whether or not mergers have succeeded. The overriding concern in this case is the seniority differences between the relatively senior US Airways employees and the more-junior AWA employees. This could lead to lengthy and difficult discussions on labor integration that could delay some of the merger's synergy benefits. Mitigating these concerns somewhat is the fact that pilots and flight attendants at both airlines are represented by the same unions, which have established procedures for integrating seniority lists. However, there are differences in union representation for other employee groups, including mechanics and ground workers, which will make the integration of those groups more challenging.

Despite its strengthened liquidity position, US Airways' leverage continues to be high, albeit improved over pre-Chapter 11 levels. The carrier's debt load is currently estimated at approximately $3.5 billion. Upcoming debt maturities and capital spending needs will continue to consume a significant amount of cash, particularly in the 2007 through 2009 timeframe. This, combined with integration and transition expenses in 2005 and 2006, heighten the necessity that the carrier achieve many of the targeted revenue and cost synergies that it hopes to achieve through the merger. It is important to note, however, that US Airways was able to jettison its underfunded defined benefit pension plans as part of its Chapter 11 reorganization, removing those significant cash liabilities.

Fuel prices are likely to remain high and volatile for the foreseeable future, creating continued challenges for the entire industry. Fitch estimates that a 10-cent change in jet fuel prices will translate into a $125 million change in annual operating expenses for the merged carrier. If fuel prices stay at current levels or increase further, a significant portion of the synergistic cost savings will be consumed by higher fuel costs. Although US Airways has not hedged its fuel expenses, AWA has one of the better hedging positions in the industry, with 50% of its estimated fourth-quarter 2005 fuel expenses hedged with caps of $58 per barrel of crude oil. Its hedges carry into most of 2006, with a declining percentage of its fuel needs hedged in each successive quarter. Its 2006 caps are at approximately $60 per barrel.