01/07/2016

Avianca’s bid for new equity vital for fleet financing

 Avianca’s bid for new equity vital for fleet financing

Avianca is set to receive 149 aircraft between 2016 and 2024, but the airline is struggling to bring its costs down and tackle an unsustainable level of debt. The carrier’s gross adjusted leverage – as measured by total adjusted debt EBITDAR –  is 7.4x. 

Avianca have already agreed one waiver from its lenders after breaching its debt covenants. The airline is currently being advised by an investment bank on potential long-term strategic partnerships and is seeking a $500 million capital injection in order to implement its fleet renewal strategy.

United, Continental, and Delta Airlines are reported to be interested in possible equity stakes. The airline has ruled out a full sale but if the carrier fails to secure an equity injection it may struggle to fund its incoming fleet.

 

Cost cutting measures chase yield declines

 

The airline has been buffeted by harsh macro-economic conditions in Latin America that is also affecting its competitors.  Avianca made net losses of $139.5 million in 2015 due to decreased revenue and a 2.1% drop in yield.  The company also made foreign exchange losses of $177.5 million owing to the depreciation of the Columbian peso against the US dollar and a lack of cash repatriation from crisis-stricken Venezuela.

However, the EBITDAR margin increased by 1.1% to 17.6% in 2015.  Cost cutting measures include training pilots in Columbia rather than sending them to Miami, and bringing aircraft maintenance in-house.

Capacity and passenger growth were both up by 8.4% and 7.9% respectively.  However, breakeven load factor continues to rise and yield continues to fall, showing that, while growth is continuing, it is not sufficient to offset these headwinds.  

 

But debt leverage remains stubbornly high

 

Avianca’s debt leverage position has deteriorated in recent years and is now a major brake on the airline’s ability to secure future financing.  Avianca’s outstanding on-balance-sheet debt totalled $3.47 billion as of December 2015. This represents gross adjusted leverage of 7.4x, up from 5x and 6.8x in 2013 and 2014 respectively. 

The carrier also has off-balance-sheet obligations of $981 million, mainly related to aircraft operating leases. As operating performance has declined so has the airline’s credit rating. Fitch downgraded it from BB- to B in March 2016. 

Existing covenants with bondholders, ECA-backed lenders, and even some lessors are restricting the carrier’s ability to invest unless it’s EBITDAR debt to service ratio improves. They include restrictions on increasing debt, minimum cash levels and capitalisation ratios.  The airline has already breached covenant conditions necessitating a waiver from exposed lenders, however this may not be forthcoming in future if the company’s debt position worsens.

The airline’s plan is to reduce debt leverage to no more than 5.0x by YE2016.  Some progress is already under way.  At the end of 1Q 2016 the company’s adjusted net debt to EBITDAR was slightly healthier at 6.6x as a result of the company’s cost cutting measures.

But progress is stalling because of economic headwinds in Latin American markets.

 

Fleet Renewal Strategy goes on hold

 

Avianca has entered into agreements for 141 Airbus and eight Boeing aircraft to be delivered between 2016 and 2024 as part of its growth and modernisation strategy.

This includes an order for 100 A320neos. However, in April 2016 Avianca negotiated a significant reduction in deliveries prior to 2019.  This has resulted in a projected capex reduction of approximately $1.4 billion over a period of 30 months.  The question is whether it will be able to finance the incoming A320neos. The airline mostly relies on commercial ECA-backed lending and lessors. Although last year the carrier purchased six A320s and two B787s using an innovative Enhanced Aviation Investment Vehicle (EAIV) private EETC.

However, Avianca’s management intend to rely on internally-generated cash and debt financing in domestic and international bond markets to fund its growth strategy.  This may reflect an unwillingness on the part of banks to lend and a paucity in ECA cover presently available. But a failure to bring debt levels down will close these financing options to Avianca and increase its reliance on an external capital injection which may not be forthcoming.

 

Scenarios

 

What if Avianca does not manage to deleverage?   A failure to deleverage would make it harder to attract the capital needed to unlock the fuel saving and low maintenance benefits associated with the fleet renewal plan.  If lenders are not satisfied that Avianca is creditworthy then future financing terms for everything from capex to working capital and lessors will become more expensive. The average rate for ECA-backed aircraft financing was a very favourable 3.1% 2015.  If the cost of financing becomes penal, then cash flow will be reduced as interest payments swell (up 26.4% to $169.4 million in 2015) and may necessitate a refinancing of existing debt, and even the spectre of default if debt covenant conditions are broken again.  This would reduce the ability of the airline to deal with external shocks, such as the existing currency convertibility losses, and make it far less competitive. 

 

The Ishka View

 

Avianca is making good progress on reducing costs, even as they continue to be outpaced by a drop in yields. If the airline is successful in attracting the $500 million it needs, it will help the carrier to finance a new fuel-efficient fleet and weather Latin America’s current economic slow down. Given Avianca’s strong positon in the region, US airlines are likely to pursue the option of making a bid for the carrier.

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