The General Framework considered by Credit Rating Agencies (CRAs) when it comes to Industrial Companies and/or all sectors are divided into two.
The first is the fundamental business risk analysis. This forms the basis and provides the industry and business contexts for the second segment of the analysis, which is the financial risk analysis.
For the Airline Industry, the key credit risks factors are in three groups.
Group One Factors
- Market Position: This has a number of key elements, which includes its route network, the strategic positioning of the airline and revenue potential of the market it serves
- Revenue Generation: The capacity utilisation and pricing and how diversified the revenue base is (based on geography, types of passengers, amongst other considerations)
- Operating Cost Structure. This is in relation to the company’s revenue model/portfolio and that of competitors
Group Two Factors
- Revenue Diversity: This is based on location, types of passengers, and contributions from non-passenger services
Group Three Factors
- Technological factors, age and suitability of aircraft fleet to airline’s operating requirements;
- Employee/labour relations; and
- The standard of services provided and reputation.
Business Risk Analysis
This is sub-divided into four as follows:
- Country risk and macroeconomic factors (economic, political, and social environments): Country-related risk factors can have a substantial effect on company creditworthiness, both directly and indirectly. Sovereign credit ratings suggest the general risk local entities face, they may not fully capture the risk applicable to the private sector. Therefore, there is the need to look beyond the sovereign rating to evaluate the specific economic and other country risks that may affect the entity’s creditworthiness. Such risks include the effect of government policies, safety and environmental regulation, the air traffic control system, airport infrastructure, and labour law.
- Industry risk characteristics: Risk categories are broadly similar across industries, but the effect of these factors on credit risk can vary markedly among industries. The lower the industry risk, the higher the potential rating on companies in that sector. However, a high industry risk profile does not automatically limit the rating of a company. Industry risk analysis sets the stage for company-specific analysis.
- Company-specific analysis: The business risk part of this analysis is divided into Company competitive position (including market position, diversification, operating efficiency and technology/R&D); management assessment; and profitability (incorporating industry peer group company comparisons).
- Company competitive position: Industry leaders that are globally or regionally well-diversified, predominantly focusing on relatively attractive markets with operating cost advantages can sometimes mitigate industry risk sufficiently to achieve stronger and more consistent profitability and business risk profiles (and may be considered for investment-grade ratings, given prudent leverage and financial policies). In analysing an airline’s competitive position, consideration is given to market position, diversification, operating efficiency and management.
Financial Risk Analysis
The company’s business risk profile generally determines the financial risk expected for any rating category. Financial risks are largely assessed through quantitative means, particularly by using financial ratios.
Accounting characteristics, financial governance/policies and risk tolerance, cash flow adequacy, capital structure and leverage, and liquidity/short-term factors are the risk categories under financial risk analysis.
Accounting adjustments for airlines generally follow the methodologies applied to companies in other industries. Attention is particularly paid to leasing as airlines extensively use leases to finance aircraft and facilities.
Cash flow ratios show the relationship of cash flow to debt and debt service, and to the company’s needs. Due to calls on cash other than for repaying debt, it is important to know the extent to which those requirements will allow cash to be used for debt service or lead to a greater need for borrowing.
When compared to most industrial companies, most airlines’ debt-to-capital ratios are high, both overall and relative to like-rated companies in other industries. Focus is placed on the materiality of assets shown in the statement of financial position to ensure they are not understated. Such assets include international route rights or takeoff and landing slots at crowded airports.
Most companies faced with severe liquidity pressures may likely make internal adjustments to maximize near-term cash flow. Airlines have some possible ways of doing that, each of which has possible advantages and disadvantages.
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