Frankfurt am Main, April 22, 2022 -- Moody's Investors Service ("Moody's") has today upgraded TRANSPORTES AEREOS PORTUGUESES, S.A. (TAP SA or the company) corporate family rating (CFR) to B3 from Caa2 and probability of default rating to B3-PD from Caa2-PD. The rating on TAP SA's EUR375 million senior unsecured notes due 2024 has been upgraded to B3 from Caa2. Concurrently the Baseline Credit Assessment has been upgraded to caa1 from caa3. All ratings previously were placed on review for upgrade. This rating action concludes the review for upgrade initiated on January 24, 2022. The outlook on all ratings has been changed to stable from ratings under review.
RATINGS RATIONALE
The upgrade of TAP SA's CFR to B3 from Caa2 balances (i) the materiality of the State aid provided by the Portuguese government to TAP SA under the European Commission's Rescue & Restructuring state aid framework and the resulting significant improvement in TAP SA's liquidity profile, (ii) the simplification of TAP SA's corporate structure following the capital increase of December 2021, whereby TAP S.G.P.S. has ceased to be the parent company of TAP SA, (iii) the credible restructuring plan presented to the European Commission for approval of the State aid and the cost improvement measures already implemented so far, (iv) a history of weak profitability before the pandemic and the execution risk of the restructuring plan in a market environment that remains volatile.
The Portuguese government will have injected EUR3.2 billion of common equity into TAP SA since the beginning of the pandemic. This compares to a total balance sheet volume of EUR5.2 billion and a Moody's adjusted gross debt of EUR3.7 billion as per 31st December 2019. The equity injection also more than compensates for the cumulative negative Moody's adjusted FCF of around EUR1.4 billion that TAP SA has incurred since the beginning of the pandemic. Arguably TAP SA's balance sheet was very weak pre-pandemic with a Moody's adjusted gross leverage of around 7.0x and a debt / book capitalization of 95%.
TAP SA's liquidity has significantly improved as a result of the Portuguese State aid. Its cash on balance sheet will have increased from EUR397.6 million of cash on balance sheet as per 30th September 2021 to EUR1.8 billion million as per December 2021 pro forma of the reception of all the new money from the support package (EUR990 million capital increase remains outstanding and should be enacted by the Portuguese parliament between June 2022 and December 2022). This compares to a 2020 negative FCF of EUR-829 million and a 2021 negative FCF of EUR-607 million. The liquidity injection should be sufficient to fund further modest negative free cash flows and upcoming debt maturities over the short- to medium term, provided a successful execution of the restructuring plan.
With the implementation of the capital increase of December 2021 the Portuguese government has become the sole and direct shareholder of TAP SA. TAP S.G.P.S., the former parent company of TAP SA has ceased to own a stake in TAP SA. As a result of these changes TAP SA will be solely focused on operating its airline activities under the TAP SA brand and under Portugalia. The drag on earnings and cash flows from the Brazilian MRO operations will cease. The Brazilian MRO operations have been a significant drag on TAP SA's cash flow before the pandemic with a receivable of close to EUR1 billion in the form of an intercompany loan building between TAP SA and TAP S.G.P.S. While there was a receivable impairment and a provision at the end of 2021 there will be no more drag on TAP SA's cash flows going forward.
The restructuring plan that underpinned the State aid request and the approval from the European Commission is credible and is a continuation of what TAP SA has started to do following its partial privatisation pre-pandemic. The restructuring plan is centered on refocusing TAP SA's operations on its airline activities, reducing its capacity albeit with an aircraft fleet strategy centered on the rejuvenation of the fleet, reducing costs with significant reductions achieved to date already and revenue enhancing strategies. The key challenge for TAP SA will be to improve its profitability either through a higher RASK or through a further lowering of its cost base.
Despite being an unionized airline TAP SA has been able to reduce fixed operating costs since the beginning of the pandemic. Employee costs reduced by 11% in 2021 with the average staff reducing by 18% y-o-y. Other cost items excluding fuel did increase less than revenue in 2021. However European airlines are currently facing significant cost inflation stemming from increasing labor, maintenance and airport charges. Higher fuel prices will also significantly dent profitability in 2022 at least. TAP SA has already faced a 31% increase in fuel costs (higher increase than revenue) and 6% increase in traffic operating costs in 2021.
The current rating remains constrained by a history of weak profitability before the pandemic and the execution risk of the restructuring plan in a market environment that remains volatile. TAP SA had weak profitability metrics before the pandemic as illustrated by a Moody's adjusted EBIT margins of 2% to 2.5% in 2018 and 2019. The weak profitability of TAP SA was largely linked to a weak pricing power as its CASK was competitive against other European network carriers. TAP SA's restructuring plan includes measures to enhance revenue including a new ancillary revenue and a stronger digitalisation strategy. TAP SA has also discontinued certain unprofitable routes and launched new routes.
While the restructuring plan presented by TAP SA is credible, there is execution risk notably on the cost side against a backdrop of an inflationary macroeconomic environment. We recognize the progress made to date especially on the employee cost side but TAP SA will need to sustain these savings to prove the long term sustainability of its operations. We also expect the operating environment to remain volatile both on the demand and cost side, which will challenge the return to profitability of TAP SA.
RATIONALE FOR THE STABLE OUTLOOK
The stable outlook assigned to the rating is underpinned by our expectation that TAP SA will continue to successfully implement its restructuring plan to gradually reduce its cash burn and restore its credit metrics with gross Debt/EBITDA to revert back to below 7x by 2023.
LIQUIDITY
TAP SA's liquidity pro forma of the full reception of the Portuguese State aid will be adequate. The company is expected to have EUR1.8 billion of cash on balance sheet at 31st December 2021 pro forma of the reception of an additional EUR990 million in State aid through a capital increase that will be enacted by the Portuguese government in H2 2022. This liquidity buffer should be sufficient to cover modest operating cash burn over the next 12 to 18 months as well as capex and upcoming debt maturities of close to EUR400 million in 2022 and 2023.
STRUCTURAL CONSIDERATIONS
Most of TAP SA's capital structure is unsecured and ranks pari passu with the EUR375 million senior unsecured notes. There is approximately EUR137 million of debt that is secured by certain contractual rights.
Moody's treats trade payables as unsecured claims in line with the EUR375 million senior unsecured notes due to the absence of an all asset pledge security package for the secured debt instruments. In light of the relatively low percentage of secured debt in the capital structure, the rating of the senior unsecured notes are in line with the CFR at B3. The recovery of the corporate family is assumed to be 50%.
ENVIRONMENTAL, SOCIAL AND GOVERNANCE CONSIDERATIONS
TAP SA faces high environmental risk due to carbon transition. This will depend on evolving decarbonization policies around the globe and regulations which may increase operating costs for airlines. However TAP SA has a younger and more fuel efficient fleet than most of its European network peers.
We consider social risk across the industry and for TAP SA to be high. This reflects our view of a linkage between carbon transition and demographic and societal policies. The high score indicates the potential for policies and/or trends that lead to lower travel volumes or higher costs, or both. TAP SA, and some of its European network carrier peers, also have high human capital risk because of a history of labor disruption due to strikes of a unionised workforce and the potential shortfall in skilled labor (pilots and mechanics), which would negatively affect operations and or increase costs.
The government of Portugal has taken full control of TAP SA during the pandemic. Whilst the government of Portugal has granted TAP SA material support during the pandemic (EUR3.2 billion State aid and damage compensation), the ownership and governance strategy of the government of Portugal has not been consistent over time with strategies of privatisation followed by reinvestment as during the pandemic.
FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS
Positive pressure would build on TAP SA's rating if gross debt/EBITDA of TAP SA would move sustainably below 6.0x, EBIT margin would trend towards 5% on a sustainable basis and TAP SA would generate consistent positive free cash flow.
On the contrary gross debt/EBITDA of TAP SA remaining sustainably above 7.0x beyond 2023 and persistent negative free cash flow generation leading to a deterioration in the group's liquidity profile would put negative pressure on the ratings. In addition (FFO + Interest Expense) / Interest Expense remaining below 2.0x and the failure of TAP SA to improve its EBIT margin above 2% could also lead to negative pressure on the ratings.
The methodologies used in these ratings were Passenger Airlines published in August 2021 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1277191, and Government-Related Issuers Methodology published in February 2020 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1186207. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of these methodologies.
REGULATORY DISCLOSURES
For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.
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Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at http://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1288235.
At least one ESG consideration was material to the credit rating action(s) announced and described above.
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Stanislas Duquesnoy
Senior Vice President
Corporate Finance Group
Moody's Deutschland GmbH
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Germany
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Christian Hendker, CFA
Associate Managing Director
Corporate Finance Group
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454
Releasing Office:
Moody's Deutschland GmbH
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Frankfurt am Main, 60322
Germany
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454
