OREANDA-NEWS. S&P Global Ratings today said it raised its corporate credit rating on Air Canada to 'BB-' from 'B+'. The outlook is stable.

In addition, S&P Global Ratings assigned its 'BB+' issue-level rating (two notches above the corporate credit rating) and '1' recovery rating (90%-100%) to Air Canada's proposed US$300 million revolving credit facility due 2021 and US$720 million term loan due 2023. We expect the issue and recovery ratings to be unchanged if the deal is upsized by another C$300 million. The company will use proceeds from the refinancing to redeem some of its secured debt (term loan, first-lien, and second-lien notes).

Finally, S&P Global Ratings raised its issue-level rating on the company's US$400 million unsecured notes to 'BB-' (the same as corporate rating) from 'B' and revised its recovery rating on the notes to '3' (50%-70%, higher end of range) from '5'.

Furthermore, we have raised our ratings on the following enhanced equipment trust certificates (EETCs):The 2015-2 class A EETCs one notch to 'A+' from 'A'; The 2015-1 class B EETCs to 'BBB+' from 'BBB'; The 2013-1 series B and 2015-2 series B EETCs to 'BBB' from 'BBB-'; andThe 2013-1 series C and 2015-1 series C to 'BB' from 'BB-'.Finally, the ratings on 2013-1 series A and 2015-1 series A are unchanged at 'A', and the rating on 2015-2 series AA is unchanged at 'AA', as they are constrained by their respective liquidity provider ratings.

"The upgrade on Air Canada reflects our revision of the company's business risk profile to fair from weak," said S&P Global Ratings credit analyst Aniki Saha-Yannopoulos. "The company continues to maintain its above-average profitability in 2016, in line with 2015 levels, in spite of some weakness in the western Alberta markets and pricing pressures in certain international markets," Ms. Saha Yannopoulos said.

Air Canada has been successful in maintaining its adjusted EBITDA margins above 18% due to the company's fleet flexibility, geographic diversity, and management's focus on cost control. As a result, we expect the company to generate adjusted EBITDA in excess of the C$2.5 billion generated in 2015. In addition, we expect Air Canada to maintain its aggressive financial risk profile, while the company continues with its large capital expenditure program.

Air Canada is Canada's largest domestic and international full-service airline. The company is also the 15th-largest commercial airline in the world, serving more than 41 million customers annually. As of June 30, 2016, Air Canada operated a mainline fleet of 169 aircraft and Air Canada Rouge, the company's wholly owned leisure carrier, owns 44 aircraft. In addition, it has capacity purchase agreements with regional airlines that operate under Air Canada Express.

Our fair business risk profile assessment reflects the company operating in the North American airline sector, which we consider high risk due to cyclical demand, significant competition, high operating leverage, and capital intensity. Furthermore, the passenger airline industry is susceptible to outside events such as war, terrorism, and epidemics. Air Canada's operating cost structure compares favorably with that of other legacy North American airline carriers; the company has reduced its margin of difference through cost-cutting measures.

Air Canada's financial risk profile remains aggressive; to calculate debt leverage measures, we net all cash on hand in excess of C$1 billion given the company's minimum liquidity requirements per covenants. Even though the company's funds from operations (FFO) to net debt measure has improved, we expect Air Canada's financial risk profile to be constrained by the company's free cash flow deficit, which primarily reflects high capital expenditures for new aircraft deliveries.

The stable outlook reflects our view that Air Canada will sustain healthy profitability, in spite of some pressure in the domestic market, as the company continues to focus on its profitable international traffic, operational discipline and cost reduction, and fleet flexibility. Our outlook also takes into account our expectation that its credit ratio (FFO to debt) will remain between 25%-30%, in line with the intermediate financial risk profile.

Although unlikely in the next 12 months, we could raise the ratings if increasing cash flow results in Air Canada sustaining adjusted FFO to debt of more than 30% and free operating cash flow to debt exceeding 10%, and we believe the ratios will be maintained at those levels.

We could lower the ratings if the company's profitability metrics show deterioration from current levels, either due to higher-than-expected costs the airline incurs or negative impact of industry headwinds on Air Canada's operating results. We could also consider a negative rating action if we perceive the company's credit metrics weakening and FFO to debt deteriorates below 20% on a sustained basis.