Northwest's Lower Altitude

S&P downgrades the troubled carrier's debt rating on its considerable pension and debt obligations and the lack of labor concessions

By Philip Baggaley, CFA

Northwest Airlines (NWAC ) is navigating troubled skies. The beleaguered carrier faces anticipated heavy losses and negative cash flow this year. It has also been unable to secure needed labor-cost concessions. Adding to its woes are sizable upcoming debt and pension obligations.

Based on those factors, Standard & Poor's Ratings Services lowered its ratings on parent company Northwest Airlines Corp. and its Northwest Airlines Inc. operating unit on June 14. The actions included lowering both the corporate credit rating to CCC+, from B, and the short-term rating on Northwest Airlines Corp. to C, from B-3.


  All ratings are removed from CreditWatch, where they were placed with negative implications on May 3, 2005. The outlook is developing.

Northwest, based in Eagan, Minn., is the fourth-largest U.S. airline, with about $15 billion of debt and leases. For the first quarter, it posted a substantial net loss of $440 million, mostly due to higher fuel costs and weak pricing in the domestic market. The carrier is likely to report a large loss for the year, despite recent fare increases.

So far, Northwest has obtained only $300 million of a total $1.1 billion in annual labor concessions being sought. The pilot union last year agreed to partial, interim annual concessions, but other unions remain in negotiations and don't appear to be close to agreements.


  Talks with the mechanics' union are particularly problematic, with its leadership raising the possibility of a strike (which could occur only following a 30-day period after both sides are released from federally mediated talks).

Debt maturities for the remainder of 2005 through 2007 total almost $2 billion (excluding certain aircraft-backed debt that Northwest can extend at its option), and, absent legislative changes, cash pension requirements in 2006 and 2007 will be significantly higher than the $420 million being paid this year.

Cash liquidity is a relative strength for the company, with $2.1 billion of unrestricted cash at Mar. 31. However, losses and debt payments are expected to reduce this amount.


  The outlook could be revised to stable if Northwest achieves partial success in its labor and pension objectives, or if a further deterioration of airline industry conditions cancels out some of the anticipated savings from such initiatives.

Ratings could be lowered if the airline is unable to make further material progress in lowering its labor costs. Conversely, a satisfactory resolution of labor negotiations could, along with new pension legislation that extends the period over which airlines can pay down funding deficits, lead to a modest upgrade.

Baggaley, a credit analyst at Standard & Poor's Ratings Services, follows the airline industry

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