Moody's Investors Service, ("Moody's") has today downgraded the corporate family rating (CFR) of the German tourism company TUI AG (TUI) to B2 from Ba3. Concurrently, the senior unsecured rating was downgraded to B2 from Ba3 and the probability of default rating (PDR) was downgraded to B2-PD from Ba3-PD. At the same time, Moody's placed the company's ratings on review for further downgrade.
"Our decision to downgrade TUI's ratings reflects the company's announcement of the temporary suspension of the vast majority of TUI's operations until further notice due to the unprecedented spread of the coronavirus (COVID-19). We expect this will significantly impact TUI's earnings in fiscal 2020 and its cash outflow will be much higher than previously anticipated" says Vitali Morgovski, a Moody's Assistant Vice President-Analyst and lead analyst for TUI. "TUI's liquidity will become dependent on receiving state support that the company applied for, but it remains unclear in what form will it be, in what size and also under which conditions would it be granted" Mr. Morgovski continues. Credit metrics in the fiscal year 2019/20 are expected to be materially weaker than expected for a rating in the single-B category.
The review for possible downgrade reflects the uncertainties in terms of the duration of the operational disruption, the uncertainties to bridge the liquidity needs during an expected period of negative free cash flows as well as additional counterbalancing operational and financial measures to mitigate the impact on credit metrics. We regard the coronavirus outbreak as a social risk under our ESG framework, given the substantial implications for public health and safety.
RATINGS RATIONALE
TUI's operating results for fiscal 2019 ended in September 2019 were weak as they were materially affected by one-off costs related to the Boeing 737 Max grounding. Moody's adjusted interest coverage (EBITA/Interest) declined to 2.1x from 2.8x in fiscal 2018 (3.1x in fiscal 2017), a level that Moody's already regarded as weak for the previous Ba3 rating category. Moody's adjusted free cash flow, that excludes investments in financial assets as well as divestments, was distinctly negative in the last two years and Moody's expected it to remain negative in 2020 burdened by the ongoing 737 Max grounding.
The performance in fiscal 2020 before the outbreak of coronavirus was strong as TUI benefited from the collapse of the second largest European tour operator Thomas Cook. The company reported a 14% growth in bookings with a 3% increase in average selling prices before February 2020. However, this trend reversed sharply, albeit still being cumulatively positive, in recent weeks due to the rapid and widening spread of the coronavirus outbreak. With recently introduced travel restrictions across Europe TUI had to temporary suspend operations, which is aimed at contributing to global efforts to contain the pandemic outbreak. Moody's now expects that the cash outflow in fiscal 2020 will be much higher than previously expected despite TUI's efforts to reduce capacity, investments and costs throughout all business lines.
TUI's liquidity will be supported by the sale of the Hapag-Lloyd Cruises (announced on 7 February 2020) to TUI Cruises, a 50/50 joint venture with Royal Caribbean Cruises Ltd. (Baa2, under review for downgrade). In Summer 2020 TUI should receive around €700m net cash from the deal valued at €1.2 billion on a debt and cash free basis. In addition, TUI is in negotiations with Boeing regarding compensation in relation to the 737 Max grounding. However, in light of the expected contraction of the operations, the liquidity profile appears as dependent on external support or alternatively on raising equity, which we do not view as likely at this point.
The review will mainly focus on TUI's ability to preserve its liquidity during the time of significant earnings decline as a result of travel restrictions and TUI's announcement to suspend its operations until further notice. The company said that it has applied for the state aid guarantees and Moody's expects that the company can potentially receive it. However, the extend of state support, its timing, size and conditions are unclear. Furthermore, in case the state support will come in form of bridge loans the company's balance sheet will become significantly more highly leveraged. Credit metrics adequate for a B2 rating even assuming recovery in 2021, appears at this point as becoming out of reach. Therefore, the review will focus on the magnitude of counterbalancing measures to gradually restore credit metrics back towards the single-B category.
WHAT COULD CHANGE THE RATINGS - UP
Positive rating pressure would not arise until the coronavirus outbreak is brought under control and travel restrictions are lifted.
WHAT COULD CHANGE THE RATINGS - DOWN
The rating could be under continued negative pressure should TUI not be able to preserve a sufficient liquidity profile in light of the expected period of negative free cash flow, an extended period of operational disruption or in absence of adequate measure to restore leverage metrics.
LIQUIDITY
At the end of December 2019 (fiscal Q1 2020) TUI's liquidity consisted of €881 million cash and cash equivalents as well as around €1 billion available for cash drawing under its €1.75 billion syndicated revolving credit facility (RCF) maturing in 2022. Due to the seasonality of TUI's working capital needs the first fiscal quarter is characterized by a large negative free cash flow, which this year amounted to €1.5 billion.
The RCF contains a maximum leverage (net debt/EBITDA must not exceed 3.0x) and a minimum interest coverage (EBITDAR/net interest expense must be at least 1.5x); the financial covenants are tested every six months. Moody's expects TUI to remain in compliance with both covenants at the end of March, though compliance at the fiscal year-end in September is less certain.
PRINCIPAL METHODOLOGY
The principal methodology used in these ratings was Business and Consumer Service Industry published in October 2016. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.