American strengthened its credit profile over the past year, and further improvement appears likely in 2023. Strong demand for domestic passenger travel was the catalyst for the much higher earnings and cash flow the company generated in 2022, and we assume this will persist in 2023. American generated an FFO-to-debt ratio of 9% last year, near our upside threshold for the rating of above 10%.

We believe American is poised for further improvement amid strong demand and industry capacity constraints that should support high fares and gradual margin improvement. We estimate FFO to debt at about 15% this year and believe the company will generate positive free cash flow that it will allocate toward debt reduction. In our view, year-over-year improvement in American’s operating results could temper the risks associated with its substantial refinancing requirements over the next couple of years.

The company’s available seat miles (ASMs) were up more than 20% year over year and are approaching 2019 levels–the pre-pandemic benchmark. Utilization also improved and contributed to much higher passenger revenue per available seat mile (PRASM) that mitigated the impact of historically high jet fuel prices last year. Since the pandemic, the company has deliberately shifted capacity from its lower-margin flights (that is, certain long-haul international routes) to more profitable short-haul/Sunbelt hub flights, and we believe this contributed to higher returns.

American generated almost USD49 billion in total revenue in 2022–an increase of almost USD20 billion compared with the previous year–and an adjusted EBITDA margin of 12.5% that was comparable with that of other U.S. mainline airlines. The company’s domestic operations remain by far the largest share of revenue at almost 75%, but its Atlantic and Latin American traffic have also rebounded strongly and we expect they will improve further this year.

Demand for passenger travel shows no sign of easing in the near term.

In our view, there is material pent-up demand for passenger travel following the pandemic that has yet to be fully realized, and we incorporate this into our higher revenue and earnings estimates for American. Airline industry revenues in the U.S. increased sharply from 2020 lows but have not kept pace with economic growth. Although the shortfall (relative to nominal GDP) has narrowed, we believe this presents material future revenue upside for the industry and American, the largest U.S. airline as measured by ASMs. Moreover, hybrid work presents greater potential flexibility to travel, and S&P Global Economics forecasts real consumer spending will remain positive in 2023 (albeit well below 2022 levels).

We expect higher capacity will spur growth in the company’s operating results and more than offset cost pressures mainly from elevated jet fuel prices and rising labor costs. A shortage of trained pilots and other staff (such as maintenance, air traffic controllers), as well as delays in narrow-body aircraft deliveries, will likely persist at least into next year. In our view, the lack of excess capacity should limit downside to fares and our estimates for American.

American’s debt levels are significant but improving credit measures should lessen refinancing risk.

Our ICR on American reflects the airline’s substantial debt and large maturities that present refinancing risk. The company’s S&P Global Ratings-adjusted debt was relatively stable in 2022 at about $39 billion. American reduced its gross debt by about USD 2.7 billion last year, although mostly from cash on hand (which we net to derive adjusted debt) and a lower pension and post-retirement liability. The company plans to further reduce debt, as it faces scheduled debt payments of USD 3.0 billion this year, USD 3.5 billion in 2024, and about USD 7.5 billion in 2025.

American has a solid cash position of about USD 9 billion, which provides some financial flexibility (although it must hold at least USD 2 billion of liquidity as a requirement under multiple debt agreements) to address near-term maturities, if needed. In addition, the company demonstrated capital markets access in February 2023, which we viewed favorably given its future refinancing needs. However, yields have since increased (by more than 10% in the month since American issued secured notes) and we acknowledge the potential for credit market volatility to persist.

Our estimates for American’s credit measures remain highly sensitive to relatively small changes in our assumptions.

The potential risks and uncertainties associated with a softening U.S. economy, and looming debt maturities limit upside to our ICR on American for now. The airline industry is highly cyclical and historically sensitive to changing economic conditions. Weaker-than-expected demand or fares can have a significant adverse effect on credit measures–particularly if jet fuel prices remain high. The company also faces structurally higher labor costs (as do other U.S. mainline carriers) that increase the importance of capacity growth to mitigate overall inflationary pressures on margins.

The S&P Global Ratings energy team assumes a full-year average price of USD 85 per barrel (/bbl) for West Texas Intermediate (WTI) and USD 90/bbl for Brent crude oil in 2023, which is modestly lower than the 2022 average. However, the increase in the spread between refined jet fuel and oil prices was unprecedented last year and remains elevated from a historical perspective (and likely will remain highly volatile). We consider the potential that softer demand that could arise from a U.S. recession might limit American’s ability to cover sustainably high jet fuel costs with fares.