Investing.com -- Moody’s Ratings has downgraded the ratings of Southwest Airlines (NYSE: LUV ) Co., including its senior unsecured rating to Baa2 from Baa1. The ratings agency has also downgraded the backed senior secured rating assigned to Love Field Airport Modernization Corporation’s revenue bonds to Baa2 from Baa1. The outlook for Southwest was revised to stable from negative.
The downgrade of Southwest’s senior unsecured rating to Baa2 is based on Moody’s forecast that the current operating environment will slow the improvement in metrics previously expected in 2025. This forecast suggests Southwest’s operating margin will only improve modestly to around 2%. In March, U.S. airlines experienced a significant pullback in domestic leisure market demand due to macroeconomic uncertainty. This is predicted to impact Southwest more than airlines with strong international networks, premium product offerings, and robust cash flow from loyalty programs.
The decrease in demand has led Southwest to further reduce its year-over-year capacity growth plans for the second half of 2025. The airline now expects its full year 2025 capacity to grow 1% to 2% compared to 2024.
The softer demand from price-conscious travelers is resulting in discounting in the main cabin of the aircraft, which will put pressure on leisure-focused carriers like Southwest. Moody’s forecasts that this softness will at least partially offset improvements Southwest expected from several strategic shifts including introducing bag fees, loyalty program changes, the introduction of premium products, and expanding its distribution to online travel agencies.
Despite these challenges, Southwest’s cost-cutting efforts, which include doubling its expected cost savings to over $1 billion by 2027, and lower fuel costs, are expected to help limit further margin erosion.
The Baa2 senior unsecured rating reflects Southwest’s leading position in the U.S. domestic market, its historically conservative capital structure, and Moody’s expectation that the company will maintain strong liquidity. Southwest plans to bring its Debt to Capital ratio, which is currently above 40%, to between 30% and 35% by the end of 2027. Moody’s expects an incremental improvement in its operating margin in 2026.
The stable outlook reflects Moody’s expectation that Southwest will maintain a debt/EBITDA ratio below 2.5x and funds from operation (FFO) + interest expense/interest expense above 10x. The stable outlook also reflects the expectation that Southwest’s operating margin will improve to around 5%.
The ratings could be downgraded if the company does not realize the expected returns on its strategy to improve profitability. The ratings could be upgraded if debt/EBITDA is sustained below 2.0x, funds from operations + interest/interest is sustained above 10.0x, and EBITDA margin is sustained around 20%.
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