Fitch Affirms Continental Airlines at 'CCC'; Outlook Stable.

CHICAGO -- Fitch Ratings has affirmed the 'CCC' issuer default rating of Continental Airlines, Inc. (NYSE:CAL). Fitch has also affirmed Continental's senior unsecured rating of 'CC', with a recovery rating of 'RR6'. Continental's senior unsecured rating applies to approximately $700 million of outstanding debt. The Rating Outlook for Continental remains Stable.

The affirmation of CAL's ratings and the retention of the Stable Rating Outlook reflect the ongoing liquidity pressures that the airline is likely to face over the next year, even in the context of an improving domestic revenue environment. With very high lease-adjusted leverage, heavy debt maturities over the next two years, and virtually no remaining unencumbered assets to support future secured debt issuance, CAL could face renewed cash flow pressures if the industry operating environment does not improve markedly in 2006. While a pull-back in domestic capacity should lay the foundation for better passenger yield trends next year, CAL and all the U.S. legacy airlines face the continuing risk of further jet fuel price spikes that could undermine better unit revenue trends.

Should recent revenue per available seat mile (RASM) gains extend into 2006 and if a moderation of jet fuel prices continues, steady improvement in CAL's operating results should occur over the next several quarters. While a crushing fuel cost spike in 2005 will drive a full-year loss, CAL has taken important steps toward nonfuel cost reduction this year with the package of wage and benefit concessions that was ratified by all employee groups except the flight attendants in March. In all, the new agreements are expected to deliver $418 million of annual savings on a capacity-neutralized basis. The labor cost restructuring, coupled with stronger RASM trends in 2006, will likely support stronger operating cash flow next year and may in fact allow CAL to return to profitability. The Dec. 8 tentative agreement between management and the flight attendants' union, if ratified, would deliver additional cost savings for 2006 and beyond.

The risk of persistent $2-plus per gallon jet fuel has abated somewhat in recent weeks with the narrowing of the crack spread between crude oil and refined product prices. While East Coast jet fuel prices are still very high by historical standards, prices in the range of $1.50 to $1.70 per gallon could actually allow CAL to return to profitability if unit revenue improves as expected next year. CAL has no fuel hedges in place. A $10 swing in the price of crude oil translates into approximately $450 million of change in 2006 operating earnings. This highlights the high degree of sensitivity to future swings in jet fuel prices as fuel now accounts for a larger share of CAL's operating budget in comparison with reduced unit labor costs.

Liquidity pressures are still a concern, particularly in light of the fact that CAL has virtually no remaining unencumbered assets and very limited access to the capital markets. Scheduled debt maturities are heavy, and the carrier could face renewed liquidity stress by 2007 if the expected upturn in cash flow generation does not occur next year. As of Sept. 30, CAL had $2.2 billion of total cash and short-term investments on its balance sheet. The airline's cash position has been bolstered further by over $200 million of equity capital raised through a common stock offering in October. However, $365 million of debt maturities in the fourth quarter and seasonal weakness in fourth-quarter cash flow will drive unrestricted cash balances to approximately $1.7 billion by Dec. 31. Cash balances will build again starting in March, driven by seasonal booking trends. Heavy debt maturities of $525 million next year and $937 million in 2007 will continue to absorb most, if not all, free cash flow.

Unlike American Airlines, the other legacy carrier still operating out of bankruptcy, CAL does not face an unmanageable defined benefit pension funding obligation. 2005 contributions of $304 million through Sept. 30 have met ERISA funding requirements, and the freeze of the pilot plan has removed a big part of the pension problem. The pilots now have a parallel defined contribution plan in addition to the frozen DB plan. In an agreement with ALPA, CAL has committed to meeting a target of $500 million in additional funding of the pilots' DB plan before a dividend or share repurchase plan is launched.

CAL's growth plans in 2006 and beyond are likely to be driven by continued expansion of trans-Atlantic flying and the start-up of long-range Asian service such as the Newark-Delhi daily flight launched this fall. Although international fare and demand patterns have been far more encouraging than those seen in domestic markets over the past year, Fitch remains concerned that passenger yield pressures may intensify in international markets next year as a large amount of available seat mile capacity is redeployed outside of the U.S.

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