Leverage and risk
United’s (UAL) leverage is high compared to most of its peers. Its debt-to-capital ratio of 82.5% compares to Delta (DAL) with 48%, Southwest Airlines (LUV) with 28% and JetBlue (JBLU) with 55%. Only American Airlines (AAL) is higher, at 94.6%. A high level of debt makes UAL risky for investors, as the obligations of debt holders takes precedence over providing returns for equity shareholders. Moreover, the company’s earnings would reduce to the extent of interest expense related to the debt. So investors would prefer companies with comparatively lower leverage levels and proven operating performance, which most of United’s peers offer. In order to be on par with its peers, United has to reduce its debt. The company has planned an average of $1.2 billion in annual scheduled debt and capital lease payments until 2017, which will reduce debt to $15 billion from $19 billion in 2013.
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United’s net debt-to-EBITDA ratio (earnings before interest, tax, depreciation, and amortization) is 2.13. This ratio calculates how many years a company would take to pay back its current debt. Except for JetBlue, all UAL’s other peers have lower net debt-to-EBITDA ratios.
United’s capex plans include $2.8 billion to $3 billion from 2014 to 2017, 65% of which would be used for aircraft replacements. From the past two years, United’s cash from operating activities was less than its capital expenditure. If this trend persists, United may need extra debt to finance its capex plans.
United has a low EV/EBITDAR (enterprise value to earnings before interest, tax, depreciation, amortization, and rent costs) and forward EV/EBITDA (enterprise value to earnings before interest, tax, depreciation, and amortization) multiple of 4.7x. This makes the stock cheaper compared to its competitors. Generally, a lower multiple means the stock is undervalued, but with United, the lower multiple combines with low margins because of high fuel and labor costs and lowers yields compared to peers. A high percentage of unionized labor and volatile crude prices limit United’s power to control costs. These operational challenges couple with financial risks of high leverage. Compared to Delta Air Lines, currently, United’s only major advantage to investors is a 12% discount in its EBITDA multiple, although this comes with higher risk. However, if the structural characteristics change after the implementation of its $2 billion cost reduction program, margins will rise—and so should United’s fundamentals.