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Spirit Airlines' Turbulent Flight: A 3Q16 Earnings Preview

PART:
1 2 3 4 5 6
Part 5
Spirit Airlines' Turbulent Flight: A 3Q16 Earnings Preview PART 5 OF 6

Why Should Investors Watch Spirit Airlines’ Leverage?

High debt

Spirit Airlines (SAVE) had negligible or no debt on its balance sheet until 4Q14. 

During this time of record profitability for airlines, where most have tried to strengthen their balance sheets by reducing debt, Spirit Airlines has increased its debt.

Why Should Investors Watch Spirit Airlines’ Leverage?

As a result of its rising debt, Spirit Airlines’ debt-to-EBITDA (earnings before interest, tax, depreciation, and amortization) ratio rose from 0.72x at the start of 2015 to 1.55x at the end of 2Q16. However, it still had more cash than debt on its balance sheet, resulting in a negative net debt-to-EBITDA ratio of -0.17x at the end of 2Q16. In this way, Spirit Airlines’ leverage is still lower than most of its peers’.

At the end of 2Q16, United Continental (UAL) had a net debt-to-EBITDA ratio of 1.02x, Delta Air Lines (DAL) had a ratio of 0.57x, American Airlines (AAL) had a ratio of 1.5x, and Alaska Air Group (ALK) had a ratio of -0.56x. JetBlue Airways’ (JBLU) ratio was 0.14x, Southwest Airlines’ (LUV) was -0.01x, and Allegiant Air’s (ALGT) was 0.54x.

However, a deeper analysis shows that these aren’t really the facts. Airlines often make use of operating leases for their most expensive purchases: aircraft. An operating lease is a type of off-balance sheet financing where an asset is leased for a period shorter than its economic life without any transfer of ownership.

Spirit Airlines’ net debt plus operating leases-to-EBITDA ratio at the end of 2015 was at 1.8x. This number was higher than those of other low-cost carriers, including JetBlue Airways, Southwest Airlines, and Allegiant Air at 1.3x, 0.8x, and 0.7x, respectively. Its ratio was lower than American Airlines’ and United Continental’s ratios of 3.4x and 3.1x, respectively.

Outlook

Though SAVE’s leverage is currently not a concern, it’s still important for investors to track SAVE’s leverage, lest it rises to unmanageable levels. This will become increasingly important, as Spirit plans to purchase more planes versus leasing them. As these purchases will be financed through debt, SAVE’s leverage will likely rise further.

On the other hand, if SAVE manages to maintain a balance of debt and cash, it could end up in a much better position than its peers who also have significant debt. Spirit forms 2% of the holdings of the First Trust Industrials/Producer Durables AlphaDEX ETF (FXR).

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