Southwest (LUV) was upgraded by Standard & Poor’s (or S&P) during the fourth quarter of 2014 to a BBB rating in October with a stable outlook from BBB-. This upgrade resulted from several crucial factors:
- improving financial conditions
- expected increase in earnings
- cash flow
- credit measures supported by favorable conditions in the US airline industry
- revenue and cost synergies from the AirTran Holdings acquisition
Credit rating trifecta
Southwest is the only US airline to receive an investment-grade rating from all three credit rating agencies: Moody’s, Fitch, and Standard & Poor’s. This upgrade reflects Southwest’s strong financial position in comparison to its peers. It has the lowest debt as a percentage of capital of 28%, compared to all its peers, including Delta Air Lines (DAL), American Airlines (AAL), United Continental Holdings (UAL), and JetBlue Airways (JBLU). These airlines have a leverage range between 45%–70%. Alaska Air Group (ALK) is the only other airline with low leverage and an investment-grade rating.
Strong balance sheet
Southwest’s cash and marketable securities balance decreased by ~5% year-over-year to $2,988 million in 2014, despite a 17% increase in cash from operations. This was due to higher capital expenditure, debt repayment, and share repurchases during the year. In addition to cash, Southwest also holds a $1 billion revolving credit facility. In 2014, Southwest repaid $561 million toward debt and capital lease obligations, including a bullet payment (a lump sum payment) of $350 million on notes due in October.
Southwest’s leverage, including off-balance sheet aircraft leases, was 35%. Southwest plans to repay $182 million in 2015. The company has had a negative net debt balance for two consecutive years, which means the company’s cash balance exceeds its debt obligations. As a result, the company has excess free cash flow to return to its shareholders. The iShares Transportation Average ETF (IYT) and the SPDR S&P Transportation ETF (XTN) hold shares of Southwest Airlines and its major competitors.