Debt at nominal levels
Spirit Airlines (SAVE) had no debt until 4Q14. Since then, its debt has increased and the debt-to-EBITDA ratio has also increased from 0.72x at the start of 2015 to 1.1x at the end of 4Q15. This is still lower than most of its peers.
United Airlines’ (UAL) leverage ratio for 4Q15 stands at 1.87x, American Airlines’ (AAL) leverage ratio is 2.72x, JetBlue’s (JBLU) leverage ratio is 1.42x, and Allegiant Travel (ALGT) leverage ratio is 1.63x.
The airline industry is a capital-intensive industry with heavy investments required in building infrastructure, fleets, and aircraft maintenance. As a result, airline stocks generally have high levels of debt on their balance sheets. Spirit Airlines has the lowest leverage among its industry peers.
However, a deeper analysis shows this is not the entire story. Airlines often make use of operating leases for their most expensive purchase—aircraft. Operating leases is an off-balance sheet financing item in which an asset is leased for a period less than its economic life without any transfer of ownership.
Spirit Airlines’ net debt plus operating leases to EBITDAR ratio at the end of fiscal 2014 was 2.0x. This number is higher than other low-cost carriers Southwest (LUV) and Allegiant Airlines (ALGT), which were at 1.4x and 1.1x, respectively. However, it is lower than American Airlines (AAL) and JetBlue Airways (JBLU), at 3.6x and 3.1x, respectively.
Although Spirit Airlines’ (SAVE) leverage is currently not a concern, it is still important for investors to track its leverage. The airline industry fundamentals have improved tremendously and margins are expected to have reached its peak. If margins decline, as analysts estimate, it would mean reduced cash flows. This would make it difficult to make interest payments and leaving little on the table for investors.
On the other hand, if SAVE does manage to maintain this balance between debt and cash, it would put the airline in a much better position than peers with significant debt.
Investors can gain exposure to airline stocks by investing in the iShares Transportation Average ETF (IYT), which invests ~24% of its portfolio in airlines.