Why watch debt?
The airline industry is capital-intensive, which means it requires heavy investments in building infrastructure, fleets, and maintenance. As a result, airline companies generally have high debt on their balance sheets.
While high leverage is risky, the cyclical nature of the industry and the history of non-performance adds to investor risk.
High debt during times of an industry slowdown makes it difficult for American Airlines (AAL) to make interest payments. This, in turn, adversely affects valuation multiples.
American Airlines’ position
The airline industry has seen tremendous improvement in the last two years, mainly due to the drastic fall in crude oil prices. Most airlines have used this opportunity to reduce debt.
However, American Airlines (AAL) has been busy sorting out integration issues with US Airways. Management has paid little attention to the company’s high debt levels.
Although the company’s debt has increased, EBITDA (earnings before interest, taxes, depreciation, and amortization) has seen tremendous growth in the last two years. As a result, American Airlines’ debt-to-EBITDA ratio has decreased from 3.06x at the start of 2015 to 2.66x at the end of 2015. Its net debt-to-EBITDA ratio remained constant at 1.86x.
This is the highest among AAL’s peers. Below are net debt-to-EBITDA ratios for its peers at the end of 2015:
As integration woes are now behind American Airlines, management is focusing on reducing debt. However, the company doesn’t have a clear-cut plan yet. Paying attention to this in the future could be important for investors.
You can gain coverage to airline stocks by investing in the SPDR S&P Transportation ETF (XTN).
Next, we’ll see just how profitable American Airlines is.