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Southwest’s Leverage Reduction: What It Means for Investors

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Debt at nominal levels

The airline industry has high capital requirements due to heavy investments required to build infrastructure, fleets, and maintenance. As a result, airline stocks generally have high debt levels on their balance sheets.

Most airlines, including Southwest Airlines (LUV), have used the huge amount of cash generated in 2014 and 2015 to repay debt. Its debt-to-EBITDA ratio declined from 0.72x at the start of 2015 to 0.60x at the end of 2Q16.

Southwest Airlines went from being net debt negative (cash greater than total debt) to net debt positive at the end of 2015. However, this has again reversed. Its net debt-to-EBITDA ratio has decreased from 0.09x at the end of 2015 to -0.01x at the end of 2Q16.

At the end of 2Q16, Southwest Airlines’s peers had the following net debt-to-EBITDA ratios: 

  • American Airlines (AAL): 1.5x
  • United Continental (UAL): ~1.0x
  • Delta Air Lines (DAL): 0.57x
  • Allegiant Travel (ALGT): 0.54x
  • JetBlue Airways (JBLU): 0.14x
  • Spirit Airlines (SAVE): -0.17x
  • Alaska Air Group (ALK): -0.56x
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Cash flows help reduce leverage

In fiscal 2015, Southwest Airlines (LUV) generated ~$3.2 billion in cash flow from operations. For 1H16, LUV has already generated $2.7 billion of cash flow from operations (or CFO). The airline’s CFO has reduced its debt and simultaneously maintained $3.4 billion in total cash on its balance sheet at the end of 2Q16. The strong CFO generation ability gives investors confidence that LUV can continue to reduce its debt in the future.

Southwest Airlines has a total debt-to-equity ratio ~38.3%, which is very small when compared to the regional airlines’ industry average of 149%. This is one of the reasons that it is listed as one of the two investment-grade airlines, making it one of the less risky airline stocks. Southwest Airlines forms 0.86% of the iShares US Consumer Services ETF (IYC).

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