The airline industry is a capital-intensive industry with heavy investments required in building infrastructure, fleets, and maintenance. As a result, airlines generally have high debt on their balance sheets.
Legacy players have very high debt, while regional players seem to have managed their debts well. As you can see in the above graph, at the end of 3Q16, American Airlines (AAL) had the highest net debt-to-EBITDA (earnings before interest, tax, depreciation, and amortization) ratio or leverage of 7.3x. It was followed by United Continental (UAL) at 3.1x. Delta Air Lines (DAL) had a leverage of 1.9x.
Regional player JetBlue Airways (JBLU) has a leverage of 0.52x, and Southwest Airlines (LUV) has a leverage of 0.03x. Spirit Airlines (SAVE) and Alaska Air Group (ALK) are the most efficient in terms of leverage. Both have cash in excess of debt. At the end of 3Q16, SAVE had a net debt-to-EBITDA ratio of -0.15x, and Alaska Air’s ratio was -0.55x.
Why pay attention to leverage?
Leverage tends to make a stock volatile and thus increases investor risk. Airline industry fundamentals have improved significantly, and margins are expected to have reached their peak. If margins fall as analysts estimate, it would mean reduced cash flows, making it difficult to make interest payments and leaving little if nothing on the table for investors. In fact, all three legacy players have already declared bankruptcy once as a result of high and unmanageable debt.
On the other hand, if airlines manage to maintain a balance between debt and cash, they would be in a much better position than their peers that have significant debt.
You can gain exposure to travel stocks by investing in the iShares Transportation Average ETF (IYT), which invests 22.0% of its portfolio in airlines.