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How Will Increasing Costs Impact Alaska Air’s Leverage Situation?

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Debt reduction

Alaska Air Group (ALK) had only $500 million in debt on its balance sheet prior to its Virgin America acquisition, thanks to its consistent five-year debt reduction spree. In 3Q16, the airline raised almost $2.0 billion in debt to fund the acquisition. At the end of 4Q16, the total debt on Alaska Air’s balance sheet was $3 billion.

But ALK paid down some of that debt in 1Q17. Its total debt now stands at $2.9 billion.

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Peer comparisons

At the end of 1Q17, Alaska Air (ALK) had a net-debt-to-EBITDA (earnings before interest, tax, depreciation, and amortization) ratio of 4.3x—an approximate midpoint for the industry. The airline with the highest leverage was American Airlines (AAL), with a net-debt-to-EBITDA ratio of 14.8x, followed by United Continental (UAL) with a net debt to EBITDA ratio of 9.3x.

Spirit Airlines’s (SAVE) ratio is 1.8x, while JetBlue Airways’s (JBLU) is 1.4x. Notably, Southwest Airlines (LUV) is the only airline to have more cash than debt on its balance sheet.

Debt to increase

The interest costs for ALK’s additional debt is close to 2.4%–2.5%, and so the net interest costs will be ~$50 million. For 2017, Alaska Air has set strong cash flow expectations. The airline expects to generate about $1.4 billion in cash flow from operations. It expects to generate about $600 million in free cash flow in the upcoming year, which should help it continue on its debt-reduction path.

All this means that the net impact on leverage ratios might not be very drastic for ALK.

Investors can gain exposure to Alaska Air by investing in the First Trust US Equity Opportunities ETF (FPX), which has 1.0% of its portfolio in ALK.

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