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Southwest Airlines Is Reducing Leverage: What That Means

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Constant debt

Southwest Airlines’ (LUV) debt level has remained almost constant for nearly three years at an average of $3.0 billion. The company’s debt was $2.9 billion at the end of 2014 and increased to $3.3 billion at the end of 2015 and $3.5 billion at the end of 2016. At the end of the first quarter of 2017, its debt decreased to $3.2 billion.

Leverage ratio for Southwest Airlines as measured by its net debt-to-EBITDA (earnings before interest, tax, depreciation, and amortization) ratio has been quite volatile. Its leverage ratio was 0.01x at the end of 2015 and increased to 0.08x at the end of 2016. The good news for Southwest Airlines’ investors is that cash has exceeded debt for most quarters, which was also the case in the last quarter.

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Peer comparisons

At the end of the first quarter of 2017, American Airlines (AAL) had the highest leverage among airlines with a net debt-to-EBITDA ratio of 14.8x, followed by United Continental (UAL) at 9.3x. Alaska Air’s (ALK) net debt-to-EBITDA ratio was 4.3x, and Spirit Airlines’ (SAVE) ratio was 1.8x. JetBlue (JBLU) had a leverage ratio of 1.4x. Southwest Airlines (LUV) was the only airline with more cash than debt on its balance sheet.

Cash flows help reduce leverage

For 2015, LUV generated ~$3.2 billion in cash flow from operations, which increased to $4.3 billion in 2016. That translated to free cash flow of $1.1 billion in 2015 and $2.1 billion in 2016. That gives investors confidence that LUV can keep reducing its debt in the future.

To avoid the risk of investing in a single airline stock, you can invest in the First Trust Industrials/Producer Durables AlphaDEX ETF (FXR), which invests 1.9% of its portfolio in JetBlue (JBLU). It also invests 1.9% in American Airlines (AAL), Delta Air Lines (DAL), United Continental Holdings (UAL), Southwest Airlines (LUV), and Spirit Airlines (SAVE).

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