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Southwest Airlines’ Falling Leverage: What Does It Mean?

Ally Schmidt

Southwest Airlines Is Flying High after 1Q16 Results

(Continued from Prior Part)

Reducing leverage

In an industry like airlines that requires huge capital investment, companies usually end up taking on huge debt. High debt tends to make a stock volatile and thus risky. So investors should keep a close eye on airlines’ leverage ratios.

The good news for Southwest Airlines (LUV) investors is that it boasts the lowest leverage among industry peers. What’s more, it continues to repay debt, further improving the ratio.

The debt-to-EBITDA ratio has declined from 0.72x at the end of 1Q16 to 0.62x at the end of 1Q16. The net debt-to-EBITDA ratio improved to -0.05x at the end of 1Q16.

Let’s look at the net debt-to-EBITDA ratios for other airlines at the end of 2015:

  • American Airlines (AAL): 1.86x
  • United Continental (UAL): 0.93x
  • Allegiant Travel: 0.66x
  • JetBlue Airways (JBLU): 0.62x
  • Delta Air Lines (DAL): 0.51x
  • Alaska Air (ALK): -0.27x
  • Southwest Airlines (LUV): 0.09x

Cash flows help reduce leverage

Southwest Airlines has been successful in reducing its debt over the years. This is due to its ability to generate strong cash flows year after year, which have consistently outpaced its peers and the industry.

For 1Q16, LUV generated $1.6 billion in cash flow from operations and $1.2 billion in free cash flow. It ended the quarter with~$3.6 billion in cash on its balance sheet.

Industry fundamentals have improved tremendously in the last two years and seem to have little scope for further improvement. Reducing leverage would not only reduce interest cost but would also make LUV a safer bet compared to peers with high leverages.

LUV forms 0.5% of the holdings of the iShares Russell Mid-Cap ETF (IWR).

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