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Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Southwest Airlines Co. (NYSE:LUV) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Southwest Airlines Carry?
The chart below, which you can click on for greater detail, shows that Southwest Airlines had US$10.7b in debt in March 2022; about the same as the year before. But it also has US$15.7b in cash to offset that, meaning it has US$5.02b net cash.
A Look At Southwest Airlines' Liabilities
According to the last reported balance sheet, Southwest Airlines had liabilities of US$10.1b due within 12 months, and liabilities of US$16.8b due beyond 12 months. On the other hand, it had cash of US$15.7b and US$1.69b worth of receivables due within a year. So its liabilities total US$9.41b more than the combination of its cash and short-term receivables.
Southwest Airlines has a very large market capitalization of US$25.5b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, Southwest Airlines also has more cash than debt, so we're pretty confident it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Southwest Airlines's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Over 12 months, Southwest Airlines reported revenue of US$18b, which is a gain of 168%, although it did not report any earnings before interest and tax. So there's no doubt that shareholders are cheering for growth
So How Risky Is Southwest Airlines?
While Southwest Airlines lost money on an earnings before interest and tax (EBIT) level, it actually booked a paper profit of US$583m. So when you consider it has net cash, along with the statutory profit, the stock probably isn't as risky as it might seem, at least in the short term. One positive is that Southwest Airlines is growing revenue apace, which makes it easier to sell a growth story and raise capital if need be. But that doesn't change our opinion that the stock is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for Southwest Airlines that you should be aware of.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.