High-Flying, High-Debt Airlines Will Be Forced Back Down to Earth, Again
Pretty remarkable, when you consider the level of debt each of these companies is carrying. When the market turns, as it always does, the heavy leverage will be a tremendous burden on the ability of all of these airlines to compete and survive.
Since the industry's deregulation in 1978 more than 200 air carriers have filed for bankruptcy. US Airways has done it twice. Delta Airlines did it in 2005 and, for United Airlines, it was in 2002. American Airlines was the last legacy airline to file for bankruptcy with its Chapter 11 petition in November 2011.
All borrowed way too much to be able to survive.
A useful way to determine how well a company is being managed for debt and other considerations is to compare it with the "best practices" in the industry. Spirit Airlines (NASDAQ: SAVE) and Alaska Airlines (NYSE: ALK) are, by far, the best run airlines-- with each having a profit margin of around 9.50 percent. The debt-to-equity ratio for Alaska Airlines is 0.50. Spirit Airlines has no debt.
By contrast, United Airlines has a negative profit margin of 0.50 percent and a debt-to-equity ratio of 6.98. That means it required almost seven dollars in borrowing to produce each dollar of equity for those owning the stock.
US Airways Group has a debt-to-equity ratio of 3.93 and a profit margin of 4.10 percent. The debt-to-equity ratio for Delta Airlines is 86.86 with a profit a profit margin of 5.10 percent.
The airlines industry is one that does not hold up well with too much debt.
Fuel makes up about 40 percent of fixed expenses, and it appears to be staying at a high level. Revenues are also unpredictable, as passenger traffic fluctuates with the economy. An unstable revenue stream with high fixed costs is a classic case of borrowing short-term and lending long-term, which should always be avoided.
Writing on this subject in The Wall Street Journal in 2009, Mike Milken warned that "even a dollar of debt may be too much for some companies. Over the past four decades, many companies have struggled with the wrong capital structures. During cycles of credit expansion, companies have often failed to build enough liquidity to survive the inevitable contractions."
"Especially vulnerable." he added, "are enterprises with unpredictable revenue streams that end up with too much debt during business slowdowns. It happened 40 years ago, it happened 20 years ago, and it's happening again. Over-leveraging in many industries -- especially airlines, aerospace and technology -- started in the late 1960s."
As detailed in a previous article on Benzinga, it is far better to invest in companies with clean or lean balance sheets. That is especially so for industries like the airlines, that have unpredictable income streams with high fixed costs.
Before taking off with US Airways Group, Delta Airlines and United Continental, investors should be very wary of the debt burdens that have a history of forcing air carriers into a crash landing.
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