The Debt Dogs of Airlines

Charlie Munger, Warren Buffett's business partner, has condemned drugs, liquor, and leverage as humanity's three biggest downfalls. The first two are your own responsibility, but if you're invested -- or are thinking about investing -- in the airline industry, you should know which companies in the space are the deepest in debt.

Leverage is not inherently bad for a company. A rapidly growing company can intelligently employ debt to exploit its market opportunity. At low interest rates, debt can fund shrewd strategic acquisitions. Since it's generally cheaper than equity, debt can also lower a company's cost of capital.

But too often, companies end up abusing debt -- and as Munger reminds us, excessive leverage can lead to ruin. Let's examine a few of the most heavily indebted airlines.

Company

Total Debt/Capital

Interest Coverage

AMR (NYSE: AMR  )

154.9%

0.4

United Continental (NYSE: UAL  )

133.3%

2.1

US Airways (NYSE: LCC  )

98.1%

2.4

Delta Air Lines (NYSE: DAL  )

94.5%

2.2

Republic Airways (Nasdaq: RJET  )

83.8%

1.0

First of all, look at AMR, which operates American Airlines. As the 0.4 interest coverage ratio indicates, the company's operating income has been insufficient to pay the interest on its loans over the past 12 months. This is on top of the recent drama stemming from the airline's recent spat with online travel intermediary Expedia.

Republic Airways, which is just a $290 million market-cap company (the other four are valued at more than $1 billion each), is also flirting with disaster with its ability to meet its interest payments. Its 1.0 interest coverage ratio implies that it needs every last drop of its operating income to avoid defaulting on its loans.

Not surprisingly, all of these companies are trading at relatively low multiples. All of their EV/EBITDA multiples are below 7, which means they might be showing up on value-oriented screens. I'd tread particularly carefully with US Airways. This airline sports a dirt-cheap (on the surface) 3.8 multiple, but this $1.4 billion company also has a whopping $4.4 billion in debt on its books.

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Neither Alex Pape nor The Motley Fool owns shares of any company mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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  • Report this Comment On February 27, 2011, at 2:15 PM, ajvolpe wrote:

    The Airlines that are mentioned, with the exception of AMR, all used the perverse method of Bankruptcy to reduce their debt and costs. By being exempt from employee obligations and forcing lessors into less expensive contracts, they have continued to use our Government condoned program of negating worker's rights and outsourcing services. All of this in the name of presevation of "The Company" , to supposedly keep people working, but failing to note that they can't make living after this process. And by the way, no pension or medical benefits.

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