The debt-to-equity (D/E) ratio measures a company's debt burden and use of leverage. Generally, the less debt relative to equity, the better asl larger D/E's can make it more difficult for a company to service its existing debts and raise future capital. While this is generally, true, a company's D/E must be evaluated relative to its industry peers as different types of companies rely on different levels of debt to operate.
Here, we look to the commercial airline industry. In 2021, the average debt-to-equity ratio of mainline passenger, public, airline companies in the U.S. was between 5 and 6x, largely due to the continued fallout from the COVID-19 pandemic that greatly curtailed air travel. Still, 2021 saw improving debt levels, down from the industry's D/E ratio of more than 9x in 2020 when the pandemic first struck.
- Airlines are a capital-intensive industry, needing to purchase and maintain expensive aircraft and pay for the fuel to make them go.
- The COVID19 pandemic greatly impacted air travel, causing airline D/E ratios to balloon in 2020.
- In 2021, many airlines got their debt under control, with smaller and regional airlines faring the best.
The Debt-to-Equity Ratio
The debt-to-equity (D/E) ratio is an important financial tool in assessing the health of a business. Many times when a person hears the word "debt," a negative connotation is associated. However, debt isn't necessarily a bad liability, and it is important in running a company when managed correctly and taken on at appropriate levels.
The D/E ratio is a calculation used to assess how much debt is being used to run a business compared to the equity of the business. It shows how much debt you have for every dollar of equity you have. It is calculated, simply, as total liabilities divided by shareholder equity. Both these numbers can be found on the balance sheet of a company's financial statements. If a company has a high D/E ratio, it typically indicates that the company has a high debt level per each dollar of shareholders' equity. Therefore, investors favor companies with low D/E ratios.
A high D/E ratio could indicate that a company is under financial stress and lacks the ability to pay down its debt burden. A D/E ratio that is too low indicates that a company is relying on its own equity to run its business and can be seen as an inefficient use of cash. The D/E ratio is important for financial analysts to determine the health of a company, as well as for management on deciding how they should be running operations, and also for financiers on deciding whether they should be lending money to a company.
The Debt-to-Equity Ratio in the Airline Industry
It is crucial to compare the D/E ratios of companies in context to the industry that they are in. Every industry has different requirements and so will have different debt requirements. For example, a company that primarily operates online is less capital-intensive than a construction company. A construction company requires tremendous amounts of equipment to operate and the need to take on debt to finance the purchase of that equipment.
|The Debt-to-Equity Ratio of Major U.S. Airlines (2021)|
The average D/E ratio of major companies in the U.S. airline industry was between 5-6x in 2021, which indicates that for every $1 of shareholders' equity, the average company in the industry has more than $5 in total liabilities. The airline industry is a highly capital-intensive sector and is often considered to have some of the highest D/E ratios. Still, looking at the table above, we can see the Frontier, Southwest, Spirit, and Allegiant have fared relatively better in terms of debt. These smaller, regional carriers may have been able to shrug off the pandemic more easily than larger and international carriers. Note that American Airlines has a negative D/E since it has negative equity.
Airlines companies need to purchase planes, outfit those planes, pay for fuel, air hangars, flight simulators, repairs on planes, pilots, flight attendants, baggage handlers, and a multitude of other costs. It is not a surprise that their debt levels are high.
The airline industry is a service industry that uses the income it generates to pay off its debt. This puts tremendous levels of strain on airline companies, as they are constantly under pressure to generate business, and therefore income, to continuously pay off their debt. In addition, the airline industry is a seasonal industry. People tend to travel more in the summer months when the weather is warm and children are on summer holidays. This seasonality can make it difficult to pay down debt throughout the year as incoming cash flows fluctuate.
Is the D/E Ratio of the Airline Industry High?
The airline industry has one of the highest D/E ratios because of the capital-intensive nature of running an airline. Different airlines should thus be compared with one another, or with oneself over time, in order to determine if they are able to continue paying their long-term obligations.
Why Do Debt-to-Equity Ratios Vary Among Industries?
The amount of debt that a company takes on will depend, in part, on the industry that it is in. Capital-intensive industries will naturally rely on a greater degree of leverage in order to acquire, maintain, and expand their capital resources. As a result, industries like airlines, manufacturing, mining, and utilities will have high industry D/E ratios. Financial companies, too, will often show high D/Es, not due to capital, but due to borrowing and lending activities.
Do Airlines Actually Own the Planes They Fly?
Many airplanes flown by airlines are not owned by the airline, but are leased from third-party leasing companies. The exact ratio of owned to leased will vary by airline, but the trend has been toward a greater reliance on leases over the past decade.
The Bottom Line
The debt-to-equity ratio is a simple formula that shows how much debt a company is using to operate its business compared to its equity. Appropriate levels of debt can help a business function well and be successful, while too much debt can be a financial burden. When comparing a company's D/E ratio, it's important to analyze it in the context of its industry.
McKinsey. "Airlines and debt: Dealing with the long-term burden."
Macrotrends. "Air Transport Services Debt to Equity Ratio 2006-2021."
The New York Times. "The Real Owner of All Those Planes."