debt earnings airline capital industry auto companies

techsuch May 9, 2021 0 Comments

What Industry Typically Has the Highest Debt Equity Ratios?Industries that require intensive capital investments normally have above-average debt-equity ratios, as companies must use borrowing to supplementtheir own equity in sustaining a larger scale of operations. For example, theauto industry and utilities companies are historically among the industrieswith high debt-equity ratios because their business nature involves capitalintensity. However, other factors can further increase a company’s debt-equityratios, such as the lack of earnings and the easy use of transferablecollaterals. The airline industry often is considered to have the highestdebt-equity ratios.## Capital IntensityUnlike other industries, such as auto or utilities, in which a company mayneed to spend hundreds of millions of dollars to build an auto manufacturingplant or an electricity generator, the airline industry often sees itscompanies spend far more investing in hundreds of airplanes just for anaverage fleet size. Airplanes are the single largest capital asset for theairline industry, making airline operations very capital intensive. A newermodel Boeing airplane can cost more than $300 million. Moreover, the usefullife of an airplane is likely shorter than an auto manufacturing orelectricity power plant, further increasing capital investments.## Earnings RestraintsRetained earnings are the ongoing self-funding source after any initial stockissuance. The lack of earnings from operations can make a company moredependent on debt to fund capital needs, thus increasing debt-equity ratios.Compared to other capital-intensive industries, the airline industry is moresusceptible to earnings fluctuations, making retained earnings an unreliablefinancing means to implement capital investment plans. Fuel costs and costsrelated to ever-increasing security measures are the two main drags onearnings for airline companies. In comparison, auto companies may face demandissues at times, but they can control their own costs, and utilities companiesare able to generate steady earnings from selling electricity, a dailynecessity, to a large consumer base.## Borrowing ConvenienceThe convenience of borrowing for the airline industry likely also contributesto its high debt-equity ratios and is made possible by the industry’srelatively high recovery rating as assigned by credit rating agencies. Arecovery rating is the likelihood of recovery of money for creditors in theevent of a default. Collaterals used in airline borrowing can be airplanes,which are highly transferable. While it is unlikely that a creditor would takeover a plant or possess any equipment for money recovery in a debt default byan auto or utilities company, the same creditor could seize an airplane andtransfer it to a new buyer for debt recovery. It’s easier to find buyers foran airplane than for a power plant or auto dealership.## Debt RevolvingAirline companies sometimes take on new debt in the way of debt revolving tosimply pay down existing debt in addition to meeting capital requirements. Thecontinuation of debt borrowing prevents the airline industry from lowering itshigh debt-equity ratios. A persistent high level of debt eventually hasnegative effects on earnings because of ever-present heavy interest paymentscoming from earnings. When debt principals are due, there may not be enoughearnings left to pay down the debt, and companies have to refinance it, orkeep revolving it, to avoid potential default.

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