Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Alaska Air Group, Inc. (NYSE:ALK) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Alaska Air Group's Net Debt?
As you can see below, at the end of September 2020, Alaska Air Group had US$3.82b of debt, up from US$1.71b a year ago. Click the image for more detail. However, it does have US$3.76b in cash offsetting this, leading to net debt of about US$63.0m.
How Healthy Is Alaska Air Group's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Alaska Air Group had liabilities of US$4.21b due within 12 months and liabilities of US$7.09b due beyond that. Offsetting this, it had US$3.76b in cash and US$321.0m in receivables that were due within 12 months. So its liabilities total US$7.22b more than the combination of its cash and short-term receivables.
When you consider that this deficiency exceeds the company's US$6.46b market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. Alaska Air Group has a very little net debt but plenty of other liabilities weighing it down. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Alaska Air Group can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Over 12 months, Alaska Air Group made a loss at the EBIT level, and saw its revenue drop to US$5.0b, which is a fall of 42%. To be frank that doesn't bode well.
While Alaska Air Group's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable US$1.0b at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. It's fair to say the loss of US$696m didn't encourage us either; we'd like to see a profit. And until that time we think this is a risky stock. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for Alaska Air Group (1 is potentially serious!) that you should be aware of before investing here.
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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