Health Check: How Prudently Does Southwest Airlines (NYSE:LUV) Use Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Southwest Airlines Co. (NYSE:LUV) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Southwest Airlines

How Much Debt Does Southwest Airlines Carry?

The chart below, which you can click on for greater detail, shows that Southwest Airlines had US$11.2b in debt in September 2021; about the same as the year before. However, it does have US$16.0b in cash offsetting this, leading to net cash of US$4.76b.

How Strong Is Southwest Airlines' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Southwest Airlines had liabilities of US$9.14b due within 12 months and liabilities of US$17.7b due beyond that. On the other hand, it had cash of US$16.0b and US$1.48b worth of receivables due within a year. So it has liabilities totalling US$9.38b more than its cash and near-term receivables, combined.

Southwest Airlines has a very large market capitalization of US$26.2b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Southwest Airlines boasts net cash, so it's fair to say it does not have a heavy debt load! 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 Southwest Airlines 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, Southwest Airlines saw its revenue hold pretty steady, and it did not report positive earnings before interest and tax. While that hardly impresses, its not too bad either.

So How Risky Is Southwest Airlines?

While Southwest Airlines lost money on an earnings before interest and tax (EBIT) level, it actually booked a paper profit of US$1.0m. So when you consider it has net cash, along with the statutory profit, the stock probably isn't as risky as it might seem, at least in the short term. Until we see some positive EBIT, we're a bit cautious of the stock, not least because of the rather modest revenue growth. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Southwest Airlines you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.