The effects of operating and financial leverage on the stability of airline returns over time: The contrast between Southwest, Delta and USAir

Through the early months of the year 2000, the country's major airlines hav e continued to enjoy an unprecedented prosperity. Relatively low fuel costs and interest rates have combined with the fruits of past labor concessions and the ongoing American economic boom to create an extremely favorable op erating environment. Add to this the increase in industry concentration due to airline mergers and alliances, and the sizable built-up operating and f inancial leverage that characterizes the industry, and it is no wonder that record profits have been the recent rule. In our view, this last factor-th e prevalence of substantial built-up operating and financial leverage in th e airline industry-is of particular interest. Having been widely blamed for creating past industry problems, these high-leverage positions now serve t o magnify the beneficial influence of the other cited factors to swell curr ent airline profitability. However, even in such prosperous times the poten tial danger of these positions should not be ignored. This study highlights, by example, the effects of varying leverage position s on airline profitability. To accomplish this, we've applied previously de veloped measures of risk to three major U.S. air carriers-Southwest (SWA), Delta (DAL), and U.S. Air (USAir).(1) These particular carriers offer signi ficant contrasts: SWA has always been a strong performer, conservatively fi nanced;USAir has had several bouts with severe financial problems due to ex cessive debt finance; DAL is a carrier between the two extremes in both per formance and philosophy, but a carrier considered by most analysts to be on e of the strongest in the industry.