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 supplement their own equity in sustaining a larger scale of operations. For example, the auto industry and utilities companies are historically among the industries with high debt-equity ratios because their business nature involves capital intensity. However, other factors can further increase a company's debt-equity ratios, such as the lack of earnings and the easy use of transferable collaterals. The airline industry often is considered to have the highest debt-equity ratios.
Unlike other industries, such as auto or utilities, in which a company may need to spend hundreds of millions of dollars to build an auto manufacturing plant or an electricity generator, the airline industry often sees its companies spend far more investing in hundreds of aeroplanes just for an average fleet size. Airplanes are the single largest capital asset for the airline industry, making airline operations very capital intensive. A newer model Boeing aeroplane can cost more than £195 million. Moreover, the useful life of an aeroplane is likely shorter than an auto manufacturing or electricity power plant, further increasing capital investments.
Retained earnings are the ongoing self-funding source after any initial stock issuance. The lack of earnings from operations can make a company more dependent on debt to fund capital needs, thus increasing debt-equity ratios. Compared to other capital-intensive industries, the airline industry is more susceptible to earnings fluctuations, making retained earnings an unreliable financing means to implement capital investment plans. Fuel costs and costs related to ever-increasing security measures are the two main streets on earnings for airline companies. In comparison, auto companies may face demand issues at times, but they can control their own costs, and utilities companies are able to generate steady earnings from selling electricity, a daily necessity, to a large consumer base.
The convenience of borrowing for the airline industry likely also contributes to its high debt-equity ratios and is made possible by the industry's relatively high recovery rating as assigned by credit rating agencies. A recovery rating is the likelihood of recovery of money for creditors in the event of a default. Collaterals used in airline borrowing can be aeroplanes, which are highly transferable. While it is unlikely that a creditor would take over a plant or possess any equipment for money recovery in a debt default by an auto or utilities company, the same creditor could seize an aeroplane and transfer it to a new buyer for debt recovery. It's easier to find buyers for an aeroplane than for a power plant or auto dealership.
Airline companies sometimes take on new debt in the way of debt revolving to simply pay down existing debt in addition to meeting capital requirements. The continuation of debt borrowing prevents the airline industry from lowering its high debt-equity ratios. A persistent high level of debt eventually has negative effects on earnings because of ever-present heavy interest payments coming from earnings. When debt principals are due, there may not be enough earnings left to pay down the debt, and companies have to refinance it, or keep revolving it, to avoid potential default.