Spirit Airlines, Inc. (SAVE) | Daily Alert January 22
Despite solid U.S. economic performance, the airline industry offers some very low valuations right now. If economic conditions remain favorable for consumers and if fuel prices do not rise drastically, Spirit Airlines, Inc.’s ambitious growth strategy could make it a very rewarding investment.
Spirit is an ultra-low-cost carrier operating 600 daily flights to 75 destinations in 16 countries. The ultra-low-cost model has been popular in Europe for many years and seems to be gradually gaining favor in the U.S. as well. Spirit is leaning into the opportunity. It will end 2019 with about 145 planes in operation, double the size of its fleet at the end of 2015. Its growth plans
call for an additional 48 planes delivered over the next two years, approximately 15% growth per year.
The company’s competitive strategy is to cram its planes as full as possible and pass the savings on to passengers. It configures seating for maximum density and charges extra for carry-on bags, discouraging passengers from filling up the cabin with heavy luggage. It also upcharges for seat assignments and other benefits that many other carriers provide de rigueur.
At the end of the day, only half of revenue comes from base ticket fares, with the other half coming from upcharges and ancillary revenues. Even with the upcharges, the company claims that its all-in price remains about one-third lower than competitive carriers’ all-in prices. Low price can be a difficult strategy. Executed well, however, it is a very reliable one. Spirit does not provide the most pleasant experience in the sky, but it has its loyal customers.
One of the things that attracts us to Spirit is its young, standardized fleet of aircraft. Spirit flies the Airbus 320 family of planes, the same planes that fellow IAS company Allegiant Travel (ALGT) has standardized on as well. Owing to its fast growth, Spirit’s fleet is actually the youngest among major carriers. A young fleet depreciates faster but requires less maintenance. Spirit historically outsourced most of its maintenance but has started investing in its own labor and facilities. This will become more important over time as its growth naturally slows and its fleet ages.
The balance sheet is very solid for a growing, capital intensive business. Net debt (debt minus cash) is approximately $2.2 billion, safely less than the 3x EBITDA multiple that lenders and investors generally view as aggressively levered. We expect the company to draw down its $1 billion cash hoard as it accepts delivery of 48 new planes over the next two years, but with
help from operating cash flow, net debt should remain safely under 3x EBITDA as long as industry profitability does not erode dramatically.
This is never a guarantee in the airline industry. A normal economic downturn could imperil Spirit and its equally-indebted neighbors, although Spirit should do better than many. Its status as a low-cost operator should make it relatively resilient. Still, we can well imagine a scenario where management is cancelling deliveries and scrambling to finance the planes it does accept. The balance sheet looks robust enough to weather a storm, but that fact would be more comforting to lenders than stockholders.
This industry is no place to invest going into a recession, but an investor betting on continued, steady economic growth may find a lot to like here. The company’s growth story is simple—add more planes and more service routes. The pace of growth looks ambitious, but not wild. Even if growth is slower than hoped for, the low valuation could rise, and stockholders could make good money, nonetheless. We don’t see many pockets of deep value in the market at present, but this does look like one.
We model 10% compound EPS growth starting from a base of $3.80, which could generate EPS of $6.12 in five years. That figure, combined with a high P/E of 17.1, generates a high price of 105. For a low price, we apply a low P/E of 8.7 to 2014 GAAP EPS of $3.08—the company’s lowest normalized EPS performance in the last five years. This yields a low price of 27. On that basis, the upside/downside ratio is 5.7 to 1.
Doug Gerlach, www.InvestorAdvisoryService.com, 1-877-33-ICLUB, January 2020