April 17, 2018 - 5:53pm EST by
2018 2019
Price: 36.84 EPS 3.30 4.30
Shares Out. (in M): 68 P/E 12.3 8.6
Market Cap (in $M): 2,514 P/FCF 0 0
Net Debt (in $M): 598 EBIT 0 0
TEV ($): 3,112 TEV/EBIT 0 0

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Spirit can more than double its earnings over the next 5 years.  The stock price should at least keep pace and might easily do even better given its compressed multiple today.  Spirit has a clear growth strategy with attractive economics and has demonstrably improved its operating performance.  A takeover/merger with Frontier Airlines, for which there is both strong industrial logic and market speculation, would be icing on the cake.




Background and Recent History:


Spirit has been recommended on VIC four times previously.  There is valuable context in each writeup.  I would also highlight a presentation by Whitney Tilson from November, 2015:  www.tilsonfunds.com/SAVE.pdf


In May, 2017 HighLine09 proposed Spirit with the stock at $55.50.  While the stock has not performed well I think the analysis was thoughtful.  From this price--Spirit is trading at historic P/E and P/S multiples--the risk/reward should be much better.  Note that if the stock regained that level in two years the IRR would be over 20%.


Three key factors led to the sharp decline in the stock in mid-2017:


° Pilot Action:  Spirit began negotiating with its pilots in 2015.  Frustrated by the lack of progress, the pilots began a work slowdown in the spring of 2017.  With the release of Q2:17 earnings, the company announced that 850 flights had been cancelled because of the work action, leading to a loss of $45MM--$25MM in lost revenue and $20MM in additional costs, primarily rebooking of passengers on other airlines.  Some disruption persisted in the second half of the year.  Earlier this year, Spirit signed a new pilot contract (more on this below).  


°  Price Competition:  Beginning last June the industry environment changed, similar to what had happened in 2015.  While the advent of “basic economy” fares at the major airlines has been widely discussed, this was different in kind: Higher cost carriers charging lower prices than Spirit in many city pairs.  Over the course of Q3 management estimated that 50% of its total base was impacted by abnormal competition.  In recent months, this has abated to some extent.  Spirit has not reported Q1 earnings yet but  did pre-release selective data:  Total Revenue per Available Seat Mile (TRASM) declined 2.4% Y/Y.  In the second half of 2017 the decline was about 4%.



° Fuel Costs:  Oil prices have risen sharply in recent months. In Q1:18, the cost/gallon rose 21% Y/Y. Thus, while Spirit has delivered excellent results on Cost per Available Seat Mile ex Fuel (CASM Ex), margins have been squeezed.


These real negatives both for Spirit and the industry have obscured some favorable developments.  


°  Pilot Contract:  The union approved a new 5 year contract in late February.  The pilots got an average raise of 43%.  Spirit got better work rules which should produce greater reliability.  Management projects flat to lower CASM Ex in 2018 and 2019 even with the large pay increase.  In addition, the company was reluctant to order additional aircraft without a contract.  Now Spirit is in a position to add to its unit growth in 2020 and 2021.


° Ancillary Revenues:  Almost half of total revenues--seats, bags, drinks, insurance, etc.  In 2014 each passenger generated $55 in ancillaries.  This declined somewhat after that but is now on the rebound, climbing 3.8% Y/Y in Q4.  Management is guiding a return to $55 by the end of 2018 and believes there is additional room for improvement, which should undergird the corporate margin structure.


°  Operations:  Spirit has made major strides versus the industry in on-line performance and completions over the last couple of years.  This improvement, coupled with a greater understanding by customers of the Spirit experience (for instance, that you have to pay to put a bag in the overhead compartment and, if you wait to do so until you are at the airport, that you have to pay a lot), is very important to both financial results and building a brand with a positive image.


° New Corporate Tax Rate:  Airlines are a major beneficiary.


Growth/Earnings Potential:


Obviously, modeling an airline for the next quarter, let alone 5 years, is an exercise in humility.  Here are my basic assumptions:


--14% CAGR in ASMs.  This requires a modest increase in the current fleet plans (161 aircraft at the end of 2021 versus 112 at the end of 2017), which management appears eager to do.


--Operating income/ASM:  1.5¢  (Note:  1.37¢ in 2017, but 1.58¢ adjusted for labor issues and hurricanes).  I actually believe Spirit can surprise to the upside here over time as it was once over 2¢, though I do not believe those levels are attainable for very long.


--25% tax rate


--Steady share count (Spirit has been buying in stock but I don’t model this).


This yields EPS of $8-9 in 2022.  If they can do this, worrying about the proper multiple is silly.




Privately owned Frontier Airlines is the second largest (after Spirit) ULCC in the US.  The company is based in Denver and currently has a fleet of 80 Airbus planes (and a very large order placed last fall that will triple the size of the company over the next decade.  Its strategy is very similar to Spirit:  Low ticket prices; minimal frills; ancillary revenues; high aircraft utilization.  Frontier is owned by Indigo Holdings, Bill Franke’s private equity firm.  Franke headed America West and then went on to control Spirit from 2006 through its IPO. 


Frontier filed for an IPO in 3/17 but never proceeded with the offering due
to the fare war last summer.  Especially given its ambitious growth plans, it’s hard to imagine it staying private for too long.  A deal with Spirit would make sense and be a back door way of going public.  Based on disclosures in the Frontier S-1, the cost structures of the two companies are remarkably similar. Hard to model but there would definitely be some cost savings and operational efficiencies.The route maps also fit together pretty well. Frontier has an open pilot contract that is in mediation; it could be debated whether this is an impediment to a combination or another factor arguing for it.  And it’s very hard to tell from the outside whether the management teams (and Franke) would even consider this, but there are periodic rumors and it would seem to make sense for them to at least talk to each other.




It’s an airline.





I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.


1.  Margin stabilization:  Should become evident over the next few quarters.

2.  Potential Frontier merger

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