Spirit Airlines Inc. (SAVE, Financial) ended 2017 in red as the stock plunged almost 23%. The ultra low-cost carrier was hurt by three hurricanes as well as a dispute with its pilots regarding pay hike. Also, the stock is off to a lousy start heading into 2018 as it is down nearly 11% year to date. After a long run of remarkable profit growth, the ultra low-cost carrier has faced extreme margin pressure over the last two years.
The carrier’s recent problems have been driven mainly by competitive pricing strategy shifts by United Continental Holdings Inc. (UAL, Financial) and American Airlines (AAL, Financial) which has forced Spirit Airlines to further drop its fares in bug hub markets such as Chicago and Houston. However, there are several significant factors which should help the carrier reverse its downturn in the year ahead.
Spirit Airlines reported strong fourth-quarter results on February 6. For the quarter, revenue rose 15.3% year over year to $667 million, surpassing analyst’s estimate by nearly $1.65 million. Earnings per share came in at 73 cents, also topping the analyst consensus estimates by 2 cents.
The company nearly stabilized its unit revenue, while accomplishing a massive improvement in its non-fuel unit costs. Its overall GAAP operating expense jumped 16.5% year over year to $574 million, whereas its adjusted operating expense escalated 19% to $577.5 million. Most significantly, its aircraft fuel expense surged by 38.5% compared to a year ago period. That was primarily due to the robust recovery in oil prices.
As a matter of fact, Brent crude oil price is up more than 45% from its 52-week low of 44.82. Although increasing oil price is bad news for airlines, the same does not appear in the case of Spirit Airlines. Back in 2014, when oil prices were reasonably higher, Spirit Airlines had a significant margin lead over other legacy carriers.
As the oil price plunged, the margins of other airlines expanded. The higher margin allowed legacy carriers to offer competitive prices on routes where Spirit Airlines was growing swiftly. With a recent forecast of oil being above $65 per barrel for this year, shareholders should see higher margin lead of Spirit Airlines compared to legacy carriers.
Apart from this, the ultra low-cost carrier is aggressively trying to diversify its route network, but it will take a long time to diversify its route network fully. It continues expanding its capacity for serving leisure destinations like Las Vegas, Orlando, and Fort Lauderdale. Meanwhile, it is also cutting its capacity in big hub markets like Chicago where it has been fighting competitive wars with legacy carriers.
For the current quarter, the ultra low-cost carrier expects its revenue per available seat mile (RASM) to decline by 1% to 2.5%. On the other hand, it anticipates achieving a stunning 5.5% to 6.5% drop in its non-fuel unit costs.
Summing up
Although 2017 was a disappointing year for Spirit Airlines’ investors, things could change significantly this year. The company is starting to stabilize its profitability after suffering severe margin decline last year.
On the other hand, the rise in oil price should help Spirit Airlines regain its margin lead and giving it a higher room for capacity expansion as well as reduce chances of facing aggressive competitive prices from other carriers.
Spirit Airlines’ spectacular cost structure has enabled it to remain firmly profitable even with the persistent revenue pressure it has faced throughout the past few years. It currently has trailing-12 month revenue of $2.6 billion, significantly less than that of legacy carriers. This clearly suggests that Spirit has plenty of room to expand itself in the years ahead.
As an outcome, I would recommend shareholders consider buying the stock at a current market price as its future looks healthy.
Disclosure: No positions in the stocks mentioned in this article.
