Spirit Airlines (SAVE, Financial) did not perform well in 2015, which is why the stock is looking very attractive now. The company lost about half of its value in 2015 because it slashed its unit revenue guidance several times throughout the year.
However, Spirit’s worst days are behind it as the company’s management has taken several steps to improve its business going forward. The carrier’s pretax profit margin has continued growing despite the increasing competition and capacity growth. Spirit’s profit margin has grown from 19.2% in 2014 to over 21.5% in 2015 despite its capacity growing by over 30%. The company’s performance is obviously astonishing, but it perhaps would not have taken place without the tremendous fall in oil prices.
The company plans to surge its capacity further by 20% this year. This hasty growth will have comforting effects on its unit revenue concerns. Apart from this, if oil prices drop again this year, then it will offer a great opportunity to generate stellar pretax margins of more than 20% for the second consecutive year.
Spirit Airlines expects to increase capacity by 15% to 20% yearly for the foreseeable future. If the price of oil remains low in 2016, then the company’s profit margins may increase.
Long-term gains despite short-term growth pain
The company’s speedy growth rate is definitely exerting some amount of pressure on its profit margin. At present, new routes are not performing well and are less gainful as compared to its settled routes. However, the company’s management believes that the majority of its new routes will mature and become extremely profitable this year. This clearly means the short-term ache of rapid growth will be a long-term advantage for development.
The company's position is similar to where Southwest Airlines (LUV, Financial) was in 1990. In 1990, Southwest produced $1.2 billion in the top line, approximately the same as Spirit's 2015 top line after adjusting for price. Southwest completed that year with 106 planes.
Over the next decade, Southwest more than tripled its fleet size with 345 airplanes. On the basis of available seat miles, its capacity grew at a 14% compound annual rate. Southwest was profitable for the entire decade and grew gradually. At the start of the decade, it had a single-digit operating margin; later, Southwest’s operating margin rose above 15% in 1997. Yet, at the end of 2000, its operating margin crossed a level of 18%.
The message for Spirit is quite simple. As long as the company continues yielding double-digit operating margins, the stock can appreciate considerably from its current levels.
Conclusion
Spirit Airlines’ shares have jumped considerably in the last two days, but the stock is still undervalued. Spirit’s improving profit margin, cheaper crude and maturing routes will drive the stock higher. Moreover, there’s also a possibility of merger with the likes of Frontier. All these factors make Spirit a great value play.
