Spirit Airlines (SAVE, Financial) has been on a horrible run this year as the stock has dropped 55% in 2015. While my other recommendations in the aviation industry like JetBlue (JBLU) and Volaris (VLRS) have returned double-digit growth, investors have punished Spirit Airlines due to concerns regarding declining unit revenue.
Due to falling oil prices, all airlines have slashed air fares to compete on price. As a result Spirit, which already sells the cheapest ticket in the industry, had to slash prices as well. Due to heavy discounting, Spirit’s passenger revenue per average seat mile, or PRASM, dipped significantly over the last few months.
In addition, American Airlines’ (AAL) aggressive stance on price competition further spooked investors as about half of American and Spirit’s routes overlap. While shares may have broadly underperformed the market, I think investors should use this as a buying opportunity. Spirit Airlines has bottomed and the stock is currently significantly undervalued with massive upside potential.
Spirit has the highest profit margin in the aviation industry and analysts are expecting the company’s earnings to post double-digit growth for the coming quarters. In addition, the company only commands a small market share of the aviation industry and still has a lot of room to expand. As a result, analysts expect the company’s sales to grow in double-digits in FY 2015 and FY 2016.
Despite the massive expected growth, Spirit Airlines is trading at 8x forward earnings. Any company with Spirit’s expected growth usually trades at an earnings multiple of over 20, and the fact that Spirit’s forward P/E stands at 8 further highlights the undervaluation of the stock. I believe the stock possesses 100% upside potential from here, and investors should consider buying it at the present valuation.
What makes an investment in Spirit even more lucrative is the fact that the carrier has a healthy balance sheet. Most of the airlines worldwide are highly leveraged, but Spirit Airlines has over $750 million in cash compared to $530 million in debt. And despite offering the cheapest tickets, Spirit has an operating margin of 23%. The company’s business model is sturdy enough to survive any price war.
Oil price
Lower oil prices have been a boon for airlines and especially for low-cost carriers like Spirit. Back in 2014, when oil was priced at over $100 per barrel, Spirit was spending roughly 40% of its revenue on fuel expenses. With oil prices now down roughly 60%, Spirit is enjoying record profits despite the weak air fare environment.
According to EIA, oil prices are expected to stay near the present levels for years to come. As per EIA’s factsheet, the agency sees oil prices reaching $80 per barrel in 2020 in their New Policies Scenario, the World Energy Outlook 2015’s central scenario.
Spirit will most likely use the oil savings to expand into other markets for the years to come. Consequently, I expect Spirit Airlines to sustain its double-digit revenue growth for at least three more years.
Conclusion
In today’s market, it is very difficult to find a company that has 20% operating margin, net cash, and 20% annual growth rate that is trading at a meager forward earnings multiple of 8. Given the valuation and growth potential, I think Spirit Airlines has fallen into deep-value territory and the stock is a definite buy at present levels.
