It’s been a disconcerting year for Spirit Airlines Incorporated (NASDAQ:SAVE), the largest and fastest growing ultra low cost carrier (ULCC) in the Americas. They serve over 225 nonstop markets with over 470 daily flights and 60 destinations. The stock has plummeted since January, down a stomach wrenching 44% compared to a 12% gain for the S&P 500 and a 13% gain for the Dow Jones. Compare those performance figures to the dominant ULCC in Europe, Ryanair Holdings plc (ADR) (NASDAQ:RYAAY), which has up 28% YTD.
Given that Spirit’s business model is essential identical to that of Ryanair, from my vantage point, current valuations provide an attractive entry point for a company that can replicate RYAAY’s growth trajectory. They benefit from the same self-reinforcing low cost structure, which has proven very effective in beating competitors on price and driving passenger volumes.
SAVE’s cost advantage will continue to drive growth and widen their advantage in the ULCC category.
Why is SAVE down?
One overhang, though it should be resolved, is the purported Federal Aviation Administration (FAA) regulatory restrictions on minimum seat sizes that would impair Spirit’s ability to optimize every inch of plane layouts. Note that “no aviation regulator in any country has established minimum seat width or pitch requirements.”
This appears to be a headline risk rather than a material negative for the business. So long as the sizing and spacing of seats allows for all passengers and crew to evacuate within 90 seconds, the FAA should not press further. The amendment died in the Senate, and while it could always reemerge in a slightly adjusted form in future bills, I don’t foresee it getting congressional approval.
Another major issue that has weighed heavily on investors’ minds is the turf battle with United Continental Holdings Inc (NYSE:UAL). UAL wasn’t exactly thrilled at SAVE opening a gate at Newark, which is one of their major hubs.
Broad-based discounting in response to SAVE’s move (some would said it’s a form of retaliation) has people worried about Spirit’s future in UAL’s stronghold. Naturally, if someone can pay the same price for a wider seat and more leg room without having to pay for every little additional add-on, they’ll choose to fly with that airline over a low cost carrier.
But with Spirit’s cost structure in place, they are best positioned to weather any price war. Management has been through these cycles of overreaction and knows when to make adjustments based on longer term economics rather than a knee-jerk reaction.
Ryanair’s legacy and Spirit’s data indicates that low fares result in people flying to more places more often. On average, Spirit’s low fares grow the traffic base by 35-40%.
The market opportunities are significant and the demand is there. Spirit intends to open another 125 routes in the next five years and expand capacity at least 15%, focusing on “large urban centers, mid-size cities, and select international markets.” There are numerous markets that Spirit has yet to establish a presence in that provide adequate growth to turn a profit.
Leveraging its low cost model, the flywheel of more flights and thus volume will enhance Spirit’s pricing power as it negotiates with regional airports and aircraft manufacturers, which will produce savings that Spirit can pass on to consumers. Lower fares for consumers means higher passenger volumes for Spirit, and a moat starts to emerge.
Bottom Line on SAVE
While Spirit may not have the scale of Ryanair yet, they are well on their way to achieving a similar position of dominance. Hiccups are bound to occur, and that’s exactly what Spirit’s stock is going through at the moment, a temporary hiccup.
As SAVE shows that it can weather competitive pricing in good form, improve customer service (an issue which is universal in the airline industry), and get consumers more comfortable with their add-on pricing model, there is nothing from stopping its explosive growth. And trading at less than 10x trailing earnings, it’s a compelling entry point.
As of this writing, Luce Emerson did not hold a position in any of the aforementioned securities.