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Spirit Airlines Incorporated Stock Could Benefit from the Southwest Effect

Spirit stock - Spirit Airlines Incorporated Stock Could Benefit from the Southwest Effect

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Spirit Airlines Incorporated (NYSE:SAVE) continues to make waves in the airline industry. Although employee issues and complaints of poor service plague the airline’s image, Spirit stock continues to impress investors.

As profits grow and service expands, Spirit continues to enjoy the highest profit growth in the industry. However, one move the company is currently mulling could lead to an even higher level of profit growth for Spirit stock.

Helping Passengers SAVE on Airfare

From an investor standpoint, Spirit stock has become the darling of the airline industry. Its ultra-low-fare strategy has been a boon to passengers who want cheap fares, and investors who enjoy higher profits from lower costs.

This ultra-low-fare segment has changed the industry. Along with airlines such as Ryanair Holdings plc (ADR) (OTCMKTS:RYAAY), Allegiant Travel Company (NASDAQ:ALGT), and Frontier Airlines, it offers “ultra-low” airlines fares and makes its margins with fees on checked bags, carry-ons, and other amenities.

This separates SAVE from carriers such as Southwest Airlines Co (NYSE:LUV) or JetBlue Airways Corporation (NASDAQ:JBLU). Though still considered “low cost,” Southwest and JetBlue offer a higher level of amenities.

However, regarding revenues and earnings, no airline has enjoyed more success with this strategy than Spirit. Over the last five years, revenue growth has averaged about 15% per year. Net income has also increased by an average of 30%.

As I mentioned in a recent article, growth should continue long term. The company will release quarterly earnings on April 26th, and Spirit issued new Q1 guidance on April 11. SAVE expects revenue per available seat mile to fall by 2.4%.

However, with cost per available seat mile falling by 5%, profit should increase amid falling revenues. Spirit also expects a capacity increase of 22.3% on a year-over-year basis.

Spirit Stock and Pilot Pay

Still, not every battle to keep costs low succeeds. In February, Spirit and its pilots ratified an agreement to increase pilot salaries by an average of 43%. While this will reduce profits in the near term, profit growth will resume in future years.

Amid these higher costs, Spirit Airlines Incorporated plans to temporarily slow its expansion. However, “slow” means a minimum of 10%. The airline is making this move to evaluate growth and to slow the pace of fare wars that have squeezed margins for the entire industry.

Still, analysts still expect a brisk level of capacity expansion going forward. Adding planes remains part of the plan. Like Southwest, SAVE uses only one aircraft type to keep costs low. Its entire fleet consists of Airbus A320 family of jets. SAVE plans to add 49 more Airbus jets by the end of 2021, bringing the fleet size to 161.

Southwest’s Strategy

However, a new type of expansion could become the best reason of all to own Spirit Airlines stock. Facing a saturation point in the U.S., Spirit is Considering adding a smaller jet to its fleet. Utilizing smaller jets would make serving mid-size markets more cost-effective.

Many mid-size markets are served only by legacy carriers such as American Airlines Group Inc (NASDAQ:AAL), Delta Air Lines, Inc. (NYSE:DAL), and United Continental Holdings Inc (NYSE:UAL). Legacy carriers dominate many of these markets and charge high fares. An ultra-low-cost carrier entering that market could change that.

A Department of Transportation (DOT) released in 1993 found that when Southwest Airlines entered a market, on average fares dropped by 50% and air traffic more than tripled. The DOT called this result the “Southwest Effect.”

However, Spirit could become the ultimate beneficiary if it can supplant legacy carriers in most or all mid-size markets. Such a game-changing move could take Spirit stock to new levels.

Final Thoughts on Spirit stock

Amid aggressive growth, Spirit is considering new strategies that took take Spirit stock to new levels. Spirit has already achieved the fastest growth rate in the industry. After a new pilot contract, the airline is slowing expansion to consider new options. One of its most significant moves could be to bring the ultra-low-fare strategy to mid-size markets.

Southwest once changed the industry by bringing lower fares to larger cities. If a move by SAVE into smaller markets has the same result, they might have to start calling the resulting lower fares and expanded capacity the “Spirit Effect.”

As of this writing, Will Healy did not hold a position in any of the aforementioned stocks.

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