Spirit Airlines Is On Track to Enjoy a Spirited Recovery

One of the bright growth stories in the travel sector in recent times has been Spirit Airlines (NYSE:SAVE) and SAVE stock. The company has grown from two planes in 1990 to 173 planes by the end of 2021. As a budget, no-frills airline, Spirit competes in the same industry segment as Southwest Airlines (NYSE:LUV) and Allegiant Travel (NASDAQ:ALGT).

A yellow, Spirit Airlines (SAVE) branded airplane flying in the air
Source: Markus Mainka / Shutterstock.com

Spirit’s ticketing business model involves ultra-low-cost base fares with the ability to add on features such as checked baggage, seat selection and early boarding.

Although SAVE stock was hurt during the 2020 pandemic year, it may be a decent recovery play.

The Truth About the Airline Industry

Most people think the airline business is about airplanes and carrying passengers from one destination to another in a timely fashion at a relatively affordable cost. But airline companies are largely in the data analytics and statistical arbitrage business.

Finding the right mix of ticket prices is a complex data-mining operation. Prices must be kept low enough to fill planes but high enough to cover costs and earn a profit. It’s been said that no two tickets purchased on a flight carry the same price. The operating statistics showed to investors in press releases and Securities and Exchange Commission (SEC) filings is an analyst’s or statistician’s dream (or nightmare in some cases).

“Airfares are determined by both intertemporal price discrimination and dynamic adjustment to stochastic demand,” says the author of a 54-page dissertation on airline ticket pricing. Which means prospective customers are very fickle, and their demand for tickets covers all possible ranges of urgency and affordability.

The Fundamentals

The airline business is very labor intensive. For Spirit, labor costs represented approximately 39.3%, 26% and 24.2% of total operating costs for 2020, 2019 and 2018, respectively. Fuel costs alone eat up about 25% of the total revenue base.

Airlines are largely a fixed cost business as the number of planes, flights and employees remain relatively steady over the short- to mid-term. That’s why those super computers must crunch those stats to keep the planes full. That is also why airlines are notorious cost crunchers, as they are always looking to cut back on unnecessary expenses. Former American Airlines (NASDAQ:AAL) CEO Robert Crandall told a fabulous and entertaining story on how far airlines will go to cut costs.

Warren Buffett on the Airline Business

In 2007, when discussing the airline industry, Warren Buffett said:

“The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money – think airlines.”

Always seeking a moat, or a firm with a strong competitive advantage in all his investments, Buffett also famously said:

“Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers. Indeed, if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down.”

Yes, it is a tough industry, but there are always exceptions in any challenging sector.

Spirit’s Financials

Spirit, of course, felt the impact of the Covid-19 pandemic lockdowns in 2020. Revenues decreased 53%, and the company reported an adjusted loss of $638 million. The company expects a partial recovery in 2021 since demand appears to be strong in the first quarter of this year. Airlines across the board are showing strong demand as vaccinations increase rapidly and many states lower restrictive lockdown mandates.

Analysts expect Spirit to generate about $3 billion in revenues in 2021. Additionally, that number is expected to increase to $4.2 billion in 2022. Those 2022 numbers are about 10% above 2019 pre-Covid levels, as analysts expect SAVE to resume its growth track by then. Furthermore, EBITDA (earnings before interest, taxes, depreciation and amortization) will likely break even this year but start to creep back to historical levels in 2022 and beyond.

Spirit’s leverage ratios seem very high, but only because of negative EBITDA last year and expected breakeven EBITDA in 2021. During a normalized recovery year (hopefully next year), SAVE’s debt-to-EBITDA ratio is expected to fall to a comfortable range of three to four times EBITDA. Liquidity at the end of Q1 2021 totaled $1.9 billion, which includes $1.8 billion in cash and short-term securities.

What to Do With SAVE Stock

SAVE stock may be a great recovery play for long-term investors. It has one of the lowest unit cost base in the airline industry with a proven ancillary add-on business model. The company has the liquidity to survive more negative free cash flows, which analysts expect this year.

It looks like as the pandemic fades and the economic recovery remains strong, SAVE can reclaim its pre-pandemic highs of over $60 in coming years.

On the date of publication Tom Kerr did not have (either directly or indirectly) any positions in the securities mentioned in this article.

Tom Kerr, CFA, is an experienced investment manager and business writer who has worked in the investment and securities business since 1994.

 


Article printed from InvestorPlace Media, https://investorplace.com/2021/04/save-stock-spirit-airlines-may-enjoy-a-spirited-recovery/.

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