Spirit Airlines' Growth: Reasonable, Risky Or Reasonably Risky?

| About: Spirit Airlines (SAVE)
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Spirit Airlines (NASDAQ:SAVE) is a passenger airline. Spirit's business model and focus is to be an "ultra low-cost carrier". While its service is flights to under-served markets, its product is its low prices. Spirit trusts low prices will drive demand. Spirit's growth projections are at nearly 20% for the next five years.

Spirit's physical aircraft configurations carry more passengers than rival airlines. Spirit's aircraft are in the sky more hours a day than competitors like JetBlue Airways (NASDAQ:JBLU) and Southwest Airlines (NYSE:LUV). An industry-accepted measure for passenger airlines is the CASM (cost per available seat mile). It provides the cost in cents to operate each seat mile offered. CASM is calculated by dividing operating costs by the number of seats multiplied by the number of miles. The lower the CASM, the easier it is to break even and to then make a profit. Spirit's CASM is lower than rivals but is more than 50% lower than major carriers like Delta (NYSE:DAL). That type of difference means majors like Delta have to charge at least 3 times more per seat to break even.

To date, Spirit accounts for less than 2% of U.S. carriers' domestic and Latin capacity. There are more than 500 markets that meet Spirit's target criteria and it currently serves only 110 of them. A target market is one that has 200+ passengers each day both arriving and departing where average fare price is high. Spirit believes it can reduce fare price by just 25% in those markets which will spur growth. Spirit has 45 aircraft in use but would need 140 to accommodate serving all the target markets. Spirit is scheduled to have 71 aircraft by year-end 2015 and has firm orders to purchase 75 more between 2016 and 2021. In the 2012 third quarter, Spirit added 22 new flight options. During the fourth quarter, Spirit added dozens of options in new flights and new seasonal flights as well as resuming seasonal flights.

Spirit has almost $400 million in cash. It has no long-term debt at all. Year-over-year revenue growth for the trailing twelve months is 18% and year-over-year EPS growth for the same period is nearly 12%. Spirit's year-to-date departures as of November 2012 are 20% greater than its November 2011 departures. Analysts are projecting more than 19% EPS growth per annum for the next five years. YPEG (5 year growth rate * next year's EPS estimate) works out to $37.25. Spirit's 50-day moving average is just below $17.00.

Spirit's fundamentals look solid. The potential for growth looks reasonable. The value looks valid. What risks could threaten Spirit?

Besides the risks standard to most business and standard to the airlines industry, for Spirit, weather, especially, needs to be considered. Spirit Airlines is headquartered in Florida. Hurricanes are a major threat in Florida, along the east coast, and in the Caribbean and Gulf of Mexico. These areas represent the majority of Spirit's current network. In October, Spirit canceled 136 flights due to Hurricane Sandy. The revenue shortage for October was estimated at $3 million as the event lasted more than a week while it tracked through the Caribbean up the east Coast to Boston. Adversity after the hurricane will continue to have a negative impact on Spirit Airlines. The decrease to fourth quarter revenue is estimated at $30-$35 million.

Also, staffing needs to be examined. Over 50% of Spirit's workforce is represented by labor unions. Disputes, strikes, and other labor-related disruptions are familiar risks to Spirit. But another type of staffing risk to the airline industry is garnering publicity: a shortage of pilots by 2020. Some claim it is an urban myth. Digging into both sides of the story turned up some interesting data to consider.

According to the Bureau of Labor Statistics, the market for airline pilots is expected to grow 11% between 2010 and 2020. This percentage is in line with the average for all occupations. The BLS projects that job opportunities at regional airlines and low-cost carriers will be more available than at major airlines.

However, a November 20th article in the Wall Street Journal detailed why a serious pilot shortage is at hand due to increased experience requirements and an impending wave of pilots retiring. In August, 2013, federal mandates will require pilots to have at least 1500 hours of flight experience. The Journal explains the current requirement is 250 hours. Airline companies will find training costs increasing as more time is required to prepare pilots for the sky. In early 2014, federal mandates will increase the amount of daily rest rule for pilots. It is projected airlines will have to increase their pilot workforce by 5% to comply.

The Journal explained the complicating factors also include the mandatory retirement age of 65 for pilots and the overseas demand for pilots. According to one consulting firm, there are approximately 96,000 pilots employed in the U.S and more than half are over the age of 50. Currently, industry experts estimate opportunities for pilots due to retirement, departure and expansion ranges somewhere between 60,000 by 2025 to 65,000 by 2020. The WSJ reported the historical trends regarding the production of qualified pilots. According to the Journal, in the past eight years, less than 36,000 applicants have passed the FAA's Air Transport Pilot exam. It also reported that, in the past decade, FAA data reflects issuance of commercial pilot certificates are down 30%. Although there is no national verification of the trend in flight schools, unofficial reports cite attendance down by 30% to 40% over the past five years with current attendees tending to be foreign students.

Audries Aircraft Analysis is a website with an extensive aviation database. The site provides analytical trending and argues against the myth that a pilot shortage is looming. Audries projects 2000 to 4000 pilots per year will be needed due to fleet growth and pilot retirements at the major airlines through 2020. For regional carriers, 2000 to 3000 pilots per year will be needed due to fleet growth and pilot attrition. It explains there are still 3000 pilots on the American Airlines and United Airlines (NYSE:UAL) furlough list. Audries believes the 3000 pilots on the furlough list are currently employed by the smaller, regional carriers. As the majors experience retirement departures, the 3000 on the furlough list will move from the regional carriers back to the majors. That attrition feeds the 2000 to 3000 openings at the regional carriers. This musical chair effect is why Audries believes there is a misconception about the total number of openings to expect. Audries states the issuance of commercial pilot licenses has averaged over 8000 per year for at least a decade. Audries calculates an industry standard pilot to aircraft ratio is 12.3.

So, for clarification, the Federal Aviation Administration (NYSEARCA:FAA) issues many levels of licenses for pilots. A "commercial" pilot may be paid for flying. The minimum flight time to become a commercial pilot is 250 hours. Most regional and commuter airlines hire commercial pilots with a minimum of 800 hours flight time. An "airline transport" pilot (ATP) is the certificate for the highest ability. This license is required to captain a vehicle in airline operations. An ATP must have a commercial license and a minimum of 1500 hours of flight time. These distinctions are important because the media is reporting on both and sometimes mixing information between the two. The August 2013 mandate will require all airline pilots to have an ATP certificate and thus have a minimum of 1500 hours of flight time.

The FAA produced a report entitled "FAA Aerospace Forecase Fiscal Years 2012-2032". The FAA projected the aviation industry will grow at an average annual rate of 3.1% through 2032. According to the forecast, the number of commercial aircraft will grow from 7,185 in 2011 to 9,853 in 2032. Of the 9,853 forecast, 5,528 will be for the majors' passenger fleet, 2,980 for the regional carriers' fleet and 1,345 are large cargo aircraft. Airline transport pilots are projected to increase from 142,500 in 2012 to 148,100 in 2020 to 160,300 in 2032 for an average annual increase of 0.6%.

Remember the Wall Street Journal report that in the past decade FAA data reflects issuance of commercial pilot certificates as down 30%? Information from the FAA report does not validate this. FAA data shows commercial pilot licenses issued in 2000 as 121,858 and in 2011 as 120,865. That is a decrease of 0.8%. An initial reaction would be to check the ATP category. Airline transport pilot licenses in 2000 were 141,596 and in 2011 were 142,511. That's an increase of 0.6%. The Journal also claimed less than 36,000 applicants have passed the FAA's Air Transport Pilot exam in the past eight years. Statistics are available for 2004 through 2011 - eight years. The number of ATP licenses issued is 40,592. If you exclude 2004, the number is 35,410. Audries reported the number of commercial licenses issued the past decade has averaged over 8000 a year. The FAA data on commercial licenses for 2004 through 2011 averages 8,240.

Industry trends, in the past, have the military and smaller, regional carriers serving as the training grounds for major airlines. Regional carriers are less likely to have unlimited funds for pilot pay and training. They may be forced to reduce and eliminate flight options just to comply with FAA regulations. The FAA recognizes the regulations will

"have the greatest impact on air carriers that operate regional jet airplanes and/or turbopropeller airplanes. These air carriers generally hire pilots with a commercial pilot certificate and typically less than 1,500 hours total time as a pilot."

Those who subscribe to the shortage thesis believe there are two underlying trends that will fuel the shortage - 1) fewer military pilots will be available and 2) it will be too expensive for civilians to accumulate the necessary flight time hours. Even with the attempt to clarify and validate the numbers, only time will tell whether the aviation industry manages to comply with the increased restrictions with the fewest disruptions and changes.

Spirit's network has historically been primarily regional and its model is an ultra low-cost carrier. But, it is classified as a major airline rather than a regional carrier. So, it will be relying on the supposed shrinking trickle from the regional carriers and military for future pilot staffing. And, it will be competing with the major majors for that trickle.

By expanding its geography, Spirit Airlines is definitely taking steps to minimize the impact of one-off weather threats like Hurricane Sandy. Expansion obviously requires more aircraft. More aircraft obviously require more pilots. Based on Audrie's staffing model, Spirit employees more pilots per aircraft than the average. That's understandable when one weighs Spirit's high daily aircraft utilization. By 2021, when Spirit has around 146 aircraft rather only 45, it will need to have hired more than 1500 additional pilots. Considering a) high daily utilization and b) the goal to be ultra low-cost and c) the coming regulations for required rest time per day for pilots and d) the projected increases in fleet size and flight options, it would certainly be reasonable for Spirit to have a staffing plan similar to its fleet plan. If it does, the plan is not published or referenced in required reporting. Currently, Spirit has only one opening listed for a pilot. The qualifications list an ATP license and 3000 flight hours as a minimum, 4000 hours preferred.

Spirit Airlines' history of growth is impressive. It is debt-free. Its focus on ultra low-cost is clear and its targets are marked. Based on price valuation ratios like YPEG, it looks undervalued. With reasonable risk, it looks like a good investment.

Risk certainly can not be avoided. But, risk can be addressed and mitigated. Spirit's plans to expand geographically address its primary weather concern. Regarding staffing and unions, Spirit thoroughly acknowledges the risks in its requisite reporting. Regarding the possibility of a pilot shortage, there's no visibility into Spirit's stance. Spirit could well have an unpublished staffing plan it is confident in to increase its pilot workforce. By the way, that would be an increase of over 250% in nine years. And, that would also be by requiring qualifications that are even more stringent than the upcoming tightened federal regulations. And, that would be while still achieving its low-cost business model. Or, it could be totally discounting the pilot shortage threat. Because of the publicity the issue has received and because Spirit's vision is focused so particularly on growth, Spirit should, at least, keep its shareholders abreast of its stance on such a risk.

Long-term investors should proceed with caution, paying attention not only to Spirit but taking a bird's eye view (pun intended) of the industry as well. If a pilot shortage does ensue, by the time the media reports it for majors like Delta or United, it will have already grounded Spirit Airlines.

Disclosure: I am long LUV. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The investment club to which I belong has an investment in LUV.