Back at the start of 2017, Spirit Airlines (NYSE:SAVE) dropped off our investment radar due to a cloudy outlook. The discount airline was again focused too much on capacity growth rather than profit metrics while the stock had rallied to yearly highs above $50.
Source: Spirit Airlines presentation
Capacity Headwinds
Spirit Airlines tends to shoot itself in the foot due to overly aggressive expansion. A prime example is the approximate 29.0% growth in available seat miles (ASMs) forecasted for Q2 following a 22.3% gain this year.
The market is never going to favorably value the stock when the total revenue per ASM (TRASM) is targeted to dip by 7%. Price wars never end well in the sector and for some reason Spirit Airlines keeps choosing to aggravate the market.
The targeted growth for the year of 22.5% and a more reasonable plan to reduce ASM growth toward the 15% range going forward will alleviate the current fears in the market, sending the stock down to $35. The current plan is to add 16 planes in 2019 for growth of 12.5% during the year.
The one hiccup with this plan is the expansion has already been bumped up from the March levels. Similar to my article last year, Spirit Airlines deviated from the forecast for down to 15% capacity growth and eventually bumped that up substantially.
Source: Spirit Airlines presentation
The growth is focused on the A320 plane that could add some ASM growth beyond just trip volumes. Though the combination of reduced capacity growth and the stock down at $35 around multi-year lows makes the story more interesting.
Spirit Airlines appeared to pull back in capacity growth in 2016 as low stock prices took a toll on the willingness to expand to only end up with the decision to return to growth in 2017 as the stock approached $60. The stock price likely dictates the restrain on capacity growth for now.
Margin Pressure
The issue with the capacity headwinds is easily highlighted in the margin chart. The company went crazy with capacity and margins tanked, dipping to only 15.2% last year following a couple of years above 20%. Even excluding the impacts of the hurricanes, the operating margin dipped substantially to 17.8%.
Source: Spirit Airlines presentation
Spirit Airlines took a $3 one-way fare hike last week in another sign that the airline is led by the stock weakness, such as in 2016.
The other part to like about the story is the opportunity to purchase an airline stock with oil prices at more normalized levels. The risk to jet fuel prices with Brent crude around $75/bbl is probably to the downside which is bullish for airlines.
For Q1, Spirit Airlines reported a whopping 46.4% increase in fuel costs due to rising oil prices. The increased expenses were only partially due to the increase in fuel costs, but the capacity growth further highlights the importance of this key cost. Of the roughly $114 million revenue gain (due to capacity growth), fuel costs grew $65 million and over half of the additional revenues were eaten up by this operating cost.
Takeaway
The key investor takeaway is to buy Spirit Airlines when the company discusses pushing capacity growth down toward the 15% range and the stock is at lows like now. The time to dump the stock will occur when the airline starts discussing capacity ramps after the stock rallies back toward $60.
