Spirit Airlines' New Growth Strategy Is Great News For Investors

Feb. 20, 2020 8:30 AM ETSpirit Airlines, Inc. (SAVE)17 Comments

Summary

  • Spirit Airlines stock has been trading at a huge discount to the market recently, due to the airline's volatile profitability.
  • After focusing on entering new markets in recent years, Spirit Airlines is pivoting towards growth in existing markets.
  • Deploying the vast majority of its capacity in mature markets should help Spirit stabilize its profitability and even expand its pre-tax margin modestly.
  • Spirit Airlines stock has upside to at least $100 over the next two years: more than double the current share price.

Just five years ago, Spirit Airlines (NYSE:SAVE) traded like a growth stock, as investors bid up its valuation following several years of strong revenue growth and margin expansion.

However, the fast-growing budget airline has experienced significant margin erosion since 2015. Its adjusted pre-tax margin peaked at 23.4% in that year, but fell to 11.9% by 2018 and remained at that level in 2019. As a result, Spirit Airlines stock has been trading for less than 10 times earnings recently.

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Spirit Airlines does have moderately high leverage, with more than $3.5 billion of debt and lease liabilities. Nevertheless, the company merits a much higher valuation, due to its high growth potential and solid margins, which are likely to improve modestly over time. Spirit's recent move to focus its growth on mature markets should enable steadier margin performance and more predictable earnings growth. That's great news for investors and could enable substantial gains for Spirit Airlines stock over the next year or two.

New cities vs. depth of service

Over the past few years, Spirit Airlines has dramatically expanded its route map. By the end of 2019, Spirit served (or had announced new service to) 75 cities in the U.S., Caribbean, and Latin America, up from 60 cities served just two years earlier.

Adding service to new cities is strategically important. A growth airline like Spirit Airlines needs to develop new markets that can support further expansion in the future. That said, margins tend to be significantly lower on routes to new cities when they are first launched. First, Spirit doesn't have a built-in customer base in those markets yet. Second, it needs to add infrastructure and staff at the new airport, even if it only operates a small number of flights there.

By contrast, it's often possible to grow

This article was written by

Adam Levine-Weinberg is a value investor who has been researching and writing about stocks for Seeking Alpha and The Motley Fool since 2011. He graduated from Swarthmore College in 2007, received an M.A. in Political Science from the University of Chicago in 2009, and received his CFA charter in 2017. He is always on the hunt for irrationally beaten-down stocks, particularly in the aerospace, retail, real estate, and auto sectors.

Disclosure: I am/we are long SAVE. 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.

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