- Spirit Airlines more than tripled to $25 on the recent rebound.
- The airline has plenty of liquidity now as cash flows approach break-even.
- The stock faces dilution by up to 40 million shares.
- Spirit has upside from limiting dilution and obtaining a higher P/E multiple when normalized income returns.
- This idea was discussed in more depth with members of my private investing community, DIY Value Investing. Get started today »
After the recent rally in the stock, some investors are quickly cashing out of those big gains in Spirit Airlines (NYSE:SAVE). The airline had more than tripled off the bottom, but the stock still has plenty of upside with the dip back to $20 now. My investment thesis remains highly bullish on the airline stock in part due to the concept of the previous disaster discount for the sector disappearing after surviving the virus which nearly shut down the industry.
Image Source: Spirit Airlines website
Eliminating Cash Burn
Most of the airlines provided daily cash burn numbers back towards early May before the real rally in passenger traffic. Spirit Airlines reported Q1 results on May 6 and the company repeated the $4 million daily cash burn estimate via the May 19 presentation.
A lot of the cash burn figures in the industry were provided before the traffic surge over Memorial Day weekend. The airlines appeared reluctant to include improving bookings estimates in the daily cash burn figures when traffic was still over 90% below 2019 levels. Since the traffic jump starting with the Thursday prior to Memorial Day on May 25, traffic has nearly doubled to over 16% of 2019 levels.
As noted in my research, the $4 million daily burn rate doesn't include the $1.5 million in Payroll Support Program payments. The true burn rate was only $2.5 million and daily cash flow from bookings should've doubled here in the last couple of weeks.
The airline averaged about $11 million in daily revenues in the last Q2 so revenues near 15% of 2019 levels equate to over $1.6 million in daily revenues. The biggest issue in the numbers provided by the airlines was the focus on cash burn rates focused on net bookings versus earnings. Investors can't easily tell the level of refunds.
The airline now has plenty of liquidity so bookings aren't as relevant as earnings considering the access to $2.4 billion in liquidity. Spirit Airlines hasn't pulled down the $741 million loan from the U.S. Treasury, but the amount is still on the table in exchange for warrants and collateral.
Source: Spirit Airlines May 2020 presentation
The possibility even exists for cash flows being closer to break-even soon with higher booking levels in July and August as the economy continues to reopen. As refund requests decline, the extra bookings from forward months will contribute to incoming cash flows.
With the vast majority of returning traffic focused on domestic locations, Spirit Airlines has an advantage over the competition. The company is mostly focused on domestic traffic with limited destinations in Latin America and the Caribbean.
With any price war, the airline is positioned as the lowest-cost provider. Spirit Airlines has costs roughly half that of the legacy airlines at 5.58 cents per available seat mile while even Southwest Airlines (LUV) is up at 8.40 cents per available seat mile.
Source: Spirit Airlines May 2020 presentation
Spirit Airlines already charges everyday low prices making it virtually impossible for legacy airlines to undercut their fares and generate anything approaching positive cash flow. Spirit Airlines has long promoted pricing fares under the break-even price needed by competitors. Southwest Airlines' CEO promoted the fare war concept, but the industry just doesn't have any benefits from seeing losses mount via brutal pricing competition.
A lot of the questions regarding value want to view Spirit Airlines based on the pre-virus level discounted by the damage done via share dilution to obtain funding to survive the coronavirus crisis. An investor seeing a stock trading in the $40s back in February might mistakenly see the stock as maxed out near $25 based on this share dilution:
- Q1 shares outstanding = 68.5M
- PSP warrants = 0.5M
- Share offering = 20.1M
- Convertible debt offering = 13.7M
- Loan Program warrants = 5.3M
- Q2 shares outstanding = 108.1M
Investors need to step back and realize the convertible debt and warrants can be cancelled via cash payments. Absent a big rebound in cash flows, Spirit Airlines may not have the cash to convert the debt into cash versus shares.
The airline generated a 2019 EPS of $5.09 and had plans for the 2020 EPS topping $6.00. Clearly, the stock was priced for a disaster only reaching $40 on these earnings numbers.
The stock regularly touched $60 in the past few years questioning if investors shouldn't view those levels as the normalized prices, not the $40 highs heading into fears of a recession. Surviving this recession should help release the equity from this discount and allow Spirit Airlines along with other airline stocks to trade closer to market multiples realizing that bankruptcy is no longer a financial tool in the sector.
My view is that Spirit Airlines is able to convert a large portion of the debt into cash, not stock, to reduce dilution. In addition, the airline is unlikely to need the majority of the $741 million put aside for the Loan Program via the CARES Act. Less debt will reduce the warrants issued to the U.S. Treasury while the airline will still have the option to purchase any issued warrants before conversion.
Using a pre-virus $6 EPS estimate and 68.5 million shares outstanding, Spirit Airlines was expected to generate $411 million in net income. The EPS targets based on updated share counts are as follows:
- 88M shares = $4.67
- 100M shares = $4.11
With a more normalized earnings environment in 2021 which appears very likely considering how traffic is already rebounding in early June, Spirit Airlines will trade far above the recent $25 highs on an EPS target above $4 despite the dilution. My target has the airline stocks reaching forward P/E targets of 12 placing the stock price target closer to $50 on the low end and $60 on the high end.
The key investor takeaway is that the recent rally to $25 is just the start for Spirit Airlines. The dip to $20 today is an opportunity to own the airline stock below long-term value. The market is worried about a second virus wave providing the opportunity to own this stock on the cheap.
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This article was written by
Stone Fox Capital (aka Mark Holder) is a CPA with degrees in Accounting and Finance. He is also Series 65 licensed and has 30 years of investing experience, including 10 years as a portfolio manager.Mark leads the investing group Out Fox The Street where he shares stock picks and deep research to help readers uncover potential multibaggers while managing portfolio risk via diversification. Features include various model portfolios, stock picks with identifiable catalysts, daily updates, real-time alerts, and access to community chat and direct chat with Mark for questions. Learn more.
Analyst’s 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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