Spirit Airlines Offers Cheap Airplane Tickets Along With A Cheap Share Price

Spirit Airlines Offers Cheap Airplane Tickets Along With A Cheap Share Price

In his 2007 Chairman’s letter, Warren Buffett said that, in the airline industry, “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.” However, the industry has evolved considerably since 2007, which is why Buffett has become an investor in the airline industry. Moreover, Spirit Airlines (SAVE) appears to be an up-and-coming carrier with a sustainable competitive advantage that is also trading at a very reasonable share price.

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The Airline Industry Evolution

In 2007, when Buffett made his remarks, industry profitability was consistently terrible. At the time, eight different companies controlled 85% of industry capacity, and price wars which summarily destroyed profitability were a regular occurrence. Today, just four companies control 85% of industry capacity and, as a result, price wars are less frequent and less protracted.

Most U.S. airline boards have begun linking management compensation to profit margins and returns on invested capital, and the majority of management teams have compensation packages linked to profitability. Moreover, it’s not just management teams that have pay tied to profits; employee profit-sharing programs have become very popular within the airline industry.

As a result of these and other changes, airlines have improved their ability to match capacity with consumer demand and maintain high load factors during both peak and off-peak times, resulting in improved profits and better asset utilization. It is no wonder, then, that Buffett’s Berkshire Hathaway has become a top-two shareholder in all four of the largest airlines (United, Delta, American, and Southwest).

Spirit Airlines – An Attractive Business

Within the context of improving airline profitability, low-cost carriers, especially Spirit Airlines, have driven most of the industry growth in recent years. Spirit and other low-cost carriers have gained market share by stealing the legacy carriers’ cost-conscious passengers and attracting those who would have taken a different form of transport. Moreover, due to their extreme cost consciousness, these airlines are generally more profitable than the legacy airline companies.

Indeed, Spirit Airlines has been generating a double-digit return on invested capital while also increasing revenues at a double-digit rate for years. As the largest low-cost U.S. airline, Spirit enjoys a cost advantage which is so large that most competitors’ unit costs are higher than Spirit’s unit revenues. Spirit also operates the most fuel-efficient fleet in the United States which should help it weather any cost increases related to higher fuel prices. Moreover, even after doubling sales over the past five years, Spirit should still have ample runway for further growth. Compared to the market penetration of low-cost airlines such as Ryanair in Europe, Spirit’s penetration in the United States remains very low.

Because of its strong focus on keeping costs down, Spirit Airlines should have the kind of durable competitive advantage which Buffett used to claim was so elusive in the airline industry. Unfortunately, the market capitalization of Spirit Airlines is probably still too small for consideration as an investment by Berkshire Hathaway.

Spirit Airlines – An Attractive Valuation

As a result of several one-off events this year, costs per available seat mile are temporarily expected to increase by approximately 5% year-over-year, and Spirit’s share price has quickly become inexpensive in both absolute and relative terms.

The cost increases have been driven mostly by temporary factors, including a runway closure in Ft. Lauderdale, Spirit’s most important airport, bad weather, and the fact that Spirit has been adding more short routes which will have a negative impact on unit costs. These short routes, while more costly on a per mile basis, may also generate more revenues on a per mile basis. Temporary factors aside, Spirit remains the most cost-efficient airline in the industry, and its long-term advantage is, if anything, increasing.

Since January, Spirit’s share price has declined by more than 40%, from $64/share in early 2019 to $37/share currently. With a Price/Earnings ratio of 7.0x and a record low Price/Book ratio of 1.2x, Spirit shares are trading as if it is a no-growth company incapable of generating profitable returns going forward.

It could be just a matter of time before Spirit Airlines once again exceeds investors’ current expectations and returns to mid-teen growth and profit margins. In the meantime, the company’s shares appear to be as much of a bargain as their airplane tickets.

Disclosure: Adam Strauss owns Spirit Airlines (SAVE) in some of the investment portfolios which he manages. This article is for informational purposes only and is not a recommendation to buy or sell a security. The views are those of Adam Strauss as of the date of publication and are subject to change and to the disclaimer of Pekin Hardy Strauss Wealth Management.

 

Source:- forbes

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