A Big Short for 2012 and Beyond?

I've never shorted a stock before, but I'm strongly considering doing it. My target: Spirit Airlines (Nasdaq: SAVE  ) .

I got burned giving the airline a red-thumb after it IPO'd, but I'll be reinitiating my bearish CAPScall on my CAPS profile, and I think you should consider doing the same. Here's why:

Solid financials... for now
One reason my initial call was losing to the market by more than 50 points was because Spirit has an impressive balance sheet. Consider its cash-to-debt ratio, as well as its revenue and earnings growth over the past three years, when compared to other airlines.

Company

Total Cash

Total Debt

3-Year Revenue Growth

3-Year Earnings Growth

Spirit $351 $0 8.78%* 23.02%*
American (NYSE: AMR  ) $4,296 $11,620 (0.38%) N/A
US Airways Group (NYSE: LCC  ) $2,043 $4,471 1.68% N/A
Southwest (NYSE: LUV  ) $3,656 $4,206 8.57% 5.13%
United Continental (NYSE: UAL  ) $8,357 $13,157 17.47% N/A
Delta (NYSE: DAL  ) $3,265 $14,613 14.95% N/A
JetBlue $1,210 $3,057 7.46% N/A

Sources: S&P Capital IQ, SEC filings. Dollar figures in millions. N/A = not available due to negative earnings. *FY 2008 to the last 12 reportable months in 2010 and 2011.

Based on this alone, Southwest is the only airline that comes even close to holding a candle to a company like Spirit—which has kept itself out of debt, and is producing amazing income growth.

In fact, growth trends are accelerating at Spirit, with third-quarter 2011 year-over-year revenue growth of 41.7%, and third-quarter year-over-year operating income growth of 112.4%. Numbers like that simply aren't supposed to show up among airlines these days. And with the stock trading at a paltry 8 times future earnings, you can see why investors have bid shares up more than 50% since mid-August.

So, why would I short it?
It's how Spirit obtained these numbers that has me bearish on the company's long-term prospects. Billing itself as an ultra-low-cost carrier, I simply don't believe there are enough travelers out there who are willing to put up with Spirit's nickel-and-diming to provide a solid stream of repeat customers.

I recently used Kayak.com to find tickets to Costa Rica for next year. Not surprisingly, Spirit showed up as the cheapest flight by a wide margin. But how much does it really cost?

Low-cost leader or hidden-cost leader?
Consider the comparison from my real-life example -- when all of the extra fees are included -- between Spirit's price and the tickets we eventually bought from Delta. This assumes two carry-ons, one checked baggage (both paid for at the airport), a desire to sit next to my wife, and water for the flight.

Item/Action

Spirit's Cost

Delta's Cost

Base fare, taxes, fees  $518  $573
Carry-on  $80  $0
Checked bag  $86  $0
Seating  $20  $0
Print boarding pass  $10  $0
Water  $6  $0
     
Total  $720  $573

Source: Spirit Airlines site. Author's results. All prices round-trip.

No, your eyes aren't deceiving you. You have to pay for carry-ons, having an agent print your boarding pass will end up costing you $5 per pass, and you even have to pay $3 for water on-board (but, of course, the salty pretzels that you get are free).

Oh, and the $518 base fee includes a nearly $34 fee just for booking online.

These fees really add up for the airline. Back in 2007, they only accounted for roughly 11% of revenues. As of the last quarter, that total had more than tripled, as the add-ons now account for a whopping 35.3% of revenue.

Source: SEC filings. 2011 number shows Q3 percentage of revenue from non-ticket items.

I find this trend especially troubling. The segment of the company's revenue that's really driving growth is, I believe, the same segment that will eventually push flyers away from the airline's service.

Beyond price
JetBlue, which famously has little legroom, sets its standard from 34 to 38 inches. Where does Spirit come in? A paltry 28 inches. It gives less room than literally anyone else.

The company's prospectus also states: "We achieve these low operating costs in large part due to our productive workforce." That's really just a fancy way of saying that the company's employees are overworked and the company is understaffed.

The numbers back up the weak service. Skytrax, which bills itself as the world's largest airline review site, offers telling evidence. Here's the average rating of customer satisfaction for the following airlines.

Airline

Customer Review Average Rating (out of 10)

Southwest 8.0
JetBlue 7.6
United 4.1
Delta 3.8
American 3.4
US Air 3.3
Spirit 3.1

Source: Skytrax.

Don't make this mistake
If there's anything I've learned this year, it's this: Not every stock has an obvious consumer angle. But for those that do, it's vitally important for them to provide valuable, high-quality products and services.

When Netflix (Nasdaq: NFLX  ) began outraging customers with its poor communication this summer, I was slow to catch on -- and paid the price. The company has seen its stock price fall more than 75% since mid-July. Unless you'd like a similar thing to happen to you with Spirit, I suggest staying away.

The company certainly is showing impressive gains by winning over customers with those low prices they see when they type in their flight searches. And while there probably are some customers with whom Spirit's model jives, I'm guessing the majority first-time customers won't be repeat ones.

Eventually, Spirit will simply run out of people to dupe.

Lest I leave you without any ideas of where you should invest your money, I suggest checking out our special free report, "The Motley Fool's Top Stock for 2012." Inside, you'll find out all about the one company our advisors think will outperform the market next year. Get your copy today, absolutely free!

Fool contributor Brian Stoffel has used Spirit before, and, after his experience, vows never to do so again. He owns shares of Netflix. You can follow him on Twitter at @TMFStoffel. Motley Fool newsletter services have recommended buying shares of Netflix and Southwest Airlines. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (5) | Recommend This Article (7)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 06, 2011, at 3:35 PM, Hawmps wrote:

    Compelling evidence for a short position... growth, yes, but at what cost? Nice article.

  • Report this Comment On December 06, 2011, at 9:57 PM, shamapant wrote:

    Nice article but I always feel wrong about shorting a company, you know the risk you take with a short over a long position, if it isn't quantitatively wrong in some aspect that someone has overlooked. You make good points about their revenue sources, but It makes me nervous.

  • Report this Comment On December 06, 2011, at 10:03 PM, TMFCheesehead wrote:

    @shamapant-

    Good point, and that's why I've never shorted before and am only *thinking* about doing so.

    Either way, I won't go anywhere near this growth story.

    Brian Stoffel

  • Report this Comment On December 07, 2011, at 1:27 PM, Thinker66 wrote:

    Brian, some of your facts are not correct and by using just one sample itinerary, you are giving your readers alarminlgy false investor guidance as a result.

    1. Delta DOES charge for checked baggage (unless you happen to hold their AMEX credit card, in which case you get one free bag).

    2. Spirit does charge for carry on bags, but that fee comes with some very customer friendly benefits including boarding the plane first and having ample available overhead bin space near your seat as a result.

    3. Many Spirit fees are truly optional. You can get a seat assignment at no charge at the airport. By printing the boarding pass a home, there is no charge. I understand that using Spirit airport personnel involves a cost. I am happy to use my own printer and ink in exchange for a lower fare.

    4. Clearly, Spirit is not the airline for everyone but there are legions of loyal customers -- myself included -- who buy during the airline's frequent fare sales and we know that at the end of the day we are still saving money over other airlines.

    We factor in the optional charges in our buying decisions. I looked at dates in February 2012 from Atlanta to Costa Rica. Spirit was $467. Delta was $680. If you add in one carry on bag paid in advance, that raises Spirit's total travel cost to $527. I'll spend $6 extra from water and print my boarding pass at home. All told I'm saving $147 by choosing Spirit. That $147 I'm saving will go towards a lot of fun in Costa Rica or to buy a few shares in SAVE!

  • Report this Comment On December 07, 2011, at 1:34 PM, TMFCheesehead wrote:

    @Thinker66-

    1. Delta does not charge for the first checked baggage on int'l flights. This is important b/c Spirit focused intensely on int'l flights to Latin American countries..

    2. I would never use "customer friendly" to describe that.

    3. Fair point.

    4. As I said, there are some with whom this model will jive, just not enough to keep these growth rates up.

    Most importantly, as you've shown, experienced fliers have figured out how to reduce their extra costs (printing at home, reserving at home, etc.). As the expansion of non-ticket fees has been a major driver of revenue growth, non-ticket revenue from repeat customers will surely go down as time goes on.

    Brian Stoffel

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