Spirit Airlines Inc. Investors Had No Need to Worry

After Spirit Airlines, (NASDAQ: SAVE  ) reported Q3 earnings back in late October, investors briefly panicked. The stock dropped as much as 8% after the earnings report came out, dipping under $40 before recovering.

To any longtime airline industry follower, it was clear that the sell-off was overdone. While Spirit Airlines is pricier than most airline stocks, it earns industry-leading margins and has huge growth potential. Spirit's recent Q4 earnings report proved that this is a solid business built to deliver big returns for long-term investors.

Unfounded fears of cost creep
One of the main reasons why investors were unhappy with Spirit's Q4 earnings report was that the company projected a 4%-5% jump in nonfuel unit costs. Spirit's business model is built around having the lowest costs of any airline, so it is somewhat understandable why this guidance was worrisome.

Spirit Airlines relies on having the lowest unit costs of any airline. Photo: Spirit Airlines

That said, the main cause of this increase was an unusual engine blowout that occurred in October. Later that month, Spirit estimated the repair expenses at $10 million. This seemed like an overly conservative cost estimate at the time.

Sure enough, the company revised that guidance last month to $8 million in repair expenses. Spirit also found additional cost savings during the quarter, allowing it to further reduce its unit cost growth. Finally, on Wednesday the company announced that it believes all of its costs will be covered by insurance, other than a $750,000 deductible. The result: Spirit's nonfuel unit costs actually declined by 2.5% last quarter!

Looking good for 2014 and beyond
Keeping unit costs low is the key to Spirit's business model. By doing so, it can earn very high margins even while charging significantly less than rivals. Due to its consistent price leadership, Spirit rarely has to worry about filling its planes.

Thus, with unit costs declining yet again, Spirit had no trouble generating rapid earnings growth -- EPS more than doubled year over year. For the full year, Spirit's revenue soared 25.5% while its adjusted pretax margin expanded from 12.7% to 17.1%, boosting earnings by more than 60%.

Spirit isn't likely to post such rapid profit growth in 2014. Due to the timing of Spirit's aircraft deliveries, capacity is expected to grow at a more modest 16.7% pace this year. Nonfuel unit costs are expected to rise slightly due to higher maintenance expenses and the impact of new federal regulations for pilot rest periods. This will keep Spirit's operating margin in a 16%-18% range -- roughly flat year over year.

But growth will accelerate toward the end of the year and into 2015. Spirit now expects capacity to rise 29% in 2015. This will lead to faster revenue growth, and it should also allow Spirit to reduce its unit costs by better leveraging fixed costs. As a result, Spirit's profit growth should accelerate again next year.

Foolish bottom line
Spirit Airlines investors got a brief scare last October, but contrary to the company's initial expectations, unit costs continued to fall last quarter. Spirit's continued cost discipline and long growth trajectory both bode well for long-term investors. If you're looking to buy and hold one airline stock forever, Spirit Airlines is still definitely one you should consider.

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Read/Post Comments (3) | Recommend This Article (1)

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  • Report this Comment On February 20, 2014, at 2:14 PM, sharkflyt wrote:

    I said many times before and I will say it probably more times than not but Spirit Airlines is one of the best if not the best business model in airline history. They have kept up with the most modern fleet and have over 150 new aircraft joining the company. This is a recipe for shareholders to buy and hold this stock (SAVE).

    They are adding additional routes every month and connecting their hub cities with the most direct flights which beat most if not all competition with their hub and spoke combo which we know doesn't work for SWA or Delta these days. This stock will pass $100 plus over this year. With 11 aircraft coming this year alone you can expect revenue to reach 4th quarter with quadruple earnings and zero debt.

    I thought I would never invest in the airlines but it is exactly the opposite for this one. Spirit gained my attention when people complained about bag fees yet they had a choice of what to bring on for little to no cost. I love an options airline like this one! The rating is a "BUY" and I believe this stock is still so cheap you can still get in but wait too long and it may become a millionaires players court.

  • Report this Comment On February 20, 2014, at 2:21 PM, sharkflyt wrote:

    I would love to see Spirit focus on more west coast cities and even Hawaii. This would connect a system that most leisure and business travelers crave. I can see this airline shopping the west cost sooner rather than later with U.S. Airways and American having to give up gates at cities like Seattle(SEA) and Orange County even Long Beach. I believe Orange Country (SNA) and Long Beach,CA would be a gold mine for Spirit because Southern Californians look to less traffic areas as for an airport.

    If Spirit moves on the west coast it will be one of the best moves and into star like ratings for the airline.

  • Report this Comment On February 21, 2014, at 9:15 AM, TMFGemHunter wrote:

    I think it's unlikely that Spirit will serve other LA-area airports, except perhaps Ontario. The company's business model is based around keeping costs down, and one way to do that is to focus on one airport per metro area. Additionally, I think that Long Beach Airport is capacity constrained due to local ordinances, and Orange County's runway is really short. I don't know if a fully loaded Spirit A320 could safely take off from SNA.

    Adam

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