Should Spirit Airlines Incorporated Investors Be Frightened?

Spirit Airlines Incorporated provided relatively weak revenue guidance earlier this week. Are investors in danger of losing their big gains?

Apr 10, 2014 at 3:15PM

Spirit Airlines Incorporated (NASDAQ:SAVE) was one of the best-performing stocks in the market last year, soaring more than 150%. Its year-to-date performance hasn't been too shabby either -- Spirit shares are up about 30% in 2014.

SAVE Chart

Spirit Airlines Incoprorated YTD stock chart, data by YCharts.

However, Spirit Airlines shareholders encountered a bit of a bump this week when the carrier reported that unit revenue declined by about 2.5% in Q1. By contrast, Spirit saw a 2.8% increase in that measure during 2013, which helped drive better than 60% earnings growth. Should shareholders be worried about the sudden drop in unit revenue?

Explaining the drop
Earlier this year, Spirit Airlines CEO Ben Baldanza forecast that the company would post a 13%-14.5% operating margin in Q1. That would be down slightly compared to its 14.4% operating margin (excluding special items) from Q1 2013.

At the time, Baldanza provided several explanations for the expected operating margin decline. Most importantly, the shift of Easter from March to April hits Spirit particularly hard because it primarily carries leisure travelers. This calendar shift was expected to reduce Q1 unit revenue by 1.5 percentage points, with a corresponding benefit in Q2.


Spirit has seen a big demand shift from March to April due to Easter's timing. Source: Spirit Airlines.

Additionally, weather-related flight cancellations will impact Spirit's Q1 results, as is the case for most other airlines. Spirit has not quantified the total impact of weather, but management noted that the cancellations increased Spirit's unit costs and also affected revenue, as many customers chose to cancel and receive a refund rather than rebook.

Q1 earnings could miss expectations
Spirit's expected unit revenue decline will be offset to some extent by a decline in unit costs. According to Spirit's most recent guidance, unit costs should fall by about 1% year over year. That would imply an operating margin near the bottom of Spirit's guidance range, or 13%.

Even with a modest operating margin decline, Spirit should still be able to show some earnings growth since revenue is still increasing rapidly. However, analysts are currently expecting 20% EPS growth for Q1 -- which can't happen if Spirit's operating margin falls.

There's one big caveat, though. Spirit has a tendency to issue very conservative guidance. Even though the company is currently projecting a 1% decline in unit costs versus a 2.5% decline in unit revenue, the gap between those two key metrics may be a lot smaller when Spirit reports its Q1 results later this month.

It doesn't even matter that much
In light of Spirit's strong track record over the last couple of years and its industry-leading cost structure, shareholders shouldn't be too concerned, even if Q1 earnings miss expectations. Spirit will probably be able to return to unit revenue growth in Q2 because of the favorable impact of the Easter shift. Moreover, the company still has a huge runway for growth.

Even after Spirit's strong stock performance in the last 18 months or so, shares still trade for just 16 times forward earnings. That's quite a bargain considering Spirit's revenue growth averages over 20%, and EPS is growing even faster than revenue!

With its low-cost focus, Spirit is poised to take advantage of rising fares at larger carriers to gain market share among price-sensitive travelers. If Spirit's stock drops because of an earnings disappointment later this month, long-term investors should consider "buying the dip." In the long run, Spirit Airlines shares are probably headed much higher.

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