Last year, Consumer Reports readers ranked ultra-low-cost carrier, or ULCC, Spirit Airlines (NASDAQ: SAVE ) as not just the worst airline in the U.S. but one of the worst companies in any industry. Despite this dubious honor, Spirit Airlines and fellow ultra-low-cost carrier Allegiant Travel (NASDAQ: ALGT ) routinely post the highest profit margins in the business.
In fact, while a vocal minority will always complain about being nickel-and-dimed by Spirit and Allegiant (and the newest member of the ULCC group, Frontier Airlines), most customers are grateful for their rock-bottom base fares. Business is booming in the ULCC world, and as a result, Spirit and Allegiant are able to post continuous earnings improvements.
Beating expectations again and again
Spirit and Allegiant have both shown an uncanny ability to provide fairly solid initial guidance, then raise the guidance and ultimately beat the higher projections. This is a sign that both companies are maturing and reaching a point where they can deliver very consistent profit growth.
For example, on the cost side, Spirit Airlines projected a 4%-5% increase in non-fuel unit costs for Q4 last year. Considering the potential cost impact of an engine blowout that occurred in October, this would have been a perfectly fine result.
However, Spirit was able to find other cost savings during the quarter, and the engine repairs turned out to be less expensive than the original (conservative) guidance. This didn't really matter, though; the engine costs were completely covered by insurance, aside from a $750,000 deductible. Instead of rising 4%-5%, non-fuel unit costs ultimately declined by 2.5%.
The same trends often play out on the revenue side. Allegiant's performance last quarter was fairly typical. In late January, the company provided initial guidance for total revenue per available seat mile, or TRASM, to decline by 2%-4%, due in part to the shift of Easter from March to April this year.
It quickly became clear that this guidance was overly conservative. Just a week later, Allegiant reported that TRASM rose about 5% in January, and the strong trends continued throughout the quarter. In early March, Allegiant revised its TRASM guidance to be down 0%-1%.
Even this was too pessimistic, as Allegiant eventually reported a 0.7% increase in TRASM for Q1. Incidentally, Allegiant also easily beat its cost guidance for the quarter.
Good stocks for buying the dips
Spirit Airlines and Allegiant Travel have both experienced minor stock sell-offs at various points in the last year or two, but in each case the stocks have quickly recovered. Typically, what happens is that management mentions some potential headwind -- causing investors to panic briefly -- but the underlying strength of the business ultimately shines through, keeping earnings moving higher.
Spirit and Allegiant have both proven the resiliency of their business models. Executives at both companies tend to offer conservative guidance, so investors get plenty of warning when potential headwinds arise. This is much better than getting blindsided by an earnings miss due to aggressive forecasting by management.
More often than not, the headwinds discussed from time to time by Spirit and Allegiant turn out to be very manageable. Both businesses have grown EPS very consistently in recent years, due to good cost control and a strong demand environment. As a result of this steady performance, long-term investors can feel reasonably comfortable "buying the dips" for both stocks.
Foolish final thoughts
Spirit Airlines and Allegiant Travel have demonstrated the potential of the ULCC model in the U.S. airline industry. While the airline business is very volatile, demand for low-fare, no-frills airline service vastly outstrips supply today. This provides huge long-term-growth potential for both companies -- and ensures that their high profit margins are sustainable.
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