Source: Flickr user Frank Kovalchek.
I know what you're probably thinking: The words "love" and "airline" in the same sentence must either be a mistake or an intentional oxymoron. However, with regard to low-cost airline Spirit Airlines (SAVE 0.14%), it's the honest truth.
While most people don't enjoy waiting in airport ticket-counter lines, going through a tedious security check, or being stuck in a cramped airplane for hours on end, one thing Wall Street and investors absolutely seem to love is Spirit Airlines' stock. If you're wondering why that is, it's because Spirit Airlines is a cheap stock.
What makes Spirit Airlines "cheap"
What constitutes a cheap stock? To determine this, we'll turn to one of the market's most widely followed metrics, the price/earnings-to-growth ratio, or PEG ratio.
The PEG ratio simply takes a company's price-to-earnings ratio and divides it by a company's forecast growth rate over a specific time period. For example, if a company were trading at a P/E ratio of 20, and had a five-year projected growth rate of 25%, its PEG ratio would be 0.8 (20 divided by 25). Generally speaking, a company trading below a PEG ratio of 1 is considered to be a "cheap" stock.
P/E ratios already give us a rough idea of how well a company is doing relative to its profitability over the past year, but the PEG ratio allows investors to look into the future at forecast growth rates over a specific time period and determine if a company is trading inexpensively relative to its growth expectation. In the case of Spirit Airlines, its PEG ratio is a mere 0.78 with a forecast five-year growth rate of 28.4%, placing it among the cheap stock category.
Why Wall Street loves Spirit Airlines
Yet Spirit Airlines is more than just cheap; it's also loved by Wall Street analysts. At the moment there are 15 Wall Street firms covering Spirit Airlines' stock, of which seven rate it the equivalent of a strong buy, five the equivalent of a buy, and three a hold.
What makes Spirit Airline so loved? Let's take a closer look.
The factor that probably stands out most is that Spirit Airlines' business model is based on low costs and high margins. Spirit's approach to attracting customers is to bait them with extremely low ticket costs that far undercut those of their peers.
Source: Flickr user Jaysin Trevino.
Where Spirit is able to generate its healthy profit margin, which sits at 11.4% for the trailing-12-month period, is in the collection of its so-called "optional fees." These fees are for services such as carry-on and checked luggage, the ability to select your own seat, buy food, or even to have an airport agent print out your boarding pass. Spirit has arranged its business model in such a way that it encourages travelers to print out paperwork at home and handle as much of the check-in process before they get to the airport. This, in turn, frees up Spirit's agents and allows the company to rely on its point-of-sale and website rather than its agents to drive its profits. In other words, Spirit is pocketing a significant portion of these optional fees as profit, and Wall Street loves it.
Spirit also has one of the youngest fleets in operation. According to AirFleets.net, the average age of Spirit's planes is just 5.4 years. Newer planes are considerably more fuel-efficient, which helps control costs throughout the year. Furthermore, newer planes also require less maintenance, meaning Spirit's planes spend more time up in the air earning money and less time in a garage getting repairs.
Finally, unlike the major airlines in the United States, Spirit Airlines' balance sheet won't give Wall Street indigestion. Spirit is currently sporting no debt and a cash balance of $567.2 million as of its most recently reported quarter. This lack of debt gives the company flexibility to add to capacity or perhaps even make acquisitions in the future.
Spirit Airlines may be cheap, but is it a buy?
Keep in mind that just because a stock is cheap based on a few financial metrics, and is also loved by Wall Street, doesn't mean that it's automatically a buy. As we just saw, Spirit does have plenty of positives working in its favor, including a high-margin business model, a young fleet of planes, and a squeaky-clean balance sheet, yet it also has a few red flags.
Source: Flickr user Eider Chaves.
Perhaps the biggest warning sign is that Spirit Airlines was rated, by far, the worst airline in Consumer Reports' customer satisfaction ratings, which were released in May 2013. Don't get me wrong; price is clearly an important factor that continues to drive travelers to Spirit. The concern here is whether or not Spirit will be able to drive repeat business if a significant number of passengers are leaving the plane dissatisfied with their flying experience. If Spirit is unable to develop a loyal customer base, it could find its profits are fleeting (no pun intended).
As for my personal view, I suspect that Spirit's success will be controlled more by how it manages its fleet than by customer satisfaction. The airline industry is already one of the most disliked industries in America -- ranking third-to-last in ACSI's annual customer satisfaction survey -- so I suspect the impact of Spirit's optional fees, while upsetting some, won't be too meaningful in terms of how many new consumers it brings in.
Instead, I believe the keys to Spirit's success will be keeping its fleet young and relishing the benefits of lower fuel costs, which are the primary expense of airlines these days. To that end, I'd suggest that Spirit has another five to eight years to handily outperform the industry average (and that's with the assumption that it doesn't buy any additional new planes, which is an unlikely scenario) -- and could, within that time, see its stock head even higher.
