Low-cost carrier Spirit Airlines' (SAVE -3.22%) first-quarter earnings report was unimpressive at first blush, with declines in unit revenue, operating margin, and net income compared to the year-ago period. However, for investors, there's plenty on the horizon to get excited about. Unit revenue is almost certain to return to growth next quarter, paving the way for stronger earnings for the remainder of the year. In addition, the company's efforts to improve its customer experience appear to be gaining traction, which could provide an extra boost to growth over the long term.
Unit revenue growth is finally within sight
For the first quarter, Spirit's total revenue per available seat mile (TRASM, also called unit revenue) fell 4.2% year over year. While disappointing, this was driven primarily by the calendar shift of Easter to the second quarter, and to a lesser extent, by winter storm Helena and the Fort Lauderdale airport shooting. Based on management's numbers, minus these events, it appears that TRASM would have eked out a tiny gain.
Image source: Spirit Airlines.
But the good news is that after more than two years of quarterly declines, management is now guiding for TRASM growth of 4.5% to 5.5% in the second quarter. While the Easter shift will be responsible for around 4 percentage points of that, Spirit also said that the industry pricing environment has improved a bit. And most important, the company says that many of its revenue initiatives -- including pushing yields (the average fare paid per mile per passenger) up on higher demand days -- are beginning to bear fruit even earlier than expected.
Management believes that once Spirit turns the corner, unit revenue growth will continue for the remainder of the year. That means that during a year in which Spirit's capacity (also known as available seat miles, or ASMs) is expected to increase 17% to 17.5%, the company will soon be booking higher revenue for each of those ASMs. That's a big tailwind that should help provide healthy rates of top-line growth for the rest of 2017.
Operating margin won't stay subpar for long
Spirit has historically boasted stellar margins, with adjusted operating margin coming in above 20% for each of the last two years. In the fourth quarter of 2016, this figure fell to 16.2%, and in the first quarter of 2017, it dropped again to 11.0%.
This wasn't entirely unexpected, as late last year, management cited higher depreciation and amortization costs for increased maintenance events coming into 2017. However, the company expects most of these costs to eventually be offset by its strategic shift to purchasing more -- and leasing fewer -- of its aircraft. Additionally, as the company keeps adding ASMs at a steady clip, sheer scale will continue to drive its cost per available seat mile (CASM) lower. While Spirit's CASM excluding fuel increased by 0.5% in the first quarter, the company is guiding for this number to be flat to negative 1% for full-year 2017.
Spirit's margins can also be lumpy, with the first and fourth quarters generally lower than the higher-demand quarters in the middle of the year. With the company believing it can hold the line on costs, and with revenue set to expand, Q2 and Q3 margins should show big improvement. And for the full year, management is targeting an operating margin in the "mid-teens or higher."
Better customer service -- a wild card for future growth?
In addition to its cheap fares, Spirit has, unfortunately, also long been known for poor service. However, about a year ago, newly appointed CEO Bob Fornaro made it a top priority to improve Spirit's overall customer experience. By the end of 2016, the airline had already lowered its complaint rate by more than 60% while making huge strides in its on-time performance.
On the first-quarter conference call (transcribed by Thomson Reuters), Fornaro noted:
The competition was used to looking at Spirit being at the lowest point of every operational metric, and that's no longer the case. And so I would say, we're really on the move, but like I said, it's -- big moves have already occurred, but there's a number of things that we'll need to occur over time to get us in the right spot.
This progress continued in the first quarter, with Spirit's on-time performance rising 10.2 percentage points, to 75.5%. Fornaro also said that by midyear, Spirit will have dramatically cut its complaint ratio again. While there's still more work to do here, if Spirit can eventually raise its perception to be seen as even an "average" airline, it could attract a whole new group of flyers willing to give Spirit a try.
While this wasn't a fantastic quarter for the airline, investors can breathe a little easier now after suffering more than two full years of unit revenue declines. With revenue, operating margin, and net income all likely to take off again soon, Spirit's stock has a good chance of doing the same.
