Last week, Spirit Airlines (SAVE 0.25%) reported yet another quarterly profit decline. However, while the company's first-quarter earnings fell by roughly 50% year over year, Spirit's forecast implies that profit growth is about to resume.
Indeed, while Spirit Airlines has posted volatile earnings results in the past few years, the company has consistently earned pre-tax margins of at least 15% while increasing capacity 15% to 20% annually. This growth model paves the way for strong earnings growth at Spirit Airlines in the years ahead.
Unit revenue is turning positive
In the first quarter, Spirit's revenue per available seat mile (RASM) fell 4.2% year over year. The decrease was caused by a shift in the timing of Easter, as well as the negative impact of an airport shooting in Fort Lauderdale and a severe winter storm that hit almost simultaneously in early January.
This unit revenue decline -- along with increases in fuel prices and non-fuel unit costs -- led to last quarter's big earnings drop.
Spirit Airlines' earnings declined significantly last quarter. Image source: Spirit Airlines.
By contrast, Spirit Airlines expects to get a roughly 4 percentage point RASM benefit from the Easter shift this quarter. Demand is improving steadily, as well. Furthermore, Spirit's internal efforts to increase fares and ancillary revenue are starting to gain traction. As a result, the company projects that RASM will rise 4.5% to 5.5% year over year this quarter.
This level of unit revenue growth should more than offset Spirit's expected 3.5% to 4.5% increase in non-fuel unit costs, as well as the impact of higher fuel prices. Based on the midpoint of Spirit's guidance, earnings per share could reach $1.24 in the second quarter, up from $1.11 a year ago.
Long-term cost performance remains solid
Spirit Airlines' non-fuel unit costs increased slightly last quarter, and the company expects a more significant increase during the second quarter. Nevertheless, Spirit is sticking with its goal of gradually reducing its unit costs as it grows.
Indeed, for the full year, Spirit expects its non-fuel unit costs to be flat to down 1%. This implies that non-fuel unit costs will decline 2% to 4% in the second half of 2017. Fuel cost pressure will also abate in the second half of the year, putting Spirit in good position to continue posting double-digit earnings growth then.
Looking ahead, Spirit Airlines will at some point need to give its pilots big raises to keep up with significant increases in pilot pay across the airline industry. But the company has several key tools to offset that future cost pressure.
First, Spirit Airlines is expanding its fleet of larger A321 jets, which make better use of pilot labor. Spirit entered 2017 with just 16 A321 aircraft, but by this time next year, it will operate 30 A321s. Second, Spirit is in the midst of adding four seats to each of its A320s, a project that will wrap up by year end. Third, Spirit is shifting toward owning most of its planes rather than leasing them, which will save a lot of money over time. Fourth, Spirit's steady growth will allow it to spread its overhead costs over more flights.
The stock is still cheap
Spirit Airlines is on pace to return to its prior trend of double-digit EPS growth as soon as this quarter. Yet Spirit Airlines shares still trade for about 14 times earnings, well below the average for the broader market.
It's true that the airline business is fairly risky compared to most industries. Nevertheless, investors appear to be seriously underestimating Spirit Airlines' earnings growth potential. Thanks to its industry-leading cost structure, Spirit should be able to thrive no matter how the competitive environment evolves in the years ahead, all while maintaining a high long-term growth rate.
