In early May, flight cancellations surged at Spirit Airlines (SAVE 0.25%) as a dispute between management and the company's pilots spiraled out of control. Last month, the company took a preliminary tally of the damage. At that time, Spirit projected that its unit costs would soar in the second quarter because of the operational disruption, but that unit revenue would stay roughly in line with its original forecast.
On Monday afternoon, Spirit Airlines released its final investor update for the quarter. On the plus side, unit revenue will come in ahead of the company's previous guidance. However, Spirit continues to suffer an unusually high number of flight cancellations.
Spirit updates its forecast
Non-fuel unit costs surged 9.5% to 10.5% year over year at Spirit Airlines last quarter, according to the company's recent investor update. That's 0.5 percentage points above the range provided last month, and far above the 3.5% to 4.5% increase Spirit Airlines had initially expected. Unit costs were driven up primarily by the cost of dealing with the uptick in flight cancellations.
Spirit Airlines had to cancel numerous flights last quarter. Image source: Spirit Airlines.
By contrast, Spirit's flight cancellations barely impacted revenue per available seat mile (RASM). During the height of the crisis, Spirit Airlines experienced a dip in ticket sales. However, this was mitigated by strong underlying travel demand. Furthermore, flight cancellations remained elevated in June, but well below the levels of early May. As a result, Spirit was able to reaccommodate some customers using empty seats on other flights, boosting its unit revenue.
The net result was that RASM rose about 5.5% year over year in the second quarter, reaching the high end of Spirit's original forecast range.
Surprisingly strong profitability
Spirit's strong RASM growth last quarter probably offset nearly all of its steep increase in non-fuel unit costs. Fuel prices also increased on a year-over-year basis in Q2, from $1.47 to $1.64 per gallon. That said, the fuel cost increase could have been worse; as of late April, management had expected fuel costs to reach $1.76 per gallon in the second quarter.
Incorporating all of the elements of Spirit Airlines' updated guidance, it appears that earnings per share will come in around $1.10 for Q2. That would be roughly in line with the company's Q2 2016 EPS of $1.11.
Flight cancellations are still a major issue
In early June, Spirit Airlines' management claimed flight operations had returned to normal. However, while the magnitude of the problem has shrunk since early May, Spirit is still canceling an unusually large number of flights. In June, it completed only 96.1% of its scheduled flights, down from 97.7% a year earlier.
In the short run, this level of flight cancellations wouldn't be disastrous in terms of financial performance, as indicated by Spirit Airlines' strong Q2 RASM growth. Yet in the long run, poor reliability will surely drive customers away. There's no point in saving money on a plane ticket if you don't make it to your destination when you need to be there.
That's why Spirit's investor update is potentially troubling. Right now, analysts expect Spirit Airlines to post double-digit EPS growth in the second half of 2017 and 2018. That seems very achievable, but only if the company can fix its reliability problems relatively quickly.
Spirit Airlines' poor June operational performance indicates that the pilots have been right to say that the carrier is understaffed. Operational performance may improve in the fall, when aircraft utilization tends to decline seasonally. However, before the 2018 peak season, Spirit Airlines absolutely must increase staffing and mend fences with its pilots, in order to keep flight cancellations under control.
