2019 got off to a great start for Spirit Airlines (SAVE 0.95%), but it ended up being a bumpy year for the ultra-low-cost carrier. During the spring and summer, Spirit suffered from a sharp downturn in its operational performance, because of an unfortunate combination of aggressive scheduling, runway closures, and frequent severe weather events. This drove up unit costs. Meanwhile, unit revenue trends deteriorated as the year progressed, because of tougher year-over-year comparisons as well as changes in the competitive landscape.
Even with all these headwinds, Spirit Airlines posted a double-digit increase in adjusted earnings per share for 2019 as a whole. The company's preliminary guidance for 2020 implies a similar performance this year. That makes Spirit Airlines stock look like a steal at less than nine times trailing earnings.
A better-than-expected end to the year
In the fourth quarter of 2018, Spirit's revenue per available seat mile (RASM) soared 11.4% year over year, causing EPS to nearly double. That set up an extremely difficult year-over-year comparison for the budget airline last quarter. Indeed, its initial guidance for Q4 suggested that profit would fall by more than a quarter from the prior-year period.
However, a few weeks ago, Spirit Airlines revealed that it outperformed both its unit revenue and nonfuel unit cost projections last quarter. This week, it confirmed that RASM decreased just 3.6% year over year, a decent result considering the tough comparison. And while nonfuel unit costs increased 3.3%, total unit costs decreased slightly due to lower fuel prices and fuel efficiency gains from Spirit's new Airbus A320neos.
Ultimately, adjusted EPS declined to $1.24: down 10% from $1.38 a year earlier. That may not seem impressive, but Spirit's results were far better on a full-year basis, with double-digit revenue and earnings growth. Revenue reached $3.83 billion, up 15% year over year, while adjusted EPS increased 16% to $5.09.
Management expects similar overall results in 2020
Spirit expects the margin pressure that pinched its profits in the second half of 2019 to continue in the first quarter. Management is projecting a 3.5% to 4.5% increase in adjusted nonfuel unit costs this quarter, along with a 1.5% to 3% RASM decline. On the flip side, Spirit's average fuel price is on track to fall to $1.90 per gallon from $2.09 per gallon in Q1 2019, which will more or less offset the expected nonfuel unit cost increase.
The net result is that Spirit Airlines expects to report an adjusted pre-tax margin between 6.5% and 7.5% this quarter, compared with 8.6% in the first quarter of 2020. At the midpoint of that range, Spirit would produce adjusted EPS of approximately $0.74, down from $0.84 in Q1 2019. Still, that would be far better than the $0.46 analysts had been expecting.
However, just as Spirit Airlines posted solid EPS growth last year despite a 10% EPS decline in the fourth quarter, management expects good full-year results in 2020, notwithstanding the subpar start to the year. First, nonfuel unit costs are likely to rise just 1% to 2% on a full-year basis, thanks to easy year-over comparisons in the second and third quarters related to Spirit's operational meltdown last year.
Second, RASM trends should improve steadily over the course of the year. Rather than adding lots of new cities to its route network, as it has done in the past two years, most of Spirit's growth in 2020 will come from extra flights on existing high-performing routes or new routes between cities it already serves. For example, Spirit recently announced that it will add frequencies on its routes from Baltimore to Fort Lauderdale, Orlando, and San Juan and from Cleveland to Fort Lauderdale, Orlando, Las Vegas, and Myrtle Beach this year. Since brand new markets tend to produce lower unit revenue initially, this route network shift should boost RASM and profitability.
Thus, for the full year, management expects to achieve an adjusted pre-tax margin of about 12%, roughly in line with its 2019 result of 11.9%. Importantly, that estimate assumes an average fuel price of $2.05 per gallon: significantly higher than recent market prices. If fuel prices remain low, there could be upside to Spirit's 2020 margin target.
Investors and analysts are skeptical
The new year has just begun, and the airline business can be quite volatile: Fuel prices, demand, and the competitive environment can all change on a dime. As such, there's obviously a good deal of uncertainty behind Spirit Airlines' confident full-year outlook.
Clearly, analysts and investors don't believe management. Spirit Airlines stock fell nearly 4% on Thursday after the earnings report and guidance came out. Meanwhile, analysts are calling for full-year EPS of $5.39, up modestly year over year. Management's guidance implies that EPS would be more than 10% higher than that figure, potentially surpassing $6.
However, Spirit Airlines' low valuation leaves a huge margin of safety for investors. In fact, the stock now trades for just seven times the earnings implied by management's 2020 guidance. Considering Spirit's industry-leading cost structure and massive long-term growth opportunities, Spirit Airlines shares have a ton of upside even if the budget carrier's earnings growth does slow or even pause, this year.