Over the past decade, Spirit Airlines (NYSE:SAVE) has grown from a niche carrier with just 30 aircraft into a major competitive force. Spirit's fleet recently surpassed 150 jets, making it the biggest ultra-low-cost carrier in the United States. Its expansion has played a big part in keeping average domestic airfares virtually flat since the beginning of 2011 (and down significantly after adjusting for inflation).

Initially, this rapid expansion paid off handsomely for shareholders. Spirit Airlines stock surged from an IPO price of $12 in 2011 to a peak near $85 in late 2014. However, earnings growth has been hard to come by since 2015, and margin pressures have offset its continued revenue growth.

As a result, Spirit Airlines stock lost half of its value in the five years after its late-2014 peak. By the end of 2019, it was trading for around $40. Furthermore, after air-travel demand evaporated due to the COVID-19 pandemic, it was one of the hardest-hit airline stocks. It has been trading near an all-time low recently, closing at just $8.30 on Thursday.

SAVE Chart

Spirit Airlines Stock History, data by YCharts.

While Spirit Airlines faces stiff headwinds from the COVID-19 pandemic and has a below-average balance sheet compared to other major airlines, its rock-bottom costs and leisure-travel focus could enable it to return to profitability much faster than its rivals. That makes the stock look oversold at recent levels.

Plenty of cash, but not much incremental flexibility

For many years, Spirit Airlines has carried a lot of cash on its balance sheet. Entering 2020, it had $1.1 billion of unrestricted cash and investments. That was equivalent to more than 28% of its 2019 revenue -- the highest cash-to-revenue ratio of any major U.S. airline. That cash cushion has been very helpful for Spirit in navigating through the current crisis.

On the other hand, Spirit also had $3.6 billion of debt and lease liabilities at the end of 2019, which contribute to its substantial fixed cash expenditures. Furthermore, due to its growth plan, the carrier began the year with 41 new aircraft scheduled for delivery in 2020 and 2021. While it is working with Airbus to delay some of those deliveries, many of those aircraft will arrive as scheduled, adding to Spirit's liabilities.

Lastly, Spirit Airlines doesn't have a lot of unencumbered assets. As of March 31, its unencumbered tangible assets were worth a little more than $900 million, limiting its ability to issue secured debt. By contrast, many of its airline industry peers have been able to use their aircraft, airport slots, and gates as collateral to raise substantial amounts of capital at reasonable rates.

Shoring up the balance sheet

On the bright side, Spirit Airlines has made substantial progress in reinforcing its balance sheet recently. Last month, it borrowed $135 million under a new revolving credit facility, and also received the first half of the $335 million of payroll support grants it is entitled to under the CARES Act. (The rest will arrive by July.)

A yellow Spirit Airlines jet parked at an airport gate

Spirit Airlines has been working to bolster its balance sheet. Image source: Spirit Airlines.

These moves allowed Spirit to end April with $915 million of unrestricted cash and investments, despite significant cash burn in March and April due to refunds and ongoing operating expenses.

Since then, Spirit Airlines has raised approximately $361 million of additional capital by issuing shares and convertible debt. It also expects to receive a roughly $180 million income tax refund later this year. Additionally, if needed, it is eligible for up to $741 million of low-cost government loans under the CARES Act.

With cash burn having slowed to $4 million a day and likely to moderate further in the second half of 2020, Spirit now appears to have ample cash and access to capital to get through the next year or two, no matter how slow the demand recovery in air travel is.

However, these balance sheet improvements came at a high price for existing shareholders (such as myself). Spirit issued over 20 million shares in this month's stock offering, diluting shareholders by about 23%. There could be significant additional dilution in the years ahead from warrants issued to the government and the recently issued convertible notes, albeit only if Spirit Airlines stock rebounds by more than 50% from recent levels.

Long-term potential remains

Several months ago, I wrote that Spirit Airlines stock was undervalued in light of the company's potential to deliver steadier revenue and earnings growth. That turned out to be a dreadful call, as the unprecedented plunge in demand associated with COVID-19 has decimated Spirit's business.

Yet while the near-term outlook is extremely weak, Spirit's low fares could be more attractive than ever when people are ready to start flying again. Moreover, most analysts and industry insiders expect leisure demand (which drives the vast majority of Spirit's revenue) to recover faster than business demand. And Spirit Airlines' low costs and substantial non-ticket revenue streams -- base fares accounted for just 42% of total revenue last quarter -- allow it to make money with very low fares. (That's particularly true if oil prices remain depressed.)

Together, these factors could enable Spirit Airlines to return to profitability much sooner than most of its rivals. Even if overall travel demand remains at 50% of 2019 levels, Spirit is likely to capture more than its fair share of that demand with its low-cost, low-fare approach. Meanwhile, higher-cost airlines will have to avoid getting into costly price wars for the foreseeable future.

A rendering of a Spirit Airlines A320neo

Spirit Airlines' industry-leading cost structure could be a big advantage once demand returns. Image source: Airbus.

Lots of upside with a ton of risk

Looking ahead five years or more, there's no particular reason why the COVID-19 pandemic should undermine Spirit's growth trajectory. Nobody knows when the threat will be brought under control, but it will happen sooner or later, and when it does, pent-up demand for air travel will be unleashed. Broad economic weakness might hurt other airlines, but in a downturn, people might be more likely to choose budget carriers like Spirit to save money.

If Spirit resumes its growth after 2021 and margins gradually return to 2019 levels, adjusted earnings per share could surpass last year's $5.09 by 2025 (if not sooner), notwithstanding the recent dilution. Clearly, that gives the stock a ton of upside.

However, that upside comes with a big dose of risk. In a worst-case scenario, recurring major outbreaks of COVID-19 could cause air travel demand to remain extraordinarily weak for years. If nobody wants to travel, even industry-leading low costs and cheap fares won't allow Spirit to fill its planes and stem its cash burn. It could probably hold out for a year or two, but eventually, bankruptcy might become inevitable.

Thus, while there may be a place for Spirit Airlines stock in some risk-tolerant investors' portfolios, it would be wise to use extreme caution due to the speculative nature of this investment.