Several months ago, Spirit Airlines (SAVE 1.31%) executives and investors had aspirations for a return to profitability over the summer. However, an operational meltdown in late July and early August and a summer surge in U.S. COVID-19 cases spoiled those hopes.
On Wednesday afternoon, Spirit reported third-quarter earnings results well shy of its initial forecast but ahead of analysts' lowered estimates. Management also acknowledged that it will take longer than previously expected to return to full fleet utilization, which will negatively impact near-term profitability. Let's see what this means for Spirit Airlines shareholders.
A disappointing quarter
Back in late July, Spirit Airlines projected that it would generate record revenue of more than $1 billion in the third quarter. Based on that estimate, it expected to achieve an adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) margin between 10% and 15%.
Unfortunately, a combination of understaffing and bad weather forced the budget airline to cancel nearly 3,000 flights over the course of 11 days, driving up costs and reducing its revenue by about $50 million. Spirit also proactively cut its schedule for the rest of the quarter to limit the risk of further disruptions. In August, management estimated that those flight reductions and a downturn in demand associated with rising COVID-19 case numbers would reduce revenue by another $80 million to $100 million. This caused Spirit Airlines to slash its Q3 margin guidance, calling for an adjusted EBITDA margin between -1% and -8%.
Ultimately, Spirit's third-quarter results weren't quite as bad as its updated guidance. Revenue totaled $923 million: down from a peak of $992 million in the third quarter of 2019 but near the midpoint of the carrier's updated guidance range of $885 million to $955 million. Meanwhile, costs came in lower than expected.
As a result, Spirit Airlines generated adjusted EBITDA of $9.4 million, giving it a 1% adjusted EBITDA margin. Of course, while this result beat its updated forecast, it fell well short of the carrier's initial outlook.
Spirit Airlines also recorded an adjusted loss per share of $0.69, beating the analyst consensus by $0.33. Including the benefit from government payroll support grants, Spirit earned $0.14 per share.
The fourth quarter will be worse
Spirit Airlines expects to report weaker financial results in the fourth quarter, mainly due to typical industry seasonality and soaring fuel prices. Adding to the pressure, Spirit has reduced its capacity plan due to labor constraints. It now plans to increase capacity by approximately 11.2% relative to Q4 2019, down from its previous plan of 23% growth.
The reduced capacity plan implies lower aircraft utilization, driving unit costs higher. Furthermore, half of the capacity reduction is centered on Spirit's Fort Lauderdale operations, due to staffing shortages there. That will hurt unit revenue, as Florida routes tend to perform well above average in the fall and winter.
All told, Spirit Airlines expects to generate revenue between $938 million and $975 million this quarter, with an EBITDA margin between breakeven and -5%.
Targeting a return to normal in 2023
During the company's earnings call last week, Spirit Airlines executives said aircraft utilization probably won't reach pre-pandemic levels until late 2022, compared to a previous target of mid-2022. The airline is taking a more conservative tack on capacity deployment as it tries to address its current staffing shortage. This will drive some incremental cost pressure next year.
Looking ahead to 2023, Spirit expects more normal business conditions, allowing it to return to full fleet utilization. Even so, management expects adjusted nonfuel unit costs to stabilize just shy of 6 cents: up from 5.55 cents in 2019 and 5.3 cents in 2018, due to wage inflation, rising airport costs, and higher aircraft rent.
Many investors fear that this will permanently damage Spirit's profitability. Indeed, after rallying to around the $40 mark earlier this year, Spirit Airlines stock has retreated to $22.
That said, other airlines face similar pressure on labor and airport costs. That will drive industry fare levels higher, all else equal. Additionally, improving fuel efficiency should offset the impact of higher aircraft rent associated with Spirit's growing fleet of Airbus A320neos. Spirit Airlines' non-ticket revenue has also surpassed pre-pandemic levels and could continue growing steadily in the years ahead.
Thus, management thinks operating margins will match or exceed 2019 levels by 2023. That would boost earnings per share to at least $4 to $5. While there's no guarantee that Spirit will achieve such a dramatic earnings recovery in 2023, the sell-off in Spirit Airlines stock over the past few months has created a compelling risk-reward trade-off for patient investors.