SAVE - Spirit Airlines, Inc.

[KCLarkin]

Yes, they have breathing room with current margins. That is why the risk is limited. But if the mainline carriers respond aggressively it will limit Spirit's ability to grow. Still, I think the economics of the low cost supplier win out here.

 

My other concern -- in those markets where Frontier and Spirit compete directly, they seem to have equal share. So Spirit doesn't appear to have an immediate advantage over Frontier. There are plenty of open markets but I'd prefer not see two ULCCs competing head-to-head.

[Simple Investor]

On the surface Spirit and WestJet look like no-brainers.  They both look priced for no growth. 

[Simple Investor]

Although it is very, very hard to read the customer reviews and invest in this company.

[oddballstocks]

The problem I see with these guys is that they're at Tier 2/3 airports. 

 

I live in Pittsburgh, at the Pittsburgh airport I can get a flight to about anywhere if I am ok with connections.  There are direct flights to Europe and a number of US cities, things are streamlined, the highway is built for it etc.

 

Spirit operates out of Latrobe, and Allegiant out of Youngstown, OH.  Both are small areas.  I've been to the Latrobe airport, we went to an airshow there this past summer.  A few Spirit flights landed.  It was longer and out of the way to get there.  Would I prefer to drive 30m or an hour to the airport?  Latrobe has free parking, but in the context of a few thousand dollar trip $50 isn't that big of a deal.  There's also the factor that anyone I know who's taken Spirit has said to avoid it for how terrible it is.  And when I price the tickets they're not that much cheaper than what I could get on a mainline carrier.

 

Youngstown is worse, it's over an hour away.  While flights go to decent locations I don't know if it's worth the extra drive to get there.

 

The people I've talked to who take these flights are VERY cost sensitive.  They're the type of flyers who don't normally fly.  I will pay for an upgrade if it means I'm not squeezed into a tiny seat for hours.  I still have bad memories of flying in a disgusting plane (Delta how can you let your toilets overflow??) with a seat that's too tiny to Europe years ago.

 

These airlines have a double whammy.  They look great when times are good because seats are filled with fliers who don't normally fly or can't afford it.  Think of the blue collar set of fliers.  They'll take Spirit or Allegiant now because things are humming along, but they're the first to get hit when the economy hits the skids.  These are the fliers who are going to Vegas or Myrtle Beach for the first time because they received a bonus or flights are insanely cheap.

[kab60]

The problem I see with these guys is that they're at Tier 2/3 airports. 

 

I live in Pittsburgh, at the Pittsburgh airport I can get a flight to about anywhere if I am ok with connections.  There are direct flights to Europe and a number of US cities, things are streamlined, the highway is built for it etc.

 

Spirit operates out of Latrobe, and Allegiant out of Youngstown, OH.  Both are small areas.  I've been to the Latrobe airport, we went to an airshow there this past summer.  A few Spirit flights landed.  It was longer and out of the way to get there.  Would I prefer to drive 30m or an hour to the airport?  Latrobe has free parking, but in the context of a few thousand dollar trip $50 isn't that big of a deal.  There's also the factor that anyone I know who's taken Spirit has said to avoid it for how terrible it is.  And when I price the tickets they're not that much cheaper than what I could get on a mainline carrier.

 

Youngstown is worse, it's over an hour away.  While flights go to decent locations I don't know if it's worth the extra drive to get there.

 

The people I've talked to who take these flights are VERY cost sensitive.  They're the type of flyers who don't normally fly.  I will pay for an upgrade if it means I'm not squeezed into a tiny seat for hours.  I still have bad memories of flying in a disgusting plane (Delta how can you let your toilets overflow??) with a seat that's too tiny to Europe years ago.

 

These airlines have a double whammy.  They look great when times are good because seats are filled with fliers who don't normally fly or can't afford it.  Think of the blue collar set of fliers.  They'll take Spirit or Allegiant now because things are humming along, but they're the first to get hit when the economy hits the skids.  These are the fliers who are going to Vegas or Myrtle Beach for the first time because they received a bonus or flights are insanely cheap.

I tend to agree with everything you said - yet the numbers seem to suggest another story. Crazy growth, crazy ROIC and net cash position yet trades like a nogrowth sub 10 roe business. What you write reminds me a lot about peoples perception of Ryan Air in Europe which is also my own perception. "People" despise them and they too use tier 2 and 3 airports, but they still seem to do better than the rest. Which is also why I think there might be a good opportunity here. I just dont know anything about airline cycles. Or if they have major capex ahead.

[KCLarkin]

These airlines have a double whammy.  They look great when times are good because seats are filled with fliers who don't normally fly or can't afford it.  Think of the blue collar set of fliers.  They'll take Spirit or Allegiant now because things are humming along, but they're the first to get hit when the economy hits the skids.  These are the fliers who are going to Vegas or Myrtle Beach for the first time because they received a bonus or flights are insanely cheap.

 

I think you'd be wise to look at RyanAir or Asian ULCCs or even old Southwest to see if your assumptions about these guys getting hit hardest in the cycle is true. I would think the opposite is true. In a recession, the first thing businesses cut is travel expenses. These are the most lucrative customers for the mainline carriers.

 

---

 

Update 1: Looking at RyanAir on Gurufocus, Operating Margins dropped from 20% to 3% during the great recession (on a relatively small dip in revenue). KLM dropped to -3.8%. Only one example, but I think it is roughly representative of what happens in a recession.

Update 1b: During the great recession, RyanAir increased total traffic and had a minor drop in Load Factor. So, the drop in revenue was due to fare decreases not demand. Fuel costs spiked at the same time, which really crushed profits. http://www.staffs.ac.uk/sgc1/faculty/blb10089-3/documents/RyanAirCase.pdf

Update 2: Actually, when airlines go into a down cycle, fares tend to drop. This would tend to stimulate demand in cost conscious customers (offset by recessionary pressures). If fares rise (e.g. rising oil prices), I would expect more marginal demand to drop.

Update 3: Another way to look at this, ignoring the differences in customers and assuming all costs are fixed:

 

Peak of Cycle:

              AAL,    SAVE

Rev          1000, 1000

Costs        900,  800

Op Profit  100,  200

Op Margin 10%,  20%

 

Bottom of Cycle:

              AAL,    SAVE

Rev          900,  900

Costs        900,  800

Op Profit  0,      100

Op Margin 0%,  10%

Decline    100%,50%

 

 

 

 

 

[Guest neiljgsingh]

The problem I see with these guys is that they're at Tier 2/3 airports. 

 

I actually think Latrobe is an anomaly amongst the other places they service. ALGT is definitely a Tier 2/3 operator, which you'd expect at Latrobe or Youngstown, but Spirit tends to fly to all the big cities. Overall, they have a much greater overlap with AAL, DAL, and UAL than ALGT.

[intothebreach]

The problem I see with these guys is that they're at Tier 2/3 airports. 

 

I actually think Latrobe is an anomaly amongst the other places they service. ALGT is definitely a Tier 2/3 operator, which you'd expect at Latrobe or Youngstown, but Spirit tends to fly to all the big cities. Overall, they have a much greater overlap with AAL, DAL, and UAL than ALGT.

 

I'm not that familiar with most secondary airport in large US cities, but from my limited experience it is not always a bad thing as it also leads to smaller airports and less time required to "navigate" them (distance, moving between terminals, queues, etc.) One example is that all other things being equal I'd rather fly to Midway than to O'Hare, and the commute to downtown Chicago is also shorter from Midway (I realize that O'Hare might be an extreme example, but as I said, limited experience).

[kuberan]

The only real ULCC competition for Spirit is Frontier (the new retooled Frontier). Indigo, the PE firm that used to own Spirit wanted to buy Frontier when Republic put it up for sale in 2013. Ben Baldanza did not agree and so Bill Franke of Indigo, then Spirit's chairman, dumped his shares and bought Frontier. He also took Ben's right hand man Barry Biffle over, who now runs Frontier as a ULCC. Indigo also owns Wizz Air of Hungary which is another "real" ULCC with terrific figures and focuses on the Eastern EU market.

 

If you study Ryanair, and to a lesser extent easyJet, it is very apparent that over the long run 1. additional latent demand is stimulated 2. ULCCs gain market share 3. yields decrease; the product is inherently RASM dilutive at very high load factors (pile 'em high and sell 'em cheap) 4. customers change behavior for good and eventually tend to migrate to the low cost provider as they become more and more familiar with the product (they expect fewer or no frills) 5. ULCCs are more resilient in downturns than the legacies. ULCCs are profitable during both high and low yield environments due to their significantly lower CASMs. 6. Low cost arms of network carriers, or "straddlers", have all failed (KLM Buzz was sold to Ryanair; BA's Go! to easyJet; remember United's Shuttle, Song and Ted??) 7. Due to their inherently low cost structure - attributable to a system of reinforcing activities that are difficult to imitate - ULCCs typically win out prolonged price wars with legacy operators. History is replete with examples of failed long term price matching strategies by the legacy/network carriers. The pure ULCC model is designed to make money at low prices and the incumbents are hurt more during price wars.

 

Both Ryanair (after O'Leary started repositioning the airline after meeting Herb Kelleher) and easyJet have always been profitable. Spirit's been profitable since 2006 when they made the decision to become a ULCC. Ditto for Frontier over the last two years.

 

[Simple Investor]

keburan great insight and info,

 

Would you consider ALGT a competitor?

 

The operating CASM for Spirit ($5.39) is .56 cents lower than ALGT ($5.95) (looks close).  Is that considered significant?  Its funny that Spirit doesn’t use any ALGT info in the presentation slides.  I imagine they must compete or will in the future. 

 

They have similar size fleet but ASM for Spirit is significantly higher.  Iv only spent two days studding this industry but i assume it has to do with how many seats Spirit jams on the plane vs. ALGT.

 

It seems that Spirit to a degree counts on first time spirit flyers (which they deny).  These are the flyers who are going to pay the extra fees. I watched a debate between Ben (CEO) and a Chicago university professor.  The debate was focused on the ethics of Spirit airlines.  Ben basically said they just revamped the website to make it more clear.  Meaning not too long ago it wasn’t clear and people felt like they were getting bait and switched. If people become more educated on how to fly spirit then you would think the non-ticket revenue would decrease.  (i.e. printing your boarding pass prior and not paying $10).  Does spirit overcome that loss of revenue with a higher load factor. i think the point Keburan was making. 

 

To me spirit is paving the way in the US for the ULCC’s.  I don’t think they were as honest about it as they could have been (regarding fees).  But i think they are on the right track.  I see competition from competitors (frontier & possibly ALGT) as a risk.  But the stock price for Spirit is so cheap in comparison. 

 

Another risk that concerns me is culture risk -( Pushing the limits and squeezing out as much profit as possible).  Could that bleed into the safety of the flights. For example flying planes that need maintenance checks or just ignoring possible signs of safety because you are on a deadline. Creating a black swan event.  There are no facts to suggest this just giving thought to human nature and how people respond to incentives and pressure.  Obviously that risk is small but still concerns me.

 

Debate with professor.

 

[kuberan]

I don't think ALGT caters to the same market and I don't think they will in future. The reason being that their business model is very different from Spirit/Frontier and similar to the erstwhile charter carriers of EU.

-They fly from small/medium cities and towns to medium/large/holiday destinations. Think the Dakotas/Montana/Idaho/Small-town Midwest. Most of the route overlap is with legacy regionals.

- They operate a very low cost fleet. How? They buy almost fully depreciated planes, opportunistically. Their average fleet age is ~22 years and consists of mostly MD80s/757s. In future they would look to opportunistically buy old 319s/320s.

- The benefit of using an old fleet, in addition to lower capex, is that they can be extremely flexible ramping capacity up and down as per demand and market factors. They can park their fleet during downtime and run at very low average utilization ( I believe it is around 6 hours vs. Spirit's 13). The disadvantage is that these planes guzzle a lot of fuel and are costlier to maintain. If you look at the CASM breakdown you will see ALGT's fuel costs standing out. Adding more Airbus planes would mitigate this somewhat.

 

The risk related to a crash is present. I, personally, would assign a very low probability to that scenario. All airlines have to follow strict FAA standards and regulations regarding maintenance. ALGT is in some recent trouble and I believe the FAA is currently auditing them. I would be more worried about ALGT as they use very old planes and historically have had more maintenance related infractions. Ryanair had once used Romanian planes and pilots and O'Leary has described that era as the riskiest, as a crash would've finished the airline and probably the nascent ULCC business in EU. ValuJet is the only ULCC case I know in which a crash led to ceased operations/loss and a subsequent merger with the smaller AirTran Airways. Apparently, Maurice Gallagher, ALGTs CEO, was ValuJet's CEO prior to the crash and was on its board in 1996, when the incidents happened. Valujet's safety and maintenance procedures were suspect before the two incidents, one being the crash in the Everglades.

[Jurgis]

It seems that Spirit to a degree counts on first time spirit flyers (which they deny).  These are the flyers who are going to pay the extra fees. I watched a debate between Ben (CEO) and a Chicago university professor.  The debate was focused on the ethics of Spirit airlines.  Ben basically said they just revamped the website to make it more clear.  Meaning not too long ago it wasn’t clear and people felt like they were getting bait and switched. If people become more educated on how to fly spirit then you would think the non-ticket revenue would decrease.  (i.e. printing your boarding pass prior and not paying $10). 

 

Of course Spirit bait and switches. That's especially true if you buy tickets on Orbitz or some other 3rd party and haven't seen their website at all. You might get a note about baggage fees, but might not know about boarding pass fee at all.

 

 

The rest of this is customer PoW, might not be relevant to investors.

 

Overall Spirit experience might be OK if you know their system inside out, can stand their FUD and mind f*cking, are young and flexible (or old and cheap :P ), etc. For example, if you're flying with family/friend, Spirit will tell you to pay extra for assigned seats if you want to sit next to each other. They are somewhat bluffing - you'll get adjacent seats if you check in early / there are bunch of seats available. But there's a risk that you won't.

 

Best solution for trips where Spirit competes with legacy carriers is to buy legacy at their cheap "Spirit-buster" prices and enjoy the perks there (omg did I just call legacy cattle class a "perk"? what next - being happy for free on-plane toilets?).

 

In Boston airport Spirit has currently pretty zero signage, so if they change the gate - and they do - often - you'll be lucky if you hear the gate announcement over PA. Otherwise... well it's cheaper for them to fly with empty seat you know. ;)

On the positive side, if they change a gate they might not give a damn about your carry on - I mean "personal item" - size and you might get lucky to save that $100 or whatever they charge for carry on. They just saved the fuel on the guy who did not hear the gate change announcement, so it's a win-win, right?

[siddharth18]

This idea seems interesting at first glance...

 

Regarding the point that "customers hate Spirit" yet the Spirit planes go full and really the sustainability of their biz model - should be quite easy to figure out by looking at REPEAT customer metrics. Are customers returning? What % of new customers become repeat customers? And in that youtube interview, towards the end in the Q&A - the CEO alluded (without citing specific metrics) that they did have repeat customers. He said one of the route Spirit operates in, has been running for 15 years and the planes still go full on that route.

 

Second - I see Spirit has CASM advantage versus legacy airlines, but what if legacy airlines start behaving irrationally for a longer duration? I mean what's preventing the legacy airlines to try it's hardest (no matter what the toll) to pressure spirit's margins? I know it sounds a bit far fetched but what if the competitors decided to operate at break-even level for YEARS just to get spirit to back off?

 

And lastly - one nit I wanted to pick was how they keep claiming that every single option besides the far incurs some sort of incremental cost, hence they charge you for it...but why do they charge you for booking tickets on their website - whilst waving this charge if you go to their airport kiosk to book? Certainly having an employee book the ticket for customers would cost you more than having the customers buying themselves on Spirit.com? I wonder how sustainable that is...certainly feels disingenuous

 

...but all other charges I agree with.

Still...keeping an open mind and employing the "there's no such thing as bad assets, only a bad price" mentality and studying up on this company.

[KCLarkin]

This has quietly went on a nice run. It is out of "no-brainer" territory and into "pretty good bet". Did anyone get long this?

[Simple Investor]

bought some yesterday.  Couldn't take the run up and had to get in.  What is that bias called again?

 

 

[intothebreach]

Did anyone get long this?

 

I sure did, right after I posted on November 18 that it seemed to me like a bet worth taking (my cost basis is $35.60).

So far so good. For what it's worth, I bought it as an investment rather than just a trade as I think SAVE has a moat in their low-cost model that is defensible against incumbents as long as management does not lose focus on being the lowest cost provider and that competition remains limited in the ULCC segment.

 

Thanks again to all the posters here for their contribution to my education on a business I was unfamiliar with just a couple of weeks ago. To me, this is CoBF at its best (also feels a bit like a less complete and much less cooler version of Keanu Reeves instantly learning kung fu in the Matrix  : )

[Guest neiljgsingh]

This has quietly went on a nice run. It is out of "no-brainer" territory and into "pretty good bet". Did anyone get long this?

 

Bought at 36. Looks like the Ben Baldanza's public campaign in defense of SAVE has given it a nice run. Probably not sustainable given it's up 20% in the past 5 days, but the fundamentals are there for longer-term appreciation. Also suggested at the Credit Suisse Industrials Conference that they'll beat Q4 guidance.

[KCLarkin]

Also suggested at the Credit Suisse Industrials Conference that they'll beat Q4 guidance.

 

Nice. I missed that.

 

Not that next quarter is material to the thesis, just means that the current run might be justified.

[yitech]

I also got in around $36.3. The business model looks robust to me. Longer term this could be the next Ryanair / Southwest.

I don't think pricing pressure from AAL would last indefinitely. They do have shareholders to answer to.

[Guest neiljgsingh]

Just took another look at Tilson's presentation. A few interesting points that I'd love to bounce around with you all:

 

1. He clarifies that LUV has highest overlap with SAVE at 55%, then AAL at 51%. Seems like ALGT isn't a competitor in their current destination lineup (though this could conceivably change if they need to differentiate themselves against the big guys by flying to smaller places).

 

2. His explanation of why the stock fell in the first place after handily outperforming from 2013 to mid-2015 is interesting. "This stock was owned by growth investors – and earnings growth is likely going to be roughly flat for a few quarters, so they’ve fled." He tops it with a quote from a CS research report that basically says there are no catalysts for near-term growth. What he doesn't add, though, is why he thinks the market will change its view. I know value is a catalyst in and of itself, but it seems like Tilson always has some additional insight other than "it's cheap." Or maybe I'm unfairly comparing this thesis to some of his brilliant shorts. Who knows.

[cmlber]

I get that their costs are structurally lower than other airlines, but is that really a moat?  Can't anybody buy a few planes, copy Spirits strategy, and get routes point to point in these second tier airports and have the same cost structure?  The market might be small enough for ULCCs that nobody could (or would want to) break in and compete profitably, but it doesn't seem like it would be hard.  Planes are very easy to finance and it's a negative working capital business, so its very cheap to launch a start up ULCC. 

 

Ryanair has obviously been able to dominate and grow for a long time, so I guess that proves there is something sustainable about it, just curious to hear thoughts from anybody who knows more than I do...

[yitech]

Was American the Wrong Airline for Spirit to Engage in a Fare War?

http://www.thestreet.com/story/13387808/1/was-american-the-wrong-airline-for-spirit-to-engage-in-a-fare-war.html

[KCLarkin]

I get that their costs are structurally lower than other airlines, but is that really a moat?

 

This is not a Warren Buffet quality moat, for sure. But you aren't paying Buffet prices either. I would invert your question: Given the low barriers to entry, why does Spirit have such a large cost advantage? I think you would find that they have a narrow moat but not a very durable one. I haven't done enough work to know for sure.

[intothebreach]

KC gave a good answer. To which I would add that it is much more difficult than appears at first glance to be running any business with a true low cost philosophy and not succumb to temptations to take the easiest road. I believe it requires some kind of genuine "thrift" DNA that Spirit seems to embody. Time will tell as I have not been following the story that long.

[bci23]

KC gave a good answer. To which I would add that it is much more difficult than appears at first glance to be running any business with a true low cost philosophy and not succumb to temptations to take the easiest road. I believe it requires some kind of genuine "thrift" DNA that Spirit seems to embody. Time will tell as I have not been following the story that long.

 

I agree with this. Big companies love bloat, white collar employees of large companies are an incredibly entitled bunch that doesn't naturally embrace frugality and low cost, they love to waste money. Very difficult to fight this culture.