Thursday, December 29, 2016

Spirit Airlines 2016 Report

Spirit Airlines’s capacity growth

In November 2016, Spirit Airlines’s capacity grew 16.4% year-over-year (or YoY), which is higher than its growth in the past two months but slower than its growth in 1H16. Year-to-date (or YTD), Spirit Airlines’s capacity has grown 20.3%, which is significantly lower than its fiscal 2015 capacity growth of 30%.

Airline capacity is measured using available seat miles (or ASM). ASM is calculated as the number of seats available multiplied by the number of miles.

Low oil cost helps

Like all other airline companies, Spirit Airlines is taking advantage of the low oil cost environment to expand its capacity.

After falling more than 50% in 2015, crude prices have stayed low in 2016 as well. This helped Spirit Airlines reduce its fuel costs 17% for the first nine months of 2016. Most of the surplus cash generated is being used toward growing capacity. 


Outlook

Spirit Airlines expects to continue its aggressive expansion plan throughout 2016. Its capacity is expected to increase 15.6% YoY in 4Q16. Since the average for the first two months is 14.7% YoY, we can expect its capacity growth to increase slightly in December.

For fiscal 2016, capacity is expected to increase ~20%, given its high 25% growth in the first half of 2016. This is still higher than its peers, including low-cost carriers Southwest Airlines and JetBlue. Allegiant Travel is the only other airline with such high capacity growth.

However, one of the major contrasts to Spirit Airlines’s past capacity expansion is that the airline plans to focus on routes that are unserved by legacy air carriers. Spirit Airlines had previously aggressively targeted the largest hubs that are served by legacy carriers. This could help check the price wars, which was one of SAVE’s major concerns in 2015.

Investors can gain exposure to airline stocks by investing in the iShares Transportation Average ETF, which invests ~24% of its portfolio in airlines. Next, we’ll look at Spirit Airlines’s traffic growth.

Spirit Airlines’s traffic growth

Spirit Airlines’s traffic grew 15.5% year-over-year (or YoY) in November 2016, slightly higher than its capacity growth for the month. This is higher than its peers, including low-cost carriers Southwest Airlines, JetBlue, and Allegiant Trave.

SAVE’s traffic growth is also higher than legacy carriers Delta Air Lines, United Continental, and American Airlines.

Year-to-date (or YTD), SAVE’s traffic has risen 20.7% YoY. Its traffic growth for fiscal 2015 was higher at 27.1% YoY. Its traffic growth was boosted by lower airfares, strong network expansion, and overall strength in the industry and economy.

Airline traffic is measured by revenue passenger miles (or RPM), which is the number of revenue passengers multiplied by the total distance traveled.

Low-cost strategy

Spirit Airlines has been able to grab market share from other players mostly due its ultra-low-cost strategy. The strategy is to reduce base airfares as much as possible, un-bundling other services such as carry-on bags, checked bags, boarding passes, and food and beverages.

Users must pay extra for these services, only paying for services they use without subsidizing other passengers’ travel expenses. This strategy is expected to be a future traffic booster.


Passenger travel demand

Spirit Airlines’s passenger travel demand had a great start in 2016, growing ~6% year-over-year, the highest since 2012. However, the International Air Transport Association (or IATA) suspects the industry might be at the end of the traffic boost phase provided by low oil prices. This suggests travel demand may slow down, which would adversely impact airlines.

Next, we’ll look at Spirit Airlines’s utilization trend. SAVE forms 2.3% of the First Trust Industrials/Producer Durables AlphaDEX ETF (FXR).

Utilization improves

Spirit Airlines’s capacity growth has outpaced traffic growth throughout most of 2015, which meant declining utilization (or load factor) for the low-cost airline. In fact, SAVE saw one of the fastest-declining utilizations in 2015 among all major players with the exception of Allegiant Travel, which saw a similar decline.

However, 2016 has been a mixed year for SAVE. After five months of consecutive growth in utilization from May–September 2016, Spirit Airlines’s utilization has been declining since then. Its utilization has fallen 0.6% in October and November 2016 to 82.9% and 81.3%, respectively.

In November 2016, peers JetBlue, Delta Air Lines, United Continental, and Southwest Airlines also reported an improvement in utilization. American Airlines is the only other carrier that reported a decline in utilization.

Load factor is the most commonly used measure of an airline’s capacity utilization. It calculated as revenue passenger miles divided by available seat miles. A higher load factor indicates better utilization of aircraft capacity.
Yields decline and unit revenues follow

Spirit Airlines has mainly increased its capacity on routes served by other legacy players. This has resulted in several pricing wars, leading to the decline in average yields.

For 1H16, Spirit Airlines’s TRASM (total operating revenue per available seat mile) fell 14% to ~$0.91. In 3Q16, its TRASM fell 7% YoY to $0.96. SAVE’s unit revenues have fallen significantly, generating some concern for investors.


Outlook

Spirit Airlines believes that airfares have stabilized and expects unit revenues to rise in 2017. This could mean higher revenue growth in 2016 for SAVE.

Spirit Airlines is expected to follow its high-capacity growth strategy. However, in untapped markets, this could help reduce pressure on unit revenues. Coupled with SAVE’s low-cost strategy, this could bode well for the airline’s future.

SAVE forms 2.3% of the First Trust Industrials/Producer Durables AlphaDEX ETF (FXR).

Customer service issues

Spirit Airlines has the highest number of passenger complaints—eight complaints per 100,000 passengers to an average ~11.7 passengers for every 100,000—and the highest cancellation rate.

Adding to the passengers’ woes is their view that Spirit Airlines’s seats are very uncomfortable, with little legroom. Many passengers also seemed to have complained about Spirit Airlines’s staff’s poor communication skills.

Poor performance

According to the Department of Transportation, Spirit Airlines had one of the worst on-time arrival records in 2015. The situation improved slightly in 2016, with Spirit Airlines coming in tenth in on-time arrivals, ahead of Virgin America and American Airlines. For November 2016, SAVE’s on-time arrival record was 86.4%.

Some positives

All this leaves Spirit Airlines’s customers with a less-than-ideal flying experience. In our view, if Spirit Airlines doesn’t address these issues soon, it may losing loyal customers and hamper its demand growth.

Spirit Airlines has been taking steps to address these issues. In fact, SAVE has achieved moderate success in improving its on-time arrivals.

Spirit Airlines expected to join the Transportation Security Administration’s (or TSA) pre-check facility in November, which allows passengers with TSA clearance to check in via a faster-moving security line. To date, Spirit Airlines has not completed this process.

Spirit Airlines plans to develop a mobile-responsive website to improve its passenger experience. The airline is also considering adding in-flight Wi-Fi, at an additional cost for its passengers. Among the major carriers, including Southwest Airlines, JetBlue Airways, and Delta Air Lines, already have this facility in place.


Low fares help

Of course, having the lowest fares in the industry would keep driving cost-conscious passengers to Spirit Airlines. For example, on some routes, SAVE’s fares are $200 lower than any of its peers—a significant savings.

In the final part of this series, we’ll look at the performance of Spirit Airlines stock. SAVE forms 2.3% of the First Trust Industrials/Producer Durables AlphaDEX ETF (FXR).

Spirit Airlines stock

Since Spirit Airlines’s traffic release on December 8, 2016, the stock has risen 0.05%. Most the other airlines have also gained value during the same period. United Continental rose 3.3%, followed by Alaska Air Group, which rose 3.1%.

JetBlue Airways rose 1.7% and Southwest Airlines rose 1.2%. Allegiant Travels rose 0.33% during the same period. Delta Air Lines saw the biggest loss, falling almost 2.4%, followed by American Airlines with a fall of 0.35% during the same period.

Year-to-date performance

Until October 2016, all airlines were trading in the red. That changed in November 2016, as activist investor and long-term airline bear Warren Buffett invested in airlines.

While most airlines continue to trade in green year-to-date through December 23, 2016, Delta Air Lines and JetBlue Airways continue to be in the red zone. JBLU has lost almost 1.7% YTD (year-to-date) and Delta Air Lines has lost 1.6% YTD. This is still a huge improvement compared to the 25%–30% loss both stocks reported until October.

Other airlines have gained year-to-date 2016. Spirit Airlines tops the charts with a rise of 47.5%, followed by United Continental, which rose 30.5%. Southwest Airlines rose 17.1%, American Airlines rose 14.5%, Alaska Air Group rose 14.5%, and ALGT rose 0.5% year-to-date.


Industry performance

After a volatile start, the markets have performed quite well in 2016. The broader market, tracked by the SPDR S&P 500 ETF (SPY), has risen 10.7% year-to-date.

Economic growth is a major factor impacting airline industry demand and as a result, the industry has closely tracked the market. Year-to-date through December 23, 2016, the Dow Jones US Airline Index (DJUSAR) has risen 11.8%.

As air travel is a discretionary budget item, we can also compare the industry’s performance to the consumer discretionary sector. The Consumer Discretionary SPDR ETF (XLY) has risen 5.5% year-to-date.


(Ally Schmidt - Market Realist)

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