Frontier Group Holdings: Upside Falls Apart As Demand Crashes (NASDAQ:ULCC)

In August, I covered Frontier Group Holdings, Inc. (NASDAQ:ULCC) and concluded that the stock is a buy. However, since then the stock has seen its stock price tumble, and that warrants a revisit for ULCC stock to see whether we still see upside.

Why Did ULCC Stock Tumble?

Since my last report covering ULCC, the stock has declined nearly 35% while the S&P 500 (SP500) contracted little over 4%. Airline names are notorious for their volatility, so one can always expect airlines to show outsized price movement compared to the market.

Generally, I am also not a big fan of investing in the airline industry for the simple reason that in an unconstrained market airlines tend to throw capacity on the market to win market share and thereby dilute yields. Add oil price volatility to that, and you have a cocktail that is not always appealing. It does not mean that airlines are overpriced, but airline investment can be tricky and for many, including me, airline investments might be too volatile to comfortably invest in.

Frontier Group Holdings saw a combination of factors that led to the company revising its guidance downward for Q3, and most likely during the presentation of the results we will see pressure on the full year results as well. From the demand side, the company saw a significant weakening in bookings while tropical storm Hilary and Hurricane Idalia put pressure on the operations as well. The result is that the company revised its revenue estimate to $645 million at the lower end of the range and $655 million at the higher side of the range, indicating a $5 million lower revenue at the lower side and a $10 million downward revision on the higher side.

Furthermore, fuel prices have been $0.23 higher than expected and that is now also reflected in the updated guidance which puts the average fuel costs per gallon at $3.05-$3.10 or $0.20 higher than initially expected. All of this combined, leads to a pre-tax margin guidance of a 4% to 7% loss, while initially the company still expected a 4% to 7% profit margin. It goes to show how sensitive airlines and their stock prices are to a changing environment.

Is Frontier Airlines A Good Stock To Buy?

Following the downward revision on Q3 earnings, Citi downgraded the stock from Buy to Neutral with a $5.50 price target, while Raymond James maintained the outperform rating but with a price target trim from $12 to $9. So, without doubt the sentiment is turning.

The turn in sentiment is also visible in the analyst consensus for EBITDA in the period from 2023 to 2025:

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The analyst update to the estimates has been significant with $458 million lower EBITDA expected through 2025. For 2023, the EBITDA estimate has come down by 29%, 25% in 2024 and a 7% reduction in 2025.

Inserting the numbers in my model and disregarding the company median EV/EBITDA since the actual median EV/EBITDA is negative and has been substituted by the current EV/EBITDA we see that according to the industry median valuation, there is 52% upside with a price target of $7.33 down from my previous target of $13. There is upside, and I believe that the stock has significantly been oversold, but I would only consider buying in the name if you want to average down. Opening a new position might not be quite as appealing until management provides it full year outlook. So, I am maintaining my buy rating but I most definitely am cautious.

Conclusion: Frontier Group Holdings Stock Is A Cautious Buy

With its downward revision on Q3 guidance, Frontier Group Holdings showed exactly why I am not a huge fan of investment in the airline industry. It doesn’t mean that the stock offers no value, but the airline industry has been a tough one to invest in due to fierce competition and associated capacity additions as well as oil price volatility that can keep even the stronger performing airline stocks grounded. When I published my previous report, Frontier Group Holdings was trading roughly at the price target I have currently for the stock. So it can be said that while upside remains for the stock from the current price levels, 2023 has little to offer for those that were already invested in the stock.

On the longer term, Frontier Group Holdings, Inc. upside remains, and it will be significant, so investors could also attempt to position for the upcoming years, but there is no guarantee that we will see further downward revisions to the estimates and the operating environment. Therefore, the Q3 earnings call will be pivotal as a weaker than expected outlook could turn the stock into a Hold or even a Sell contrary to the current Buy rating.