Spirit Airlines: The Spirit Is Gone, Time To Sell (NYSE:SAVE)

In a report published in January, I discussed Spirit Airlines’ (NYSE:SAVE) challenging debt profile. I concluded that the company’s liquidity was not sufficient to service debt and operational costs. Additionally, I saw little chance for the company to successfully refinance debt, but I did see chances in sale-and-lease back transactions that could significantly shore up its liquidity position. The company has now reduced its new aircraft deliveries, as I will discuss in this report, along with the various challenges it faces. In light of the new developments, I’m also updating my rating and price target for the stock.

Spirit Airlines: Low Cost Is Key

For any airline, but particularly for low-cost carriers, it’s key to reduce its unit costs, and a major component of that cost reduction is amortizing costs over more seats to bring the per-seat costs or the costs per seat-mile down. Spirit Airlines was one of the companies that continued growing its capacity through the pandemic. By 2021, it was operating at a capacity level close to pre-pandemic levels.

However, what we do see is that while Spirit Airlines grew capacity, it was not quite able to bring unit costs down. In fact, compared to 2019, unit costs grew more than 27%, which is above the 22% inflation between 2019 and 2023. I wouldn’t want to conclude that management is not doing a good job, but I think it’s clear that absence of unit cost reduction despite capacity additions does put a lot of pressure on the low-cost structure.

At the same time, TRASM or total revenues per available seat-mile grew only 5%. So by adding capacity and normalization of unit revenues, Spirit Airlines saw its unit costs grow in excess of unit revenues’ growth. Simply speaking, it points at margin contraction.

In 2019, the company had adjusted operating margins of 13.4%, but we see that the company has been struggling to become profitable ever since despite Spirit being a frontrunner in capacity expansions and robust demand for air travel.

Putting it all together, Spirit Airlines did grow capacity but was not able to translate that into margin recovery as its unit revenues did not grow favorably compared to unit costs, which grew significantly. That’s not a sustainable business practice. Several airlines recently released first quarter earnings and what we saw was that passenger unit revenues increased by 3% for Alaska Airlines (ALK), domestic PRASM for United Airlines (UAL) grew 6.1% and Delta Air Lines (DAL) saw domestic PRASM increase 3%. Alaska Airlines yield was up 1%, domestic yields for United were up 2.6%, and flat for Delta. So, that points to there being little upside to yields while costs are continuing to rise. And assuming that Spirit Airlines is not budging the trend, it triggers a review on the current strategy.

Spirit Airlines Updates First Quarter Earnings Guidance

For the first quarter of 2024, Spirit Airlines has adjusted its earnings guidance. That guidance is not so much driven by a material change in the demand environment, but by the recognition of credits related to the Pratt & Whitney geared turbofan issues. Initially, the company expected to recognize the credits as offset to operating costs. However, the company determined that the credits should be applied against capitalized maintenance costs or cost of goods for engines, delaying the recognition of such credits in its earnings reports. As a result, the company sees its adjusted operating margin in the -14.5% to -13.5% range, compared to initial expectations of -15% to -12%. If the company would have been able to recognize credits as initially planned the margins would have been negative 11.5 to negative 10.5 percent, which compares favorably to its initial guidance driven by operational efficiencies on labor and better than expected landing fees. So, we do see some operational efficiencies materialize. But whereas some airlines are booking profits or adjusted profits for the quarter, Spirit Airlines still sees a big negative quarter. So, cost execution is looking good, but the gap with other airlines is still significant. Indeed, low-cost carriers are different from mainline carriers, but the gap does show that the low-cost model is falling short quite a bit as of now and Spirit Airlines needs to proactively manage that.

A positive is that the company has reached an agreement with International Aero Engines on a compensation for the airplanes that are grounded due to the GTF issues, and that will boost the company’s liquidity by $150 million to $200 million.

Spirit Airlines Adjusts Fleet Plan

Given that there seems to be little upside to yields in key markets and limited favorable amortization of unit costs, Spirit Airlines had to make a decision whether it would continue adding airplanes to the fleet or defer deliveries and save on the associated capex. The company decided to defer deliveries in the 2025-2026 timeframe by deferring six A320neo and nine A321neo deliveries scheduled for delivery in 2025 and approximately the same number of deliveries in 2026. The move should result in the liquidity position improving by $340 million. For 2024, that should result in a reversal of $230 million in airplane pre-delivery deposits compared to earlier guidance. Separately, the company also is laying off 260 pilots in an attempt to return to profitability.

Spirit Airlines Stock Does Not Look Appealing

After processing the balance sheet data and forward projections, Spirit Airlines’ stock is not looking extremely attractive. The reason for that is that part of its liquidity will likely be used to cover its negative operating cash flow. And even when the $1.3 billion in debt due in 2025 is successfully refinanced and capex is kept more or less flat, the company does face a challenging environment. As a result, I rate the stock a sell due to the lack of significant upside and the uncertainties regarding the company’s ability to shore up liquidity. The company does have options to successfully increase liquidity by means of sale and leaseback transactions which will provide liquidity and shed associated debt, but we have to see how the company is progressing on that end before we can be more positive about the business prospects.

Conclusion: Spirit Airlines Shores Up Liquidity But Stock Is Unattractive

Spirit Airlines has been successful in increasing its liquidity by means of airplane delivery deferrals, compensation from the GTF debacle and sale-and-lease-back transactions with possibilities for future sale-and-lease-back transactions. However, the company is having a hard time returning to an operational profit. And while we see some progress, there’s significantly more needed to return toward profits as unit costs are not showing favorable development while upside to unit revenues seems to be limited. As a result, I do not believe this is the stock you want to have in your portfolio.