Airlines have long been considered a no-man’s land for investors, yet in recent years some have thrived. With the ongoing consolidation of the airline industry, each individual company has the ability to carve out a potentially profitable niche that defies the notion that airlines are unprofitable, undesirable businesses. For this value-oriented sky-flier that released earnings last week, 2012 was a very strong year. Now, with rising fuel costs, legacy-led pricing power, and increasing ancillary fees, how does the forecast look for the this year and beyond?
Flyin’ high
According to Spirit Airlines Incorporated (NASDAQ:SAVE), 2012 was a successful year of recovery for the travel industry. The company added 29 new routes to its portfolio, bringing its total number to 110. Those moves helped Spirit Airlines Incorporated (NASDAQ:SAVE) achieve a record full-year income of $1.3 billion — all while maintaining its low average base fare of $75. More impressive is that this came in on the heels of a difficult quarter for the company. Hurricane Sandy hit the industry hard, and Spirit management believes the catastrophe brought down revenue by $25 million and operating income by $24 million.
For the quarter, the company was able to beat the Street’s expectations. EPS for the fourth quarter came in $0.03 ahead of estimates at $0.27 per share, based on $328.3 million in revenue. Sales came in at a 20% premium to 2011’s fourth quarter and, again, above Wall Street estimates of $324.7 million.
Overall, things appear strong for the discount airliner that offers bottom-line prices for bottom-line service. But how does that model play out long-term, and what other factors could change Spirit’s course?
Is it really that cheap?
There’s no doubt that Spirit is one of the cheapest airlines, if not the cheapest, on a routine basis. Allegiant Travel Company (NASDAQ:ALGT) is most similar in price point and route offering, but it also has a robust travel booking service beyond its core airline business. Though, as my colleague Brian Stoffel pointed out, ancillary fees quickly diminish Spirit’s seemingly advantageous cost platform. Now, all airlines are charging more and more ancillaries, but Spirit seems to be taking the idea of nickel-and-diming to a new low. Charging $3 for water doesn’t seem like a reasonable thing to do, regardless of increasing fuel prices or competition from other airlines. I usually bring my own water on planes, but this offends me on a fundamental level.
Will travelers be as put off as I am by that kind of behavior? The company is expanding quickly, so growth looks strong — but it will be interesting to see how its new routes perform on a long-term basis and if initial traveler interest wanes.
Rising fuel costs are another element that could change things for Spirit this year. Airlines can typically compensate by raising fares. Spirit can do this to a degree, but with its other practices (again, see $3 water), it’s only selling point is dirt-cheap airfares. If it were to increase fares by just $10 or $15, it might have to let us bring a carry-on for free.
Tailwinds and the call
Beyond my personal issues with Spirit’s business model, there do seem to be some outside factors that bode well for the company going forward. As mentioned in a recent interview on CNBC, Spirit CEO Ben Baldanza believes the merger between American Airlines and US Airways Group, Inc. (NYSE:LCC) will increase prices for legacy carriers and widen the gap between discount airlines and the others, thus creating a bigger runway for growth.
From my understanding of the merger, this could happen, but it’s not a guarantee. Both American and US Air reps have said multiple times that this does not necessarily equal an increase in fares, though analysts have often disagreed. Assuming Baldanza is correct, though, passengers may be more inclined than ever to try out Spirit and its Evian-priced tap water.
In a recent article, I touted Alaska Air Group, Inc. (NYSE:ALK) as the airline to go with if you’re intrigued by the “renaissance” period of airlines and want to invest. I like Alaska’s doubleheader of growing routes while earning more per seat per mile, its profitable West Coast niche, and, most importantly, its free water.
The article Is Spirit Air Worth the Water? originally appeared on Fool.com and is written by Michael B. Lewis.
Fool contributor Michael B. Lewis has no position in any stocks mentioned. The Motley Fool owns shares of Spirit Airlines.
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