Whenever investing in airlines, first and foremost, remember Richard Branson’s advice: “If you want to be a millionaire, start with a billion dollars and launch a new airline.”
Even Warren Buffett (Trades, Portfolio), the most successful investor, has warned us about the negative aggregate value that airlines brought to investors over time. Normally, an airline should have lots of capital for buying or leasing airplanes and fixed huge operating costs. In order to be profitable, an airline should fill as many seats as possible for any flights.
However, in 2012, I wrote about one debt-free airline, which generated significantly high return on equity. It was Spirit Airlines (SAVE, Financial). At the time of my article ("Which Airline Should You Invest In?") it was trading at only $17 per share, with the market capitalization of $1.2 billion. In December 2014, it reached more than $84 per share. Since then, Spirit Airlines kept falling, dropping to $42.8 Friday.
Growing revenue and cash flow
Since 2010, Spirit Airlines has managed to consistently grow its revenue and operating income. While its revenue increased from $781 million in 2010 to $987.8 million in 2014, its operating income jumped from $68.8 million to $355.2 million during the same period. Its free cash flow has been positive in the past five years. Trailing past 12 months, its free cash flow stayed at $355.7 million.
Its preliminary estimate numbers for 2015 are quite positive. The available seat miles reached 21.24 billion, a 30% growth compared to 2014. In the fourth quarter, the company was estimated to have an operating margin of 22.5% with the capacity of 5.7 billion available seat miles. As Spirit Airlines is the ultra low-cost carrier, the lower fuel price might enable other airlines to lower their airfares to compete with the company. Of course, Spirit Airlines will also face downward price pressure in its airfare in order to stay competitive.
Interestingly, Spirit Airlines has a lot of liquidity in its balance sheet. As of September 2015, it had nearly $750 million in its cash on hand while employing $538 million in both long- and short-term debt. Thus, with $3.12 billion in market cap, its enterprise value was lower, at $2.9 billion. The enterprise value to free cash flow ratio is quite low, at only 8.7x. Compared to other ULCC such as Southwest Airlines (LUV, Financial) and JetBlue (JBLU, Financial), its free cash flow multiple stays in between. Southwest Airlines has the EV/FCF of 10.8x while JetBlue seems to be the cheapest, with the EV/FCF of 6.45x.
Lowest cost in ULCC category
What drives me to Spirit Airlines is the high return on invested capital with the lowest unit cost advantage.
Source: Spirit Airlines’ presentation
Thus, Spirit Airlines is considered the lowest carrier in the ULCC companies. Its lowest cost advantage has enabled the company to price the lowest fares for its passengers. Interestingly, Spirit Airlines’ revenue per passenger is below the cost of all of its competitors, even compared to JetBlue and Southwest Airlines.
Source: Spirit Airlines’ presentation
Conclusions
Here we have the lowest ULCC, which consistently grows its revenue and free cash flow. Consequently, it has delivered extremely high returns on invested capital over time, ranging from 47% to 87%. Investors will have a high probability of compounding their money at a decent rate of return by buying Spirit Airlines at the current price, with the low valuation of only 8.7x Ev/FCF.
