Spirit Airlines

MIAMI — Ultra-low-cost carrier Spirit Airlines reported an adjusted net profit of $58.7 million for the fourth quarter of 2014, up 43.2 percent year-over-year (YOY) versus 2013. For calendar 2014, Spirit recorded a net profit of $225.5 million, up 27.4.  Spirit’s profit improvement for the full year was driven primarily by a 16.8 percent rise in operating revenues to $1.93 billion.

Operating expenses for the year rose 14.9 percent, driven primarily by a 19.8 percent increase in labor expenses and a 25.7 percent increase in landing fees. However capacity growth for the year, as measured by available seat miles (ASMs), came in at 18 percent, so Spirit actually reduced its operating expenses on a per-ASM basis. Overall cost per available seat mile (CASM) fell 2.5 percent YOY for the calendar year, and CASM excluding fuel fell 0.5 percent.

However, in the fourth quarter, CASM declined 8.2 percent as Spirit accrued much of the benefits from the decline in oil prices. On the revenue side of the ledger, Spirit’s revenue per passenger flight segment for the year rose 1.4 percent to $135.14. Ancillary revenue per passenger rose 2.2 percent to $55.03, while base fare revenue rose just 0.9 percent to $80.11. Total revenue per ASM fell by 1.1 percent for the full year, but 5.1 percent in the fourth quarter, reflecting broader challenges in the revenue environment in the U.S.

Indeed the revenue environment is perhaps the only tangible challenge to Spirit in 2015, though the negotiations with its pilots and flight attendants may provide moments of tension. Now the revenue environment isn’t a life-threatening problem for Spirit. Those have been a dime a dozen over the past decade, and its hard to argue with the track record of an airline that delivered a pre-tax ROIC of 30.1 percent and an operating margin of 18.4 percent last year.

At the same time, there are a few small signs that Spirit may be running into its first revenue challenges in a while. The most prominent signs are of course the deteriorating revenue environment in the Dallas metro area and the RASM numbers, but the broader consensus amongst the US airlines is that the revenue environment is officially soft. The legacies and Southwest are, for the first time in years, unable to sustain fare increases, and most U.S. carriers have guided sharp revenue declines in the first quarter.

While Spirit is obviously below the average fare for legacies in most markets, the inability of the legacies to raise fares still poses risks for Spirit. First of all, one of the reasons that Spirit has been so successful competing head to head with legacy carriers (that still largely offer a superior product) is that there has been a lot of space for them. In most markets, fares rose so fast that whatever Spirit’s shortcomings, customers were willing to fly them to save lots of money.

With legacies not raising fares as much, this gap between Spirit and the legacies will shrink. But more importantly, without the ability to increase profits by raising fares, the legacies, which have to date mostly conceded the bottom of the market to Spirit without much of a fight, may instead seek to recapture the bottom tier of the market through discounted offerings. Delta has already foreshadowed this trend with Basic Economy, and a sustained period of fare stagnancy could push other airlines into a similar boat. Spirit has largely built its ULCC platform unencumbered by any legacy competition. Revenue challenges may change that dynamic.

Some other highlights from Spirit’s quarterly earnings call included:

  • Spirit projects capacity growth of roughly 30 percent in 2015;
  • Spirit ended the year with 65 airplanes, with 15 aircraft due for delivery in 2015, including its first A320neo in the fourth quarter;
  • Spirit is seeing ‘aggressive’ pricing in Dallas market since the end of the Wright Amendment. This is great for consumers, and confirms why Spirit saw an opportunity at DFW. Dallas continues to make “good” money for Spirit. It has earned out even better than first envisaged in 2011;
  • In the long term, Spirit sees the Dallas market evolving like Chicago, with lots of options at each segment of the demand curve. Chicago O’Hare makes money for NK, so Spirit sees no reason why Dallas/Fort Worth won’t continue making money for many years as well;
  • Houston will become Spirit’s second-largest base for international flights;
  • Fort Lauderdale is on the growth path again for Spirit in 2015. Good demographics with a large discretionary traveler base fit Spirit’s model well;
  • Latin America is seeing robust demand;
  • Spirit plans roughly 35 new routes in 2015, mostly connecting existing airports, not adding new ones;
  • Lower oil prices create new opportunities so long as the underlying economy remains healthy;
  • But for now, Spirit’s capacity growth rate is tied to fleet plan. 15-20 percent growth for the next five-plus years is very doable;
  • Spirit.com booking rate is increasing, and consumers are getting ever more comfortable with its base fare model;
  • Only 15 percent of 2015 fuel volume is hedged
  • For the first time, Spirit will use its balance sheet to finance aircraft. Spirit issued $148 million of long-term debt, enabled by its strong balance sheet and cheap credit conditions.