Ever since Brexit, analysts have been touting airline stocks like Southwest Airlines (LUV) and Spirit Airlines (SAVE) that cater primarily to travelers in the U.S. over Delta Air Lines (DAL), United Continental (UAL), and American Airlines (AAL), which have loads of international exposure. The business update from Spirit Airlines last night, however, is calling that thesis into question.
With shares of Spirit off more than 6% this morning after releasing a revenue update, Stifel’s Joseph DeNardi and Sawyer McKelvey explain why it’s “getting harder to defend” the bull case on the budget airline:
Spirit provided a somewhat mixed investor update with its 2Q operating margin of ~22% at the higher end of its prior guidance but driven by softer than expected PRASM (down 14% y/y) which was offset by better CASM-ex performance (-8% y/y vs. down 5% guidance). The 14.3% PRASM decline is likely to lead shares to selloff tomorrow as consensus clearly assumes a meaningful ramp in PRASM through 2016 and 2017 and 2Q results are 50bps worse than 1Q despite roughly 3pts of lower capacity growth. Now, the company did indicate that domestic PRASM improved sequentially which implies that LatAm accounted for the all-in sequential decline. Bottom line is that Spirit needs to start showing an improvement in PRASM in 3Q or estimates are likely to come down considerably. Clearly, the catalyst for improving PRASM will be a further slowdown in ASM growth to the mid-teens range in 2H16 from mid 20% in 1H16 and lapping the effects of more aggressive fare matching from its competitors in 3Q15.
JPMorgan’s Jamie Baker and Nishant Mani point to Spirit’s fare discounting:
Spirit guidance, released after the close today, suggests an in-line earnings outcome though the individual drivers are likely to be met unenthusiastically by the market, in our view. While the company continues to anticipate a ~22% operating margin (vs. JPM initial 21.7%) TRASM of -14.3% came in at the low end of its initial range (“in-line with Q1”, which was -13.8%), whereas the company beat on ex-fuel CASM by roughly 300 basis points. Positive cost variance – of a magnitude we are wholly unaccustomed to – was driven by the timing of maintenance events, suggesting a similar deterioration in ex-fuel guidance for Q3/Q4. Spirit cited a greater than anticipated level of fare discounting than typical at the summer peak, a fact which somewhat surprises us given two broad-based fare increases during the quarter (though, in fairness, the second increase was filed with only 9 days remaining in June). In conjunction with a fuel cost $0.02/gallon higher than anticipated our earlier Q2 EPS estimate of $1.07 changes inconsequentially to $1.08 (with an accompanying 22% operating margin) versus $1.05 consensus.
Shares of Spirit Airlines have tumbled 6.2% to $44.87 at 11:00 a.m. today, while United Continental has declined 0.4% to $47.53, American Airlines has fallen 0.5% to $35.86, Delta Air Lines has advanced 0.2% to $40.17, and Southwest Airlines is off 0.5% at $42.96.