Which Airline Should You Invest In?

Anh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

“If you want to be a millionaire, start with a billion dollars and launch a new airline.” – Richard Branson 

Indeed, Warren Buffett, the most successful investor of all time, has the same opinion about the airline industry. Along with its significant growth over a century, the airline industry has brought negative aggregate value for investors. Buffett commented that the growth of the airline industry, which demanded huge capital to fuel that growth, would earn little or no money. Indeed, the business of filling seats with fixed huge operating costs is no fun for investors at all. However, I just come across one interesting airline, which carries no debt and has been generating positive cash flow for the last 3 years. It is Spirit Airlines (NASDAQ: SAVE)

Operate as its stock symbol indicates

Like its stock symbol, SAVE, Spirit Airlines is famous for its ultra-low cost (UCLL) strategy for passengers flying in the US, the Caribbean, and Latin America regions, serving 48 airports. Because of its low cost model since 2007, it has maintained to be profitable in the last 5 years, even during the period of fuel price volatility as well as economic recession. The UCLL model has enabled Spirit Airlines to offer low airfare to passengers. The average base fare was reported to be around $77-$85 in the period of 2009-2011. Indeed, as Warren Buffett mentioned, the airline industry offered customers a commodity-like product. It is a business of filling seats, and customers would like to pay the lowest cost to fly, regardless of the airline brand. As any other commodity business, the company with the lowest operating cost will be the winner. In the last 3 years, the operating margin of Spirit Airlines has been in the range of 8.8% - 15.9%.

Lowest cost among low-cost airlines

Its operating margin is much higher than those of other low cost airlines including Southwest Airlines (NYSE: LUV) and JetBlue Airways (NASDAQ: JBLU). 3 years average, Spirit Airlines’ operating margin is around 12.74%. The 3-year average operating margin of Southwest Airlines is only 5%, whereas JetBlue’s is 8.15%. In addition, Spirit Airlines enjoyed the highest double-digit return on invested capital compared to the other two airlines.

<table> <tbody> <tr> <td> <p> </p> </td> <td> <p><strong>SAVE</strong></p> </td> <td> <p><strong>LUV</strong></p> </td> <td> <p><strong>JBLU</strong></p> </td> </tr> <tr> <td> <p><strong>ROIC (%)</strong></p> </td> <td> <p>22.53</p> </td> <td> <p>4.73</p> </td> <td> <p>3.13</p> </td> </tr> <tr> <td> <p><strong>D/E</strong></p> </td> <td> <p>0</p> </td> <td> <p>0.4</p> </td> <td> <p>1.4</p> </td> </tr> </tbody> </table>

As it can be seen above, Spirit Airlines’ return on invested capital is five times higher than that of Southwest Airlines and more than seven times higher than that of JetBlue. Interestingly, it is able to achieve that high return without any help of leverage, whereas Southwest Airlines’ D/E is 0.4x and JetBlue’s is 1.4x. Indeed, Spirit Airlines has a strong balance sheet, with a debt-free operation. As of September 2012, it had $560 million in stockholders’ equity, nearly $400 million in cash and no debt.

Its operating efficiency has reflected in the share price. Since the middle of 2011, Spirit Airlines has outperformed the other two peers by wide margins. 

<img src="http://media.ycharts.com/charts/9b4537f936baf1b0cf1e3063f4d9f19f.png" />

Spirit Airlines has returned more than 48% in two years and a half, whereas Southwest and JetBlue experienced decline in the same period.

Currently, Spirit Airlines is trading at $17.14 per share, with the total market capitalization of $1.21 billion. The market is valuing Spirit Airlines at only 7.7x forward earnings. It is cheaper than Southwest Airlines’ valuation of 9.4x forward P/E but a little more expensive than JetBlue’s of 6.3x forward earnings. 

My Foolish Take

Spirit Airlines, with far more superior return as well as operating margin, should receive far higher valuation than Southwest and JetBlue. At the current valuation, I think the market undervalues the business intrinsic value. 

hoangquocanh has no positions in the stocks mentioned above. The Motley Fool owns shares of SPIRIT AIRLINES INC. Motley Fool newsletter services recommend Southwest Airlines. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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