Fast-Growing Spirit Airlines Remains Industry Threat and Value

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Anybody following this blog should know by now that the consolidation in the airline industry makes it investable for the first time possibly ever. The major airlines, including Delta Air Lines (NYSE: DAL), United Airlines, a subsidiary of United Continental Holdings (NYSE: UAL), and the ongoing combination of US Airways (NYSE: LCC) and American Airways have helped dramatically reduce the competition in the sector. The biggest threat to strong profits now is a new airline entering the fray or an existing airline undertaking overly aggressive growth.

The later threat might come in the form of Spirit Airlines (NASDAQ: SAVE) as recent results suggest the fast growth and pressure on fares could unravel the benefits of the consolidation. Or at the least, it is the biggest current concern to the potential strong profits that the likes of Delta and US Airways are now producing.

As the one-year chart below shows, the industry as a whole has done well over that time period:

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SAVE Total Return Price data by YCharts

Traffic soaring, revenue declining

For June 2013, Spirit Airlines reported a surge of 22% in available seat miles (ASM) and a corresponding 3% decline in total revenue per ASM (RASM). The combination is good for the company as it increases the load factor to 88.3% compared to only 86.1% last June.

For the industry, though, the news is disappointing as the last thing it needs is an aggressive airline pressuring pricing and filling the routes consolidated via the mega mergers over the last few years.

Is Spirit the best value in the industry?

With domestic oil inventories sloshing around at record levels, the airlines could see years of benefits from lower fuel prices. With a young fleet, Spirit isn’t likely to benefit the most from a declining fuel expense, but the company might be the best positioned to benefit from less competition and growing ASMs.

In fact, if Spirit traded similar to a normal growth stock it would be valued considerably higher. The stock only trades at 13 times forward earnings while analysts forecast a nearly 23% growth rate. If the stock traded at only 1 times the growth rate, the estimated $2.56 earnings for 2014 would place the stock around $58. A boost from lower fuel expenses by then could increase earnings even further. What if the stock traded at a more normal 1.5 times the growth rate?

Cheap industry in general

The major airlines of Delta, United, and the new American Airlines all trade at around 6 times forward earnings providing some of the best values in the stock market. All of these stocks will see major benefits from declining fuel prices as well that would easily offset competitive pressures from Spirit. More importantly though, Spirit can’t grow flights fast enough to be a major pest for a few years at least.

Spirit expects revenue to end shy of $2 billion in 2014, so it pales in comparison to the $40 billion expected by both Delta and United. Combined, the three new major airlines will reach revenue of around $120 billion. The increased competition from Spirit will only impact a few routes per year considering the existing flights are already booked to near capacity.

Bottom line

Even without lower fuel expenses, the airlines industry has market low valuations based on earnings and growth. At the worst, it appears that fuel prices could remain around these levels of the past several years causing an airline like Spirit to spend roughly 40% of expenses on that item. Depending on an investor's risk tolerance, one of these airlines probably should be owned over the next decade.

Spirit provides the best growth stock in the group while Delta is currently the leading airline while US Airways could see a significant boost from the consolidation with American Airlines. Either way, Spirit might be the biggest threat to the industry, but at less than 2% of the combined revenue of the majors it will be years before it impacts those profits in a significant way.

With the U.S. relying on the rest of the world for such a large percentage of our goods, many investors are ready for the end of the "made in China" era. Well, it may be here. Read all about the biggest industry disrupters since the personal computer in 3 Stocks to Own for the New Industrial Revolution. Just click here to learn more.

Mark Holder and Stone Fox Capital Advisors, LLC have no positions in any stocks mentioned. The Motley Fool owns shares of SPIRIT AIRLINES INC. 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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