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SAVE - Spirit Airlines, Inc.


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Whitney Tilson just pitched this at the 2015 Robin Hood Investment Conference. See his slides here: http://www.valuewalk.com/wp-content/uploads/2015/11/TilsonRH15.pdf

 

I run my university's student investment fund, which manages a small part of our endowment, and we had a successful position in SAVE last year from roughly Nov-Dec 2014. In that month, SAVE was up more than 30%, so we took the great return and cashed out. By dumb luck we avoided the drop from the $80s to $35 today. I still think the business model is great and have attached the work that a colleague and I did on it. (There's a DCF embedded in the last slide if you want a closer look at the old numbers.)

 

Needless to say I'm thinking of entering again. Anyone else taking a look at SAVE?

Spirit_Airlines.pptx

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Thanks for bringing this up. Tilson's presentation seems compelling. However, I'm a little far from my area of expertise (and Airlines, with its high-valued flying assets and relatively thin margins, is always just one public disaster away from taking a plunge).

 

At first glance, the only thing that surprised me was the significant drop in free cash flow, which seems tied in to changes in its working capital, but I haven't yet looked into the 10-Q. Do you have any idea what this relates to?

 

(EDIT: Corrected auto-correct's modification of Tilson's name into Wilson...)

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How did mohnish pabrai do on JetBlue(i think it was)?

 

I have this nagging feeling that its not worth my time(headache) to even look into Spirit nor the other airlines.

 

Not sure Monish is the right guy to ask. Maybe ask Bill Miller:

http://www.reuters.com/article/2010/12/10/us-investment-summit-miller-airlines-idUSTRE6B95OC20101210

 

The fun thing about airlines -- they are mostly terrible investments. Or great investments:

http://money.cnn.com/2002/10/01/pf/investing/30stocks/

 

See also RyanAir.

 

No opinion on SAVE but ULCC carriers have very different economics than the  mainline carriers. As Pabrai would tell you, if you are the lowest cost operator in a commodity business, you have a moat.

 

 

 

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And I think that's exactly the key here: the focus on being the lowest cost operator in an industry not exactly known for its rational competition.

 

Thanks for the articles by the way, Miller's view is practically the same as Buffett on this topic (I remember his joke in an AR that he has a special 1-800 number that he calls when tempted to invest in an airline, and they talk him down!)

 

One of the risks is that a major may be able to punish them by driving fares artificially low for an extended period of time. God knows Air Canada has done that a few times in the past around here (yet, Westjet and Porter are still flying).

 

Yet, at the current multiple, this seems a bet worth taking to me (albeit I'll be the first to recognize that I'm far off my usual turf).

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No opinion on SAVE but ULCC carriers have very different economics than the  mainline carriers. As Pabrai would tell you, if you are the lowest cost operator in a commodity business, you have a moat.

 

Econ 101 right there.....i'm more interested...and thats basically what tilson gets at in his presentation.

 

Funny story. My mom flys spirit all the time, despite complaining(in the nice ways that mothers do) about how bad it is....hmmmm

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(I remember his joke in an AR that he has a special 1-800 number that he calls when tempted to invest in an airline, and they talk him down!)

 

Thats the other side of the argument....

 

 

 

Low cost produce is the angel on my right shoulder, Buffets quote is the devil on my left shoulder.

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These ROIC and ROE numbers are just unbelievable. Either these numbers are completely unsustainable or this is going to be a homerun for Tilson. Tilson is not a guru I follow, but this is definitely worth the effort.

 

I'd like to better understand the competitive dynamics between Spirit and Allegiant. In other words, does Spirit have a competitive advantage versus Allegiant? Will one of these guys turn into RyanAir or will they end up battling for market share.

 

I already have my airline quota (WestJet), but this is very tempting.

 

Here is some insight on current dynamics:

http://centreforaviation.com/analysis/us-major-airlines-recognise-the-ulcc-threat-marketplace-dynamics-will-change-but-beware-cost-creep-250994

 

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Thanks for bringing this up. Tilson's presentation seems compelling. However, I'm a little far from my area of expertise (and Airlines, with its high-valued flying assets and relatively thin margins, is always just one public disaster away from taking a plunge).

 

At first glance, the only thing that surprised me was the significant drop in free cash flow, which seems tied in to changes in its working capital, but I haven't yet looked into the 10-Q. Do you have any idea what this relates to?

 

(EDIT: Corrected auto-correct's modification of Tilson's name into Wilson...)

 

Glad you brought it up, this scared me too. From the most recent 10-Q: "Aircraft rent expense for the nine months ended September 30, 2015 increased by $14.8 million, or 10.2%, compared to the same period in 2014. This increase in aircraft rent expense was primarily driven by the delivery of three new aircraft, financed under operating leases, subsequent to the end of the third quarter of 2014."

 

This also makes sense when looking at the number of aircraft they have on record (see attachment). They went from 58 to 76 in one calendar year, so it's not too surprising to see FCF fall meaningfully since CapEx increased a ton over the same period. I imagine this will continue to be the case as they have a huge backlog for planes to meet their goal of adding 20 new destinations by the end of 2016. That said, top- and bottom-line growth has been great even in this low-oil environment even though this should theoretically make it harder for them to operate since they succeed on margins, not PRASM.

Screen_Shot_2015-11-19_at_09_56_50.thumb.png.1dc8eb918e8f9e0b535effaaa55a490f.png

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At first glance, the only thing that surprised me was the significant drop in free cash flow, which seems tied in to changes in its working capital, but I haven't yet looked into the 10-Q. Do you have any idea what this relates to?

 

In general, FCF is volatile for airlines. With a manufacturer, you might spread out your CapEx over 10 years. With airlines, you can take delivery of 10 new aircraft in a single day. So you can see strange divergences between FCF and NI. FCF can be extremely high when the market is brutal (because they aren't buying new planes) and negative when the airline is doing well.

 

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These ROIC and ROE numbers are just unbelievable. Either these numbers are completely unsustainable or this is going to be a homerun for Tilson. Tilson is not a guru I follow, but this is definitely worth the effort.

 

I'd like to better understand the competitive dynamics between Spirit and Allegiant. In other words, does Spirit have a competitive advantage versus Allegiant? Will one of these guys turn into RyanAir or will they end up battling for market share.

 

I already have my airline quota (WestJet), but this is very tempting.

 

Here is some insight on current dynamics:

http://centreforaviation.com/analysis/us-major-airlines-recognise-the-ulcc-threat-marketplace-dynamics-will-change-but-beware-cost-creep-250994

 

Agreed, there's a ton of possibility here. Tilson's summarized thesis captures this well: "There are very few companies I’m aware of that are growing 20-30%, with 25%+ operating margins and returns on equity, with net cash positions, whose stocks are trading at 8-9x earnings."

 

I'm in the process of exploring ALGT as well. From what I can tell so far, they focus on traveling between "Tier 2" cities to reduce the costs incurred by servicing large airports. Seems like a great business model as there are always smaller airports on the outskirts of big cities (this allows them to compete with the bigger airlines if people are willing to commute into the cities) and then they can also service some of the places that aren't as well-served by the big airlines but still have sizable populations and very stable travel volume. (Think smaller cities and even college towns like Eugene, OR; Greensboro, NC; Kansas City, MO; Syracuse, NY; Provo, UT; you get the idea.)

 

That said, this model is quite different from Spirit's. As in Europe, people like to group all the budget airlines together, but I think it's worth looking into the minutiae to see where the moats really are. (E.g., Southwest, which people often call a low-cost carrier, is very different from SAVE.) At Spirit, the cost-savings come not from servicing smaller cities but from charging passengers for basically everything (e.g., no "free" beverages onboard---even water). Their destinations show a much larger overlap with the big airlines, which they should be able to handle over time since they offer a much cheaper fare (even when adding baggage charges; see Tilson's slides/my old PPT at the top for more on that). So I really don't see ALGT posing any real competitive threat to SAVE. If anything, Allegiant's success adds to SAVE's and suggests that the ULCC model can work well in the US.

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What about the whole cyclical, capital intensive part?

 

You need to be aware (and very cautious) of the cycles and the perverse impact on P/E ratios. But there is no reason to avoid cyclicals if they create value over the cycle. If you are over-leveraged and the high cost producer, you will go bankrupt. If you are the low cost producer, you ride out the cycles.

 

Capital intensity is a drawback. But if you get a very high ROIC, the capital investments are worthwhile.

 

Anyway, this is a very unique and challenging industry. It is within my circle of competence but probably not for most people here.

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The numbers look very convincing. First thought is they might simply have an advantage if they haven't been around for long and thus have less legacy union conflicts. Why the huge drop in price? Numbers look crazy good. Espescially for a friggin airliner.

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Anyway, this is a very unique and challenging industry. It is within my circle of competence but probably not for most people here.

 

KC, have you invested in Spirit and if so I'm curious to see for how long?

 

In my case, I just started this week, following the original post. The clear focus on low cost is a moat I can understand, and from what I see the CEO seems driven to increase it versus other airlines.

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Anyway, this is a very unique and challenging industry. It is within my circle of competence but probably not for most people here.

 

KC, have you invested in Spirit and if so I'm curious to see for how long?

 

In my case, I just started this week, following the original post. The clear focus on low cost is a moat I can understand, and from what I see the CEO seems driven to increase it versus other airlines.

 

No, I haven't. I own WestJet. I am familiar with the industry but less familiar with U.S. carriers. These articles might explain part of the drop.

http://centreforaviation.com/analysis/spirit-airlines-expansion--unit-revenue-declines-concern-wall-street-but-are-central-to-the-model-247097

http://www.fool.com/investing/general/2015/08/28/why-i-doubled-down-on-spirit-airlines-stock.aspx

http://www.wsj.com/articles/a-new-cheaper-frontier-airlines-with-more-fees-and-less-legroom-1440459879

 

On first glance, it looks like they are seeing fare pressure. Given the history of the industry, investors are going to cut and run as soon as there is evidence that the cycle is peaking.

 

I can't endorse SAVE simply because I am not that familiar with them or the other ULCC's in the U.S. But it is a business model that works in other regions, so I imagine it will succeed in the U.S.

 

First thought is they might simply have an advantage if they haven't been around for long and thus have less legacy union conflicts.

 

Yes, this is one of the fun parts of the airline business. The new entrants usually have a huge cost advantage. I believe SAVE doesn't have a union. But even if they did, the seniority rules ensure that younger airlines have lower labor costs. They usually have younger fleets (or get cheap used planes) so they have an OpEx and CapEx advantage too. Over time, costs rise (see Southwest Airlines) creating an opening for an even lower cost airline. It's the opposite of a moat -- a "Benefit to Entry".

 

There is a similar advantage if your are growing rapidly. Your employee seniority will be younger and your planes will be newer than slower growing competitors.

 

But it's not just cost, it is also a different business model. The CEO of RyanAir joked about charging passengers to use the toilet. Nobody believes it was a joke. IIRC, Tilson said they have 30% more seats on a plane. If true, your CASM (cost per available seat mile) is automatically 30% cheaper. Then you overbook your flights. And you cut your turnaround time (resulting in lot's of delayed flights but better utilization of planes). And you make your pilots clean the plane.

 

The results are low fares, high profits, and a terrible customer experience.

 

If you are interested in the industry, this is a great source:

http://centreforaviation.com/

 

--

Edit: that should be 20% more seats not 30%

Edit2: looks like SAVE is unionized

Edit3: I was kidding about the pilots cleaning the planes

 

 

 

 

 

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Thank you KC, your input, reference and perspective have been most helpful so far (by all means: keep going : )

 

I'm also in Canada (Montreal), but my experience with capital-intensive businesses has been mostly automotive, for which I really do not have a high regard having worked in different positions supplying the big OEMs.

 

 

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Fuel and Labor costs are the two biggest expenses for airlines. The longer we go with low oil prices, the harder labor will fight for a larger piece of the revenue pie. We are seeing this play out with pilot contract rejections at Delta and Southwest now, and Spirit is working on negotiations as we speak. More expensive labor contracts now can spell serious damage when oil prices eventually rise again. Just a word of caution.

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Fuel and Labor costs are the two biggest expenses for airlines. The longer we go with low oil prices, the harder labor will fight for a larger piece of the revenue pie. We are seeing this play out with pilot contract rejections at Delta and Southwest now, and Spirit is working on negotiations as we speak. More expensive labor contracts now can spell serious damage when oil prices eventually rise again. Just a word of caution.

 

This is true but the whole cost structure of the industry would move up in parallel (roughly), so SAVE's cost advantage would remain. Obviously, we are closer to the peak of the cycle than the bottom. But SAVE seems to be pricing this in. If you believe the growth story but are worried about the cycle, you could average in over a period of time.

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Looks like American is matching Spirit's fares in Dallas:

http://centreforaviation.com/analysis/us-major-airlines-recognise-the-ulcc-threat-marketplace-dynamics-will-change-but-beware-cost-creep-250994

 

You wonder how long American can defend these low value passengers, but it will be a headwind for Spirit.

 

This is likely to be a continuing dance. After all, in a broadly similar market profile in Europe, it is the LCCs that have prospered, to the detriment of the majors. A difference there is that the majors have not been able to wash out their costs through the bankruptcy laundry, so the unit costs of the big three Europeans are higher than the US big three's.

 

So the warning message is there for the US majors: it is fine now to allocate a percentage of seats to low yielding passengers, but once cost levels start creeping up again, vulnerability to ULCCs increases exponentially.

 

I am still looking into SAVE. The risk-reward looks compelling. But I will likely sit this one out. I find the Canadian duopoly easier to handicap.

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Yeah, that was the key risk. Still think Spirit's margins give them some breathing room.

 

One thing I do not understand from the article though:

 

"He stressed in the markets where American has matched pricing, its unit revenue performance is the same as the rest of its system. One tactic American has used is running higher load factors on off peak flights, which is a more favourable proposition in a low fuel cost environment."

 

How can the portion in bold be true? From what I get, the American Airlines guy is saying that dropping their prices has no impact on their revenue performance...  seems like a really far-fetched party line to me (and I'm also not sure I buy the higher load explanation, as if they were not already doing so whenever they can).

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