-Slower growth, short term setbacks hurt 2019 results; coronavirus worry

-By adding new planes and flights, growth expected to rebound in 2020-21

-Improved sentiment and easier comps in 2020 could result in 30% upside

I’ve been following the U.S. airline industry for decades now and for many of those years traders used to say these stocks were rented not owned. Before the consolidation in the U.S. industry over the past ten years, rising oil prices and “fare wars,”—remember those?—would send these super cyclical stocks reeling regularly. 

Not anymore.  Though still cyclical, the overall industry dynamics have improved significantly, and as you’ll see below shares of Spirit Airlines (SAVE), the ultra-low cost carrier, look attractive right now because of what I view as short term issues that should fade.

Another recurring issue to travel stocks are outbreaks of war or pestilence, to use an old-fashioned term. The coronavirus disease outbreak in China has dented airline stocks. I don’t wish to downplay the seriousness of it; people are dying.  That said, it’s also not good for air travel.

My estimation is that long term it probably won’t be a huge factor. This is neither the first nor the last such outbreak. Unless you are a gloom and doomsayer—and I’m not—I suspect that eventually the coronavirus will be contained. When that happens, air travel will pick up where it left off. People like to travel and many like to do it cheaply, and that’s where Spirit comes in.

I believe that the shares of Spirit Airlines could give a pretty nice return in 2020, perhaps 30%. The stock is down 25% from August and nearly 40% from a high around $65 some 11 months ago to about $42.66. Last year, Spirit encountered lots of bad weather, temporary airport operational issues and softer than expected demand, which weighed on sentiment. Revenue, however, continues to grow at double digit rates.

Then in October, Spirit Airlines reported that adjusted earnings per share fell to $1.32 in Q319 from $1.47 a year earlier. Margins declined too, even as fuel costs are quiescent. Nine months results were good:  SAVE reported a 16% increase in revenue from the year-ago period, but that’s down from 25% in all of 2018.  And Spirit is a growth story. Perhaps worst of all, the fourth quarter guidance given at that point was downbeat.

Then on Jan. 15 SAVE updated 4Q19 guidance and things looked less bad. I took notice.  As did the market.  The ULCC carrier said its 4Q19 total revenue per available seat mile (TRASM: a key measure of unit revenues) will have fallen 3.6% from the year ago quarter’s 9.59 cents—much better than the previous outlook of a 4.5-6.5% decline.  Since then the stock is up about 7% and that outsized jump suggests investors are primed to bid the shares up if, as I expect, more good news is coming later this year. The company will report fourth quarter results around Feb. 5.

Given that update, it will likely have a quarter that is not as bad as first feared.  What’s more, as 2020 progresses, Spirit Airlines’ quarterly comps will be against an easier 2019 result, which in turn went up against some very tough 2018 comps.

Management is making big improvements in operations and passenger comfort (new seats and technology enhancements), as well as adding new planes. Spirit serves 23 of the top 27 major markets. In 2020, they are growing their fleet by 17 aircraft to 144 and adding another 27 in 2021.  The planes are going to be put to work by filling out existing markets and adding to their rapidly growing Mexico, Central and South American markets from their profitable Florida hubs at Ft. Lauderdale and Orlando.

Spirit is introducing a new loyalty program that should bring in more repeat customers. Spirit also ordered 100 Airbus A320 planes that will allow the company to add capacity and flights and further grow sales and profits. And it doesn’t have any of the troubled Boeing MAX 737 in its fleet, unlike some of its competitors

With year-over-year unit revenue comparisons set to become easier as the year progresses and fuel costs stable, Spirit has a good chance to grow unit revenue at least as fast as unit costs, leading to stable or improving margins. I don’t think there are signs that it has saturated the market for cheap flights. I expect that double digit growth should continue.

Among the most important factors that could contribute to a renewed Spirit stock rise is improving sentiment and momentum.  For example, over the past few months, the consensus EPS estimate for 2020 moved up 2.9% to $4.93 per share, according to Zacks Investment Research. Additionally, analysts at Citigroup and Buckingham Research raised their price targets from $46 to $48 and $50 to $53, respectively. Currently, Wall Street analysts are divided on the stock, with only 8 of 16 holding a buy rating.  If more come on board, it could push the stock higher.

Trading at a price/earnings (P/E) ratio of about 8 times it’s roughly equal to or cheaper than most of its slower growing peers and its own long term average P/E of 13 times. (See table.) The shares of the biggest ULCC appear inexpensive compared to the potential strong growth yet to come. If Spirit regains its form, then 2021 estimates for EPS of $5.50 could prove too low. The P/E could expand back to 10 times or for a stock price around $55, or 30% higher.

Where could I be wrong:  In a word recession. That’s not our forecast but an economic contraction would hurt all airlines, though perhaps low-cost Spirit the least.

Bottom Line: With more planes and cheap flights, Spirit Airlines looks to reaccelerate growth in 2020 and investors should find that appealing.

Prior “Signals”