Spirit Airlines: Most Undervalued Stock in The Aviation Industry

The last few months have been great for the aviation industry as almost all of the U.S. airlines have enjoyed record profits thanks to the steep decline in crude oil prices. Consequently, airline stocks have appreciated considerably in the reference period. However, Spirit Airlines (SAVE) has been an exception to the trend as the stock is down over 30% year-to-date despite reporting record profits.

The main reason behind Spirit’s free fall has the weak air fare environment. According to the Bureau of Labor Statistics, air fares fell 3.1% month-over-month in August and are down 6% as compared to August 2014.

This comes after a huge 5.6% drop in air fares in July, which was the steepest monthly decline in airline fares in 20 years.

Overreaction creates a buying opportunity

Due to reducing air fares, Spirit Airlines had cut back its margin guidance marginally twice. These revisions didn’t go down well with investors as the stock plummeted considerably after the announcements. A minor pullback in the stock following the news would have been understandable, however given that Spirit is almost 40% lower than its all-time highs, I think the market overreacted. The plunge has created a great buying opportunity for long-term investors as I believe the stock has bottomed and will only go up from these levels.

The main reason why I think Spirit will perform better in the near future is the reducing oil price. Despite the weakness is air fare environment, Spirit will continue to generate record profits as oil prices are falling at a faster rate than ticket prices. Moreover, Spirit Airlines already offers the cheapest tickets in the industry. In fact, Spirit Airlines’ total revenue per passenger is below the competition’s breakeven cost.  This signifies that it is almost impossible for other airlines to compete with Spirit on prices and Spirit will not have to offer more discount even if air fares continue to fall.

Moreover, according to Goldman Sachs, oil hasn’t bottomed yet and still has a lot of room to fall. Analysts at Goldman Sachs cut their price target for crude oil to $20 and said:

"In fact, the oil market is even more oversupplied than we had expected and we now forecast this surplus to persist in 2016 on further OPEC production growth, resilient non-OPEC supply and slowing demand growth, with risks skewed to even weaker demand given China's slowdown and its negative EM feedback loop."

Lower crude is expected to add to Spirit’s earnings, which is why Barclays analysts David Fintzen and Jennifer Lee upped their forecast for Spirit’s EPS next year by 18% to $5.56.

Conclusion

With the company’s earnings and revenue to grow at double-digit speeds for at least a year, I think the current valuation is very cheap as Spirit is currently trading at 13x trailing earnings. Usually, a company with such growth prospects commands a P/E of 20 to 25. Clearly, the stock is undervalued, and I expect it to move higher in the coming quarters due to cheaper crude oil. Thus, I think investors should buy Spirit at present prices.

Published on Sep 28, 2015
By Ayush Singh

Copyrighted 2016. Content published with author's permission.

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