Spirit Airlines Has About 20% Upside Potential

Airline stocks have been under pressure over the last few months. Ever since oil started recovering from its multi-year low levels of $26 per barrel, airline stocks have moved in the opposite direction. After enjoying cheap fuel for almost two years, it finally looks like crude oil has bottomed and will continue moving higher.

While rising crude prices is bad for most of the stocks in the aviation industry, Spirit Airlines’ (SAVE) unique business model will help it benefit from it in the short -term.

Regaining Competitive advantage

Last year, when crude was hovering under $40 per barrel, legacy carriers like American Airlines (AAL) started offering great discounts to fend of competition from Spirit Airlines and other ULCCs.
Due to the price war, the passenger revenue per average seat mile, or PRASM, across the industry fell.

Since Spirit offered the cheapest ticket before the price war, it had to offer greater discounts, which in turn resulted in a steep drop in PRASM. Airline investors never take liking to a price war, and as a result, shares of both American Airlines and Spirit Airlines plunged last year.

However, with oil prices now slowly inching higher, Spirit Airlines stands to regain its competitive advantage of offering the cheapest ticket to lure customers. With oil trading over $50 per barrel, American Airlines will not be able to sustain its price war and the gap between the ticket prices of both the carriers will increase with the rise in crude prices.

Improving unit revenue should drive Spirit Airlines’ shares higher in the second half of the year, which is why I am bullish on the stock and have a $55 price target.

Given Spirit’s growth prospects, the stock is undervalued. Spirit is currently trading at roughly 10x trailing earnings. As a growth stock, Spirit should command at least a P/E ratio of 20. Thus, accounting for an increase in crude prices (which will have a negative impact on Spirit’s earnings) and Spirit’s growth prospects, I believe the stock has about 20% upside potential in the short-term.

Conclusion

Spirit Airlines is probably the only carrier that stands to benefit from the rise in crude prices. As mentioned above, I believe the stock has about 20% upside potential from current levels. Hence, I believe investors should accumulate Spirit Airlines at current levels for the long-term.
Published on Jul 12, 2016
By Ayush Singh

Copyrighted 2016. Content published with author's permission.

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