Dollar Store of the American Skies!

This post is syndicated at The Motley Fool Network:
http://beta.fool.com/malayappan/2012/11/28/dollar-store-american-skies/17328/

In an interview with the Wall Street Journal that was published last week, Ben Baldanza, CEO of Spirit Airlines (NASDAQ: SAVE) discussed his company’s aggressive nickel and dime strategy of profit making.  In the interview, Mr. Baldanza says that the airline’s core mantra is about offering the lowest price and how this drives everything that they do.  This strategy is amplified by the airline’s ticker symbol – SAVE! Fair enough!  Let us see how this makes Spirit a better investment.

Good for you, Good for Business

On Election Day, Spirit introduced the $100 per carry on bag at the gate for those passengers who chose not to prepay. Outrageous as it might seem, the airline’s spokesperson, Misty Pinson says that this is actually a way to deter customers from holding up the boarding process by encouraging them to pay for the bag in advance.  I have never flown Spirit Airlines before and I doubt that I ever will and I suspect that a majority of travelers feel this way.  Why?  Think of a buffet. What happens when the choices are too numerous and actually turns you off instead of stoking your desire and pleasing your palate?  The natural instinct is to turn away. Similarly, the myriad categories of fees and options available to a Spirit customer are mind-boggling!  I would want no part of that.

Mr. Baldanza feels differently.  His position is that the “unbundling” of fees serves to allow passengers to pay only for what they want and effectively not “subsidize” other passengers.  Theoretically, it might be true.  After all, a business passenger with just one carry-on, is not on an equal footing with a family of four traveling on leisure with an assortment of luggage.  Other airlines have taken care of this problem also and it is impossible to get on any airline as an infrequent passenger and not have to pay for luggage in some way, shape or form.  However, Spirit has taken this a la carte pricing to an extreme and Mr. Baldanza argues that this makes for greater profitability.  He says that with a plan to triple Spirit’s share of air traffic from 1% today to 3% in a few years, they will continue to cater to a segment of the population that cares about price above everything else.  In other words, the airline claims that it is doing well by the customer and in turn, doing well for their shareholders by focusing on a unique approach to profitability.

Flying the Cheap Skies

Mr Baldanza does not dispute (in answering the reporter’s question), that Spirit’s strategy could be a huge turn off to a significant number of airline customers, but says that there is demand for the lowest price, despite extreme nickel and diming.  There is no denying the fact that Spirit’s stock has soared from around $11 to about $17 as of November– that is about 50%.  No wonder, investors like this stock and Mr. Baldanza is so upbeat about how he runs his airline.  Airline stocks in general are not the best investment and the performance of Spirit’s direct competitors says it all.  Southwest Airlines (NYSE: LUV) lost about 20% in stock value during the same period, while Jet Blue lost 15%. 

Granted that Spirit just had an IPO in 2011, while its competitors have been public for a while, but as the Wall Street Journal reports, Spirit is “pound for pound, the most profitable airline in the U.S.” Spirit reported third quarter adjusted net income of $25.2 Million on October 31. Operating revenue was $342.3 Million, an increase of $53.6 million over third quarter 2011 according to Spirit’s earnings release.  In contrast, Southwest’s operating revenue decreased to $208 million from $285 million over the same period according to their earnings release. Southwest admits to “sluggish revenue growth” in light of the weaker economy, but it appears that Spirit is doing much better than its competitors in the same skies.  Not bad for a famously el cheapo airline!

Sustainable Growth

From all indications, Spirit is well poised to continue on its growth trajectory in an economic climate where a segment of the traveling public has embraced its pricing structure.  Mr. Baldanza claims that the airline will continue to grow 15 to 20% a year without sacrificing margins.  He must feel pretty strongly about this.  He says so in the WSJ interview and says so in the latest third quarter earnings release as well.  We better believe it!