Spirit 1Q24: Turnaround is taking time

But there is a good chance for them to make it work. It's still early in their restructuring journey.

Disclaimer: The information contained in this article is not and should not be construed as investment advice. This is my investing journey and I simply share what I do and why I do that for educational and entertainment purposes.

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After the merger with JetBlue failed earlier this year, I identified Spirit Airlines as an attractive contrarian long idea. I viewed bankruptcy speculation misguided considering that the company has various levers to pull to create shareholder value. They could retry M&A (with JetBlue or with another partner) to generate synergies that would likely exceed the current market cap manifold.

Or they could walk it alone. Restructure operations towards smaller size or at least slower growth to return to profitability. There is a lot of dormant operating leverage in the business. So if they turn the corner, there is a clear path to a profitability level that supports the current depressed valuation. And even if that did not work very well, the current valuation is so low, they could even liquidate, sell all planes and concessions and still make their shareholders money.

I concluded that 2Q24 will be crucial for the story because that is when management promised meaningful progress in their journey towards profitability. Here is more detail on my coverage on this stock so far:

Spirit 4Q23: Beginning of the Turnaround?

Catch the Spirit?

The company reported their 1Q24 earnings today. Markets did not like them. The stock is down to $3.30 as of this writing. I am approximately down 50% from my average entry as of yesterday. Quite painful. Was I wrong on this? Let’s take a look what is going on here.

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TLDR Summary

• While management did see weaker demand than expected, 1Q24 revenues and operating losses were in line with expectations. 2Q24 and even more 2H24 will prove how much potential their restructuring efforts have. Management suggested they can remain cash flow neutral for the remainder of this year and reach positive operating margins by the end of the year. Hearing that was very encouraging.

• Spirit is still very early in their restructuring journey. The recent pivot away from pursuing the merger with JetBlue has enabled them to take stronger measures to right size the business. It will take several quarters for their efforts to come to fruition. Can we believe their guidance? In my opinion, management deserves the benefit of the doubt because of their track record over the past decade.

• The company performed very well in the 2010s, taking market share from legacy airlines profitably. The underlying strengths of their business model still exist, i.e. lean operations with a highly flexible point-to-point network and a homogenous and highly efficient fleet. Once the industry has adjusted capacity, those strengths will shine again.

• Spirit has negotiated compensation with Pratt & Whitney that exceeds my expectations. Pratt & Whitney effectively buys all seats every day on a number of Spirit’s aircraft for the foreseeable future. For this capacity, Spirit does not have execution risk. They don’t have to face competition. No fuel costs. No other operating costs. They simply get money to keep them simply on the ground while the industry is hurting from excess capacity. Could be worse, couldn’t it?

• At a share price of $3.30, Spirit is now trading at 0.3x book. It used to trade consistently above 1.5x during calmer times. Their net equipment book value of $3.4bn would have to be impaired by $700m in a liquidation scenario before shareholders start to get hurt from these levels. It’s a highly asymmetric opportunity in my opinion. I am long and I have bought more today.