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Spirit Airlines: Not On Board with Valuation

Spirit Airlines: Not On Board with Valuation . Carl Brinker, Laura Conti, Ashlee Hunt, and Michelle Kelly. Agenda. How the Industry Operates. Revenues Passengers, Mail, Cargo, Services Structure Major, National, Regional, Charter Fares Variable pricing, Price wars Costs

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Spirit Airlines: Not On Board with Valuation

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  1. Spirit Airlines: Not On Board with Valuation Carl Brinker, Laura Conti, Ashlee Hunt, and Michelle Kelly

  2. Agenda

  3. How the Industry Operates • Revenues • Passengers, Mail, Cargo, Services • Structure • Major, National, Regional, Charter • Fares • Variable pricing, Price wars • Costs • Fuel, Labor, Equipment

  4. Revenue and Profit by Company

  5. Number of Destinations

  6. Market Capitalization by Company

  7. Final Valuation and Recommendation by Company Market Cap Valuation Buy/Sell

  8. Why do airlines hedge for fuel?

  9. Southwest and JetBlue • Hedge for risk in fluctuation of fuel cost • Very common and usual practice for airlines

  10. Delta Airlines • Stopped hedging for fuel • Delta Airlines purchased a refinery • Has an agreement with Phillips 66 • Any non-jet fuel products that are produced will be traded with Phillips 66 for jet fuel

  11. Spirit Airlines • Spirit stopped hedging for fuel • Currently has zero hedges • Very difficult to predict expenses when fuel prices are so volatile • Considering buying risk insurance • Problem with risk insurance: constant expense paid out each year • Hedging ideally results in zero gains or losses

  12. Lack of Hedging • Clearly shocked analysts • “And oh my gosh, did you guys stop hedging fuel too?” • Extremely risky • Adding to risk: one supplier

  13. Spirit Operating Leases

  14. Operating Leases • Market Cap: $4.159 billion • Equity value before off-balance sheet leases: $3.584 billion • Equity value after off-balance sheet leases: $2.389 billion • Change: (33.34%)

  15. Southwest

  16. Delta

  17. JetBlue

  18. The Problem with Spirit… • Capital Leases are not the same type of asset or have a similar duration • Therefore IRR is not a true reflection of operating lease risk

  19. What about alternatives? • Spirit has no debt on its balance sheet. • No RNFL • No credit rating • Difficult to find comparable firms

  20. Operating Leases • Comparison: • JetBlue: 5.25% • Delta: 12.74% • Southwest: 5.34%

  21. Operating Leases • Current Market Cap: $4,159 • Current Stock Price: $58.65

  22. WACC Problems Our calculations gave the same result… What’s going on!? Let’s look at two assumptions for Spirit: Beta and Cost of Debt

  23. WACC Problems: Beta Deriving cost of equity requires an estimate of Beta To get Beta, we evaluate Spirit’s volatility compared to the market over a long time period. The main problem: Spirit’s IPO was in 2011…we’re using less than 3 years of data!

  24. WACC Problems: Beta Spirit Airlines S&P 500 The math checks out…but does this really make sense?

  25. WACC Problems: Beta Of course it doesn’t! The S&P rebounded from recessionduring 2011-2014. We don’t have time series data…what about other comparables? …nothing useful here. Used calculated Beta. Note: Increasing Beta would further decrease Spirit’s value!

  26. WACC Problems: Cost of Debt

  27. WACC Problems: Cost of Debt How far off are we again? The Results: Sensible trend, but highly unreliablefigures and a key assumption

  28. Conclusion • Spirit is difficult to value for several reasons: • Few disclosures • Unique business model (no debt, no hedging) • Young company (no time series data) • No truly comparable firms • We are not confident in Spirit’s valuation, though all signs point to it being overvalued (despite analyst recommendations to buy).

  29. Any Questions?

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