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Spirit Airlines: Full-Information Forecasting

This document presents a detailed valuation and forecasting analysis of Spirit Airlines as of April 22, 2014. It includes various valuation models, such as Free Cash Flow and Residual Income, concluding that the company's equity is overvalued at $2.389 billion. Key insights are drawn from income statement forecasts, capitalized interest impacts, and off-balance sheet leasing effects. The analysis reveals that Spirit’s market cap at $4.159 billion exceeds model evaluations, indicating potential investor overconfidence. Sensitivity analysis demonstrates dependency on growth rates.

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Spirit Airlines: Full-Information Forecasting

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  1. Spirit Airlines: Full-Information Forecasting Module 13 Carl Brinker April 22, 2014

  2. Agenda • Final Valuation: Overview • Valuations Models • Comparison Across Models • Mid-Year and Date Adjustments • Examples of Forecasting • I/S: Hedging settlements • B/S: Capitalized Interest • Difficulties and Observations • Effect of Off-Balance Sheet Leasing • Sensitivity Analysis • Conclusion: Buy/Sell Order

  3. Final Valuation Overview

  4. Valuation Results • Value of Enterprise: $2.983 Billion • Value of Equity: $2.389 Billion • Market Cap: $4.159 Billion • Per share (forecasted): $32.18 • Per share (actual): $56.03 Conclusion: Spirit is overvalued (sell). This is likely due to overly-optomistic shareholders expecting high growth in the long term.

  5. Free Cash Flow Model Value: $2.792 Billion Market Value: $4.752 Billion

  6. Residual Income Model Value: $2.792 Billion Market Value: $4.752 Billion

  7. Abnormal Earnings Growth Model Value: $2.792 Billion Market Value: $4.752 Billion

  8. Comparing the Three Models • All models result in identical valuation • AGR Model provides the highest explanatory power within the forecasting horizon

  9. Adjustments for Date & Mid-Year

  10. Forecasting: Examples

  11. Forecasting: Overview • General methodology: • Calculate balances as percentages and identify trends over time • Extrapolate these trends using 10-K disclosures, logic and judgment • Calculate EPAT, FEAT, NEA, and NFL from resulting projections • Use these numbers as inputs for the valuation models • Generally, Spirit discloses very little information in its notes and to the public at large. This made forecasting accounts somewhat difficult.

  12. Forecasting: Income Statement • The vast majority of expenses grow with sales • Some exceptions: • Hedging settlements • Mark-to-Market gains and losses • Special charges

  13. Forecasting: Income Statement 2012 2013 • How should we forecast settlements on derivatives? • Theoretically, derivatives will deliver no gain or loss in the long-run: point estimate is zero • In addition, Spirit stopped all hedging activities after 12/31/13 as indicated in its earnings conference call and 10-K

  14. Forecasting: Income Statement 2012 2013 2014 2021 2022 Hedging settlement gains/losses are set at 0% of sales (for 0 expense) Middle forecast years omitted for easy presentation

  15. Forecasting: Balance Sheet Year-over-year trend analysis used for forecasts Example of unusual item: Capitalized Interest 2011 2012 2013

  16. Forecasting: Balance Sheet • Spirit incurred capitalized interest on plane loans as a young company. It paid some of that off in recent years. • Forecast: Spirit will pay those off in a short period of time

  17. Forecasting: Results Steady state achieved here We did it!

  18. Observations and Difficulties

  19. Off-Balance Sheet Leasing • 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 Adding leases reduces EATO (NEA increases) and subsequently reduces the value of the firm. The market appears to ignore off-balance sheet leasing.

  20. Sensitivity Analysis Majority of sensitivity analysis values come back below market value Value is heavily dependent upon perpetual growth rate and notas sensitive to WACC.

  21. Questions?

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