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Spirit Airlines: Weighted Average Cost of Capital

Spirit Airlines: Weighted Average Cost of Capital. Module 6 Carl Brinker February 12, 2014. Agenda. Introduction to Spirit Airlines Mod 6: WACC Beta CAPM Cost of Debt FCF Application Analysis. Company Background. Company Background. Ultra-low cost carrier

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Spirit Airlines: Weighted Average Cost of Capital

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  1. Spirit Airlines: Weighted Average Cost of Capital Module 6 Carl Brinker February 12, 2014

  2. Agenda • Introduction to Spirit Airlines • Mod 6: WACC • Beta • CAPM • Cost of Debt • FCF Application • Analysis

  3. Company Background

  4. Company Background • Ultra-low cost carrier • 2-star rating (lowest in USA) • Hubs in Texas and Florida • Revenues of $1.3 billion (small carrier) • JetBlue: $4.9 billion • Delta: $35 billion • Initial Public Offering in June 2011 • Carries no long-term debt – unusual for industry • Known for controversies • Poor safety record & customer service ratings • Questionable advertising campaigns

  5. WACC Calculation

  6. Beta Regression Estimation • Time Period: 5/31/11 – Present (all data from IPO date) • Frequency: weekly • More data points for increased precision, especially considering short observation time frame • “Bloomberg Approach” used (no Risk Free rate included)

  7. Beta Regression Estimation

  8. Beta Regression Estimation • How does calculated Beta compare with other sources? Small amount of data as a source of variability? Logical issue: difficult to accept that a small firm with huge growth (>20%) would have a Beta close to 1

  9. CAPM • RF Rate: 30-year T-Bill • Market Risk Premium: Assumption (same as as Valuation text) • Enterperise Cost of Capital: 8.64% is substantially equal • to expected return on market due to beta of ~1

  10. Cost of Debt • Spirit Airlines has no long-term debt • Negative NFL caused by large cash supply • Cost of Debt will have minimal impact on WACC

  11. WACC Calculation Calculations provide results similar to Bloomberg WACC

  12. WACC Calculation • Bloomberg WACC ignores Spirit Airline’s Net Financial Asset • and gives Equity 100% weight • Implied expected return on market: 6.1% (given 3.6% risk free rate)

  13. Sensitivity Analysis • FCF Valuation highly sensitive to Beta • At Beta = .63, WACC is less than Sales Growth of 7% • Despite variation, FCF Model yields a consistent “buy” recommendation

  14. Analysis & Conclusions • Recommendation: “Buy” – consistent with Mod 5 valuation implications • More confident recommendation, give sensitivity analysis • Issues: • Is 2 years enough to estimate beta? • Will Spirit continue to move with the market after the effects of its IPO wear off? • Why so much variation in Beta estimation? • Can a small, rapidly growing firm really track perfectly with the S&P 500?

  15. Questions?

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