Spirit Airline Takes A Road Less Traveled

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UpstartSpirit Airlines ( SAVE ) has thrived by offering rock-bottom fares on a limited number of routes in the U.S. and Latin America.

So how is it that in an industry known for suicidal price wars, Spirit's low fares generally produce little fare-cutting response?

It may just be because Spirit offers a novel approach to corporate growth.

"Instead of trying to be a major player, they try to be a minor player," said Imperial Capital analyst Bob McAdoo.

Huh?

Trying to be "a minor player" doesn't sound like the typical no-holds-barred corporate push to grab the gold. But in Spirit's case, it's worked just fine, thank you.

Since its May 2011 IPO, shares have climbed from 12 to nearly 30 as Spirit has managed to grow profit in a cutthroat industry.

In the first quarter of this year, Spirit grew revenue by almost 23% over the prior year. Earnings came in at 45 cents compared with 33 cents the year before. For its last 12 months, Spirit reported earnings of $1.55. And since it leases its planes, Spirit boasts a debt-free balance sheet.

Spirit first earned its flight wings by challenging American Airlines on routes to the Caribbean and Latin America out of Florida.

Limited Network

Since then , it has built a limited network of destinations in the U.S. Key cities include Fort Lauderdale, Dallas, Chicago, Atlantic City and Las Vegas. Spirit's low base fares typically sit atop Web searches for the cheapest seats.

But Spirit's head-turning fares are apparently not threatening enough to provoke a fare-slashing response from its larger rivals.

CEO Ben Baldanza offered an explanation:

"We're not trying to steal traffic from the major carriers," Baldanza told IBD. "We're not trying to be competitive with the bigger airlines with the traffic they care most about."

That traffic is the business traveler willing to pay high ticket prices for some combination of convenience and luxury. Spirit goes after the more price-conscious leisure traveler who might not even fly if ticket prices are too high. "We're an airline built to carry travelers who pay for their tickets themselves," he explained.

The Spirit formula involves offering new service on high-traffic routes where there's plenty of room for fare cuts.

"We're looking to deploy our airplanes where we can lower prevailing rates by 25% to 30%, and when we do that, we stimulate a lot of new traffic," said Baldanza. So Spirit positions itself as a market expander, not a traffic thief.

Spirit may only offer one or two flights a day out of a city that larger carriers serve with 10 or more. If you want to fly to Dallas out of the Miami-Fort Lauderdale area, you can choose from 16 American Airlines flights, notes Avondale Partners analyst Fred Lowrance. But if you want to fly Spirit, you have only two daily choices, both out of Fort Lauderdale.

So Spirit's modest goal of luring fare-conscious fliers -- but not going after the attractive business traveler -- helps keeps it out of price wars.

Besides, fare wars would be financial suicide for the major carriers.

"If American were to come down to Spirit fares, Spirit would still be generating 20% profit, but American would be losing millions of dollars a day," said Lowrance.

So how is it that Spirit can afford to undercut the fares of traditional carriers?

One key reason: Spirit unbundles services.

On Spirit flights, you'll pay extra for stored baggage. You might even pay as much as $100 to store carry-on luggage in an overhead bin. Food is an extra, of course. But you might also have to pay $10 just to have an attendant print your boarding pass.

Such ancillary charges now account for more than 40% of Spirit's revenue. That's a lot of nickels and dimes.

Still, even after tacking on all those extra charges, Spirit fares are often lower. Spirit can live with those fares because it keeps its own flying costs down.

Baldanza focuses on efficient utilization of all assets, beginning with plane real estate. "We put as many people on a plane as the FAA allows," he notes

Spirit packs 178 seats onto the Airbus A320. Jet Blue has just 150 seats, some carriers even fewer. But don't more seats mean less leg room, he was asked. "It's less leg room, but you pay a lower price," he replied.

"We also use our gates very efficiently, said Baldanza. "We operate 12 flights with a single gate."

Larger airlines, explains Lowrance, have planes sitting idle at gates for longer periods. That's because the large carriers fly through hubs, and must have planes available on the ground for numerous connecting flights. Sprint, by contrast, only flies direct.

Spirit even squeezes efficiency out of the clock. "You can utilize underutilized hours of the day," said Baldanza. A Spirit flight may take off at 10 p.m. That's not an appealing departure time for business travelers, but one cost-conscious travelers might accept in return for a cheap seat.

Small Fleet

At 49 planes, Spirit's fleet is small, especially when compared with a large carrier like Delta with more than 700 planes. But Baldanza expects to grow capacity by roughly 20% a year. And he sees ample opportunity to deploy his growing fleet of leased Airbus planes on new routes.

"We have identified more than 400 routes that we do not fly where we could profitably deploy our business model," he told IBD.

Spirit has properly recognized the importance of price to many travelers.

But safety is even more important. As long as Spirit keeps its safety record up, its pricing will lure travelers.

But analysts warn that fare-cutting airlines may be more vulnerable to consumer backlash resulting from accidents than large carriers. Though the FAA sets standard maintenance procedures for all carriers, low-fare airlines could be damaged by the perception that they cut corners to slash costs.

Fare wars could become an issue if Spirit deviates from its niche strategy and grows overly ambitious, warned analyst McAdoo.

"If they tried to dominate someone else's market with eight flights a day, they would likely have a pretty different kind of reaction," he said.

"They need to stick to what works," McAdoo concluded.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas

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