Over the past year and a half, Spirit Airlines (NASDAQ: SAVE) has been struggling with the steepest unit revenue declines in the airline industry. That trend continued in the second quarter, as Spirit's total revenue per available seat mile (TRASM) declined 14.3% year over year.
However, Spirit has managed to maintain very high profit margins despite this revenue pressure because of its extremely good cost performance. Indeed, a steep drop in unit costs allowed Spirit to deliver year-over-year earnings growth last quarter.
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Spirit Airlines results: The raw numbers
Data source: Spirit Airlines Q2 earnings release. YOY = year over year.
What happened with Spirit Airlines this quarter?
In Q2, Spirit Airlines' year-over-year fuel cost savings began to decline as the cost of jet fuel ticked up from the multiyear lows of early 2016. Spirit saved 29% per gallon last quarter compared to Q2 2015, whereas it saved 37% per gallon in Q1.
On the other hand, Spirit's revenue trajectory didn't change much. TRASM declined 13.8% in Q1 and 14.3% in Q2.
Despite the smaller year-over-year fuel cost savings and similar revenue performance, Spirit managed to post stronger earnings growth in Q2 than in the prior quarter. This can be traced to its superb cost control.
Spirit Airlines posted surprisingly strong earnings growth last quarter. Image source: Spirit Airlines.
Indeed, non-fuel adjusted unit costs fell 8.6% year over year. Productivity improved significantly relative to Q2 2015, when bad weather snarled operations, driving up unit costs. Spirit Airlines is also reaping huge aircraft rent savings by buying some previously leased planes and extending the leases on other airplanes.
What management had to say
Spirit Airlines CEO Bob Fornaro indicated in the earnings release that he isn't fully satisfied with Spirit's revenue performance.
On the other hand, Fornaro was much more upbeat about Spirit's operational performance. Since taking over in early 2016, Spirit Airlines' new CEO has emphasized reducing delays and cancellations in order to improve the company's reputation. Fornaro said:
It appears that pricing remains weak in many of Spirit Airlines' markets, so investors should brace for another steep unit revenue decline in Q3. Meanwhile, Spirit's year-over-year fuel cost savings will be much smaller going forward. (For comparison, Spirit paid $2.08/gallon for jet fuel in Q2 2015 but only $1.71/gallon in Q3 2015.)
Meanwhile, Spirit's recent non-fuel cost performance is unsustainable. In fact, CFO Ted Christie stated that adjusted non-fuel unit costs will be roughly flat for the full year, which implies a mid-single-digit increase in the second half of 2016. The sharp trend change is largely driven by the timing of maintenance events.
Spirit Airlines has a track record of outperforming its cost guidance. Thus, its unit cost increases in the second half of 2016 may be smaller than feared. Nevertheless, it's extremely unlikely Spirit will be able to match the record profit it earned in Q3 2015 in the current quarter, though it should still achieve a strong profit margin.
However, Spirit Airlines is acting decisively to improve its revenue performance going forward. In the past two weeks, it has announced a slew of new routes scheduled to begin in October and November: all of which serve Florida.
Travel demand to Florida is strong year-round, but particularly during the winter season. All of the new routes Spirit is planning either have very high fares today or are underserved. By slowing its growth rate and reorienting its route network over the next year or so, Spirit Airlines hopes to stabilize both unit revenue and its profit margin.
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Adam Levine-Weinberg owns shares of Spirit Airlines and is long December 2016 $30 calls on Spirit Airlines. The Motley Fool recommends Spirit Airlines. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.