A Quick Look At Spirit Airlines’ Cost Structure
In a previous note, we expanded on Spirit Airlines’ (NYSE: SAVE) key sources of growth and provided high-level expectations for 2018. This supplementary note covers the cost structure as well as the impact that external factors such as rising oil prices could have on the performance of the company. You can see more on our interactive dashboard for Spirit Airlines’ cost structure. You can adjust any of the company’s key drivers to see the impact of changes in the overall revenues, costs, earnings, and valuation.
Rising Oil Prices To Increase Fuel Costs
After a sharp plunge in 2016, crude oil prices have been on the rise, albeit at a moderate pace. However, the price growth gained momentum late last year and recently reached a four-year high of $80. Several factors have contributed to this growth. Consumption of oil grew by 1.6% in 2017, while the United States’ decision to exit the Iran nuclear deal as well as a shortage of supply from Venezuela have further exacerbated the situation. So, how will the rising oil prices impact Spirit Airlines? Per data from IATA (International Air Transport Association), crude oil prices and aviation fuel prices largely move together, so depending on the airline’s hedging program, oil price fluctuations could have a substantial effect. Given that the company did not enter into any fuel derivative instruments and did not have any such outstanding instruments in the first quarter, Spirit will likely bear the brunt of rising fuel prices in the near term. The impact, however, could be slightly neutralized if management focuses on hedging. Meanwhile, the company has planned to add more aircraft to its portfolio in 2018 to fulfill the requirements of new routes, which will also result in increased fuel consumption. We expect both of these factors to drive 35% growth in aircraft fuel cost.
Labor Costs and Depreciation To Continue On Its Upward Tend
During the period of plummeting oil prices, labor costs used to be the top contributor to operating expenses for most airlines. The last few years have been generally positive for the major airlines in terms of profitability. However, profitability has also provided the workforce with opportunities to demand higher wages. Meanwhile, as airlines are adding more fleets to their portfolios, the number of qualified pilots and trained mechanics required to operate and maintain aircraft have not kept pace. We expect these factors to drive 13% growth in salaries, wages, and benefits for Spirit. Furthermore, Spirit’s plans to expand its fleet further will result in higher depreciation and maintenance costs.
We have a $48 price estimate for Spirit Airlines, which is ahead of the current market price. We expect margins to contract on the back of higher costs. Disagree? Detailed steps to arrive at Spirit Airline’s price estimate are outlined in our interactive dashboard, and you can modify our assumptions to arrive at your own estimate for the carrier.
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