Traditionally, investing in the airline industry has been fraught with peril. But there are always exceptions to the rule. In its earlier days, investors could have done quite well by buying and holding on to Southwest Airlines (NYSE: LUV).
When it was first founded 28 years ago, the company had a reputation for avoiding the issues that seemingly bogged down every other airline. Its mission was simply to get people to their destination on time, at a low cost, and with customer service that was both extremely helpful and attentive. For many years it was able to eat the lunch of larger rivals because flying on them was not fun whatsoever -- the flights were costly and frequently late.
As you might imagine, Southwest shares performed extremely well during its growth heyday. Between 1992 and 2002, the share price increased more than 10-fold.
Today, Southwest's best days of growth are firmly behind it. But I've found what I think is the modern-day equivalent -- another fast-growing airline operator that could post a similar performance for shareholders...
The next Southwest?
In the airline industry, budding entrepreneurs often come onto the scene by first offering regional travel, just as Southwest did in Texas in the 1970s.In 1990, a Michigan firm named Charter One received approval from the Federal Aviation Administration to charter regional airline flights. A couple of years later in 1992, it officially changed its name to Spirit Airlines (NYSE: SAVE). Shortly afterward it moved its operations and headquarters to Florida and started offering regional flights. A couple of strategies later, the company began to focus on travel primarily from Florida to the Caribbean, and became religious on offering flights at the lowest cost possible.
In June 2011, Spirit offered shares to the public for the first time. Investors that got in on the ground floor at the date of the initial public offering saw their stock more than double, though the price has come back down to earth a bit over the last couple of months. In stark contrast, the stock market is about flat during this same period, while rivals including Southwest, Airlines (NYSE: DAL), and United Continental Airlines (NYSE: UAL) have posted much more modest gains -- and in some cases have even lost as much as 20%.
Spirit's low-cost mission is very appealing to passengers. And I dolow-cost. At the time it went public, Spirit started offering flights between Portland, Oregon and Las Vegas for as little as $9 each way (that's not including fees, of course). The vast majority of competing airlines, including the larger players, can't even come close to matching these low fare levels.
As you might imagine, the ability to mean huge growth potential. Sales have jumped more than 50% to $1.1 billion last year from $700 million in 2009. Spirit also stayed firmly profitable leading up to and during the credit crisis. Rivals haven't done so well. The last few years have seen Delta and United enter and emerge from bankruptcy, and American Airlines recently declare bankruptcy.
Legacy costs and unfriendly customer service continue to hamper the larger airlines. Delta Airlines, for example, recently announced it would be cutting back on travel capacity even though the prospects for an economic recovery continue to appear. Spirit Airlines, on the other hand, should continue to move steadily forward. During 2012, analysts project nearly 30% sales growth to $1.4 billion and profits of $1.91 per share. For 2013, sales growth should again be robust at close to 20% for total sales of $1.7 billion and profits around $2.40 per share, or annual growth of 26%.
Risks to Consider: The airline industry is extremely capital intensive and cyclical. In addition, it is very competitive and highly regulated. Despite this numerous obstacles, there are successful airline firms out there. Southwest proved just how lucrative a low-cost model can be, and Spirit is turning out to be a modern-day equivalent.
Action to Take --> Steady growth prospects and an appealing valuation could pave the way for more solid shareholder gains going forward. Spirit's forward P/E ratio is only 8.5, which is well below the industry average of about 13 and the market average of 15. Its free cash flow is also solid and exceeded reported net income last year ($104 million compared to $76 million.) This gives me a high degree of confidence that Spirit is generating excess capital and could handle a rather severe downturn in the economy. It also just raised some capital to fund future expansion and protect against a recession.
Today, buying and hanging on to shares of Spirit could turn out to just as lucrative as buying and holding Southwest Airlines from 1992-2002. But in the nearer term, the stock could quickly see gains of more than 25% if the valuation simply moves to the industry average. And with a couple of more years of double-digit sales and profit gains, the stock could easily shoot above $30 per share, a 50% gain from current levels.
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