How Will Rising Oil Prices Impact Spirit Airlines?

by Trefis Team
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After a sharp plunge in 2016, the crude oil price has been on a 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 price and aviation fuel prices largely move together, so depending on the airline’s hedging program, oil price fluctuations could have a substantial effect. We have created an interactive dashboard analysis that shows Spirit Airline’s key revenue sources and its expected 2018 performance. You can adjust the revenue drivers to see the impact on the overall revenues, EPS, and price estimate.

As An Ultra Low-Cost Carrier, Spirit Airlines Will Likely See A Boost In Load Factor

Load factor, an operating metric used in the airline industry, is the percentage of total aircraft seats actually occupied on a flight and is arrived at by dividing revenue passenger miles (RPM) by average seat miles (ASM). Spirit’s load factor of 83.2% in 2017 was lower than in previous years, indicating the competitive pricing in the airline industry. Spirit differentiates itself by providing low-cost flights. However, as oil prices were relatively low in 2017, its competitors were also able to offer affordable fares, thereby taking away business from Spirit. This may change in 2018. With no indication of a slowdown in oil prices, many competitors will be compelled to increase their fares (while Spirit may keep its fares low, as explained below). This will likely boost the load factor for Spirit.

Spirit operates on an unbundled pricing strategy, which allows the company to charge lower base fares and gives its passengers the option to choose and pay for the product or service that they want to utilize. As a result, the company generates about 48% of its revenue from non-ticket sources, which can make it somewhat less vulnerable to oil price changes. Overall, we expect the airline’s revenue to grow by 21.5% to $3.2 billion.

 

Aircraft Fuel Cost Will Offset The Growth

Spirit has been able to lower CASM (cost per average seat miles) in recent years, indicating its improving operating efficiency. However, like other airlines, Spirit will bear the brunt of rising fuel prices. Meanwhile, the company has planned to add more aircraft to its portfolio in 2018 to fulfill the requirements of new routes. We expect both of these factors to drive 35% growth in aircraft fuel cost. Furthermore, additions of aircraft will also result in higher maintenance and repair costs, depreciation, and aircraft rent. Overall, we expect the operating expenses to grow by 24.7% to $2.82 billion.

Finally, 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 company.

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