Reference no: EM132171924

For the first few years after its 2011 IPO, Spirit Airlines (NYSE:SAVE) achieved rapid profit growth, becoming a stock market darling in the process. However, the company's profit margin peaked in 2015 and has been moving inexorably lower since then. This trend continued during the first quarter of 2018. While revenue rose at a double-digit rate, this was driven entirely by capacity expansion. Unit revenue declined modestly, preventing Spirit from fully offsetting the rise in fuel prices. As a result, Spirit's profit margin and earnings declined on a year-over-year basis. Spirit Airlines results: The raw numbers Metric Q1 2018 Q1 2017 Year-Over-Year Change Revenue $704.1 million $590.0 million 19.4% Total unit revenue 8.37 cents 8.58 cents (2.4%) Adjusted cost per available seat mile excluding fuel 5.33 cents 5.61 cents (5%) Adjusted net income $29.9 million $34.9 million (14.2%) Adjusted pre-tax margin 5.6% 9.6% N/A Adjusted EPS $0.44 $0.50 (12%) Data source: Spirit Airlines Q1 earnings release. What happened with Spirit Airlines this quarter? The big highlight of the first quarter for Spirit Airlines was that its pilots ratified a new five-year contract by a 70%-30% margin. The pilots will receive immediate wage raises averaging 43%, plus improved benefits. The contract also gives the airline some additional flexibility that will help it improve its operational performance. Most importantly, the new contract should lead to a happier and more engaged workforce, heading off the possibility of future work slowdowns like one that snarled Spirit's operations last spring and alienated customers. Spirit Airlines also continued its expansion into midsize markets last quarter. The carrier began flying to Columbus, Ohio in February. In March, it inaugurated service to Richmond, Virginia and Guayaquil, Ecuador. Spirit plans to continue targeting smaller markets like these for most of its near-term growth, due to the vicious competitive environment in many of the big hub cities. From a financial perspective, though, the first quarter was somewhat disappointing. Unit revenue came in at the low end of management's initial guidance range, while unit costs didn't decline quite as much as originally expected, due to the pilot pay increase. As a result, Spirit Airlines' adjusted pre-tax margin slipped to 5.6% from 9.6% a year earlier. What management had to say While Spirit's profitability continued to fall in the first quarter, Spirit Airlines CEO Bob Fornaro highlighted the company's achievements in other areas. He noted: We ran a very good operation in the first quarter 2018, despite numerous winter storms. ... I congratulate and thank the Spirit family for delivering this operational excellence. I'm also pleased to say that during the quarter, we finalized a five-year contract with our pilot union. Indeed, on-time performance reached a record for the first quarter, at 83.4%. This represents a continuation of the operational improvements that began last year at Spirit Airlines. In the short run, better on-time performance may not have a big impact on net income, but in the long run, an improved customer experience should boost demand for Spirit Airlines tickets. Spirit Airlines' operational performance has improved dramatically in recent months. Image source: Spirit Airlines. Looking forward Looking ahead to the second quarter, Spirit Airlines is planning a 29% capacity increase. (That number is somewhat inflated due to a slew of flight cancellations in the second quarter of 2017.) However, the pressure on its profitability will accelerate. Management expects unit revenue to decline 6.5% to 7.5% this quarter, primarily due to a shift in the timing of Easter and an increase in the average length of Spirit's flights. Meanwhile, a projected 7.5% to 8.5% improvement in non-fuel unit costs will only partially offset the recent surge in jet fuel prices. On balance, Spirit's forecast implies that its second quarter adjusted pre-tax margin could fall by about half from last year's 17.9% result. Spirit's non-fuel unit cost improvements will taper off significantly in the second half of 2018. As a result, the company needs to improve its unit revenue trajectory in order to cover its rising fuel bill. Otherwise, profitability will continue to plunge rapidly. QUESTIONS: Analyze the management strategy pertaining to the contract they ratified with their pilots? What is the role of Cost strategies when attempting to enhance profitability…the goal of EVERY corporation? In your opinion, is the Spirit Airline management team’s decision-making philosophy pertaining to revenue generating strategy and cost issues successful… What recommendations would you make to the Spirit management Team?