I Still Don't Believe In This Spirit

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Before 2012 began, I went searching for the perfect stock to short for the year. My target was Spirit Airlines (NAS: SAVE) , and so far the stock is up over 27% versus a market return of about 9%.

Clearly, I'm on the losing side of this bet right now, but that doesn't mean I'm giving up. Below, I'll show you why I'm maintaining my bearish call on the company in my All-Star CAPS profile, and also offer you access to a report on three stocks that I do believe will be dominating for years to come.

My original thesis
My bearish call was based on two very simple theses.

First, Spirit bills itself as the ultra-low-cost airline operator. While the results you'll get on kayak.com or other travel sites will back this up, those results can be deceiving.

I showed how a ticket on Spirit from Chicago to Costa Rica was listed as $55 cheaper than a similar one from Delta (NYS: DAL) . But when all the extra costs were added in—including $80 for carry-on luggage and $10 to print your boarding pass—Spirit's overall costs ballooned by over $200. I simply didn't think people would return to get hoodwinked as repeat customers.

Second, the overall quality of the service at Spirit was so low, I didn't think the savings would be worth it for some customers. Not only does the company offer about 20% less legroom than other airlines, but it was also at the bottom of customer reviews for the past year.

Signs that I could be wrong
Spirit came out with earnings last week, and I'll admit -- they were impressive.

 

4Q 2010

4Q 2011

Change

Revenue $216.2 $273.927%
Net Income $9.5 $24.0153%
Net Margins4.39%8.76%437 bp

Source: Spirit Airlines. Figures in millions.

Make no mistake about it, when a company can expand their margins to the point where they roughly double, increase revenue at a brisk pace, and grow earnings by over 100%, you're looking at a company that's firing on all cylinders.

And yet, the company trades at just 13.5 times earnings. If you take a look at Spirit versus its competitors -- and consider its growth rate -- it sure looks like a steal at these prices.

CompanyTotal DebtTotal CashP/ERevenue Growth (mrq)
Spirit $0   $0.313.526.7%
Delta $13.9 $3.610.77.8%
US Air (NYS: LCC)  $4.6 $1.920.28.5%
United Continental (NYS: UAL)  $13.2 $8.410.35.9%
Southwest (NYS: LUV)  $3.8 $3.24131.9%

Source: Spirit Airlines, Yahoo! Finance. Figures in billions.

Southwest is the only company that can come close to having the same balance sheet strength as Spirit, and its revenue growth is strong, but Southwest is currently priced much higher than Spirit.

In addition, Spirit has announced that they have or will soon be adding 11 more routes to their service, with many of them being based out of Dallas. If they can continue performing with these new routes the way they did last quarter, I will almost certainly have egg on my face for this bearish call.

Why I'm still not buying into Spirit
I see two possible outcomes for Spirit once their business becomes saturated in their target markets.

First, some passengers will experience the nickel-and-diming and the poor service, and just decide that any money they might be saving isn't worth the stress and inconvenience of flying with Spirit.

I think no one was able to capture this better than CBS news and NPR personality Mo Rocca. Here's what he had to tweet about his Spirit experience: "I'm really not an airline snob but boarding Spirit Air flight to Detroit & it feels like I'm trying get last helicopter out of Saigon #chaos." The company's growth plan is just getting started, so it might take a while for the word to spread about what flying Spirit really means.

In the second outcome, I see passengers embracing Spirit's low costs, but figuring out ways to avoid the extra fees—by printing boarding passes at home, packing extra-light, and forgoing that $3 glass of water. You might think Spirit wouldn't mind passengers doing this, but in the most recent quarter, these "non-ticket" sources of revenue accounted for a whopping 38.2% of revenue. Without that revenue, the airline would have most certainly not been profitable.

Where you should put your money
In truth, I don't short stocks in real life. And it might take more than a year for Spirit's business plan to come back and bite them -- but you can be sure my money won't be going there. And I'll be maintaining my bearish CAPScall on the company.

If you'd like access to three solid, dividend-paying companies I do believe in, I suggest you check out our special free report: "3 American Companies Set to Dominate The World." Inside, you'll get the names and stories behind all three global powers. Get your copy of the report today, absolutely free!

At the time this article was published Fool contributorBrian Stoffeldoes not hold positions in any of the companies mentioned. You can follow him on Twitter at @TMFStoffel.Motley Fool newsletter serviceshave recommended buying shares of Southwest Airlines. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy..

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