Cheap Stocks Wall Street Loves: Spirit Airlines

Source: Flickr user Frank Kovalchek. 

I know what you're probably thinking: The words "love" and "airline" in the same sentence must either be a mistake or an intentional oxymoron. However, with regard to low-cost airline Spirit Airlines (NASDAQ: SAVE  ) , it's the honest truth.

While most people don't enjoy waiting in airport ticket-counter lines, going through a tedious security check, or being stuck in a cramped airplane for hours on end, one thing Wall Street and investors absolutely seem to love is Spirit Airlines' stock. If you're wondering why that is, it's because Spirit Airlines is a cheap stock.

What makes Spirit Airlines "cheap"

What constitutes a cheap stock? To determine this, we'll turn to one of the market's most widely followed metrics, the price/earnings-to-growth ratio, or PEG ratio.

The PEG ratio simply takes a company's price-to-earnings ratio and divides it by a company's forecast growth rate over a specific time period. For example, if a company were trading at a P/E ratio of 20, and had a five-year projected growth rate of 25%, its PEG ratio would be 0.8 (20 divided by 25). Generally speaking, a company trading below a PEG ratio of 1 is considered to be a "cheap" stock.

P/E ratios already give us a rough idea of how well a company is doing relative to its profitability over the past year, but the PEG ratio allows investors to look into the future at forecast growth rates over a specific time period and determine if a company is trading inexpensively relative to its growth expectation. In the case of Spirit Airlines, its PEG ratio is a mere 0.78 with a forecast five-year growth rate of 28.4%, placing it among the cheap stock category.

Why Wall Street loves Spirit Airlines

Yet Spirit Airlines is more than just cheap; it's also loved by Wall Street analysts. At the moment there are 15 Wall Street firms covering Spirit Airlines' stock, of which seven rate it the equivalent of a strong buy, five the equivalent of a buy, and three a hold.

What makes Spirit Airline so loved? Let's take a closer look.

The factor that probably stands out most is that Spirit Airlines' business model is based on low costs and high margins. Spirit's approach to attracting customers is to bait them with extremely low ticket costs that far undercut those of their peers.

Source: Flickr user Jaysin Trevino.

Where Spirit is able to generate its healthy profit margin, which sits at 11.4% for the trailing-12-month period, is in the collection of its so-called "optional fees." These fees are for services such as carry-on and checked luggage, the ability to select your own seat, buy food, or even to have an airport agent print out your boarding pass. Spirit has arranged its business model in such a way that it encourages travelers to print out paperwork at home and handle as much of the check-in process before they get to the airport. This, in turn, frees up Spirit's agents and allows the company to rely on its point-of-sale and website rather than its agents to drive its profits. In other words, Spirit is pocketing a significant portion of these optional fees as profit, and Wall Street loves it.

Spirit also has one of the youngest fleets in operation. According to AirFleets.net, the average age of Spirit's planes is just 5.4 years. Newer planes are considerably more fuel-efficient, which helps control costs throughout the year. Furthermore, newer planes also require less maintenance, meaning Spirit's planes spend more time up in the air earning money and less time in a garage getting repairs.

Finally, unlike the major airlines in the United States, Spirit Airlines' balance sheet won't give Wall Street indigestion. Spirit is currently sporting no debt and a cash balance of $567.2 million as of its most recently reported quarter. This lack of debt gives the company flexibility to add to capacity or perhaps even make acquisitions in the future.

Spirit Airlines may be cheap, but is it a buy?

Keep in mind that just because a stock is cheap based on a few financial metrics, and is also loved by Wall Street, doesn't mean that it's automatically a buy. As we just saw, Spirit does have plenty of positives working in its favor, including a high-margin business model, a young fleet of planes, and a squeaky-clean balance sheet, yet it also has a few red flags.

Source: Flickr user Eider Chaves.

Perhaps the biggest warning sign is that Spirit Airlines was rated, by far, the worst airline in Consumer Reports' customer satisfaction ratings, which were released in May 2013. Don't get me wrong; price is clearly an important factor that continues to drive travelers to Spirit. The concern here is whether or not Spirit will be able to drive repeat business if a significant number of passengers are leaving the plane dissatisfied with their flying experience. If Spirit is unable to develop a loyal customer base, it could find its profits are fleeting (no pun intended).

As for my personal view, I suspect that Spirit's success will be controlled more by how it manages its fleet than by customer satisfaction. The airline industry is already one of the most disliked industries in America -- ranking third-to-last in ACSI's annual customer satisfaction survey -- so I suspect the impact of Spirit's optional fees, while upsetting some, won't be too meaningful in terms of how many new consumers it brings in.

Instead, I believe the keys to Spirit's success will be keeping its fleet young and relishing the benefits of lower fuel costs, which are the primary expense of airlines these days. To that end, I'd suggest that Spirit has another five to eight years to handily outperform the industry average (and that's with the assumption that it doesn't buy any additional new planes, which is an unlikely scenario) -- and could, within that time, see its stock head even higher.

As fuel costs rise, perhaps it's time you took advantage of this little-known energy tax "loophole."
You already know record oil and natural gas production is changing the lives of millions of Americans. But what you probably haven't heard is that the IRS is encouraging investors to support our growing energy renaissance, offering you a tax loophole to invest in some of America's greatest energy companies. Take advantage of this profitable opportunity by grabbing your special report, "The IRS Is Daring You to Make This Investment Now!," and you'll learn about the simple strategy to take advantage of a little-known IRS rule. Don't miss out on advice that could help you cut taxes for decades to come. Click here to learn more.

3 Reasons United Continental Holdings Inc's Stock Could Rise

There are three basic things investors in any stock want to see: more revenue, lower costs, and more cash returned to shareholders. In the case of United Continental Holdings (NYSE: UAL  ) , shareholders are spoiled with all three. Each of these figures has been going in the right direction recently, and if the company's forecasts are accurate, all three will improve and could lead to an even higher share price.

Mile-high revenue
For the second quarter, United Continental reported a revenue increase of 3.3% to $10.3 billion. Passenger revenue leaped 3.6% to $9.0 million. Per passenger ancillary revenue jumped 7.9% to $21. United's Chief Revenue Officer Jim Compton stated, "We are beginning to see the benefits of the changes we're implementing to our network and revenue management processes. We have more work to do, however, and will continue to make the appropriate adjustments to accelerate our revenue growth."

One of the key ways United is working to expand revenue is from installing lighter slimline seats. That's a fancy way of saying squeezing more bodies into the same size flying tube. You thought fights are already tight enough? They're in the process of getting tighter, but just adding a few extra passengers into a flight means more revenue with not much additional cost. At the same time, United plans to expand ancillary revenue even further with more service options.

Two billion reasons wrapped into one
Cost savings can really make a huge difference to the bottom line. All things being equal, every $1 a company can eliminate in cost is $1 of pre-tax profit. United has implemented a program called "Project Quality." This is an all-hands-on-deck across all employees goal of eliminating $2 billion in annual costs by the year 2017.

Source:  United Continental Holdings

United expects to save half a billion this year, so it still has a ways to go. The target cuts sought are $1 billion in fuel through various means, $100 million in maintenance, $500 million in productivity, $100 million in distribution, $150 million in sourcing, and $150 million in other ways. Better fuel efficient planes while ditching the gas guzzlers is the first step in this process.

Analysts certainly seem to be believers. For example for the fiscal year ending December 2015, they expect on average a 30% increase in EPS on only a 3.7% increase in revenue. All those cost savings are expected to blow up the bottom line in a fashion that shows it is much more lucrative than simply selling more tickets. If the plans and hopes turn to reality, the stock could appreciate accordingly.

Shareholders have a rewards program of their own
United announced in July a $1 billion buyback program to be completed in three years. $1 billion is a perfectly even round number so dare I say the internal plans may be more aggressive with an earlier completion and a new one to be announced sooner? In any event, it's a lot of cash.

Consider that the market cap of United is just under $18 billion at the time of this writing. That's nearly a 6% return on this initiative alone. Likewise, unless the share price shoots up first, it will retire nearly 6% of the shares outstanding, giving an automatic boost to all EPS figures.

Personally I like buybacks because of the message of confidence they tend to convey from management which brings a potentially higher P/E multiple as a company performs. CEO Jeffrey Smiesk was more direct about this message in the earnings conference call. He stated, "[The buyback announcement is] perhaps the clearest demonstration of our confidence and our ability to achieve the goals of [our] long-term plan." It sounds like he doesn't expect UAL's results disappoint the Street.

Do you know this energy tax "loophole"?
You already know record oil and natural gas production is changing the lives of millions of Americans. But what you probably haven't heard is that the IRS is encouraging investors to support our growing energy renaissance, offering you a tax loophole to invest in some of America's greatest energy companies. Take advantage of this profitable opportunity by grabbing your brand-new special report, "The IRS Is Daring You to Make This Investment Now!," and you'll learn about the simple strategy to take advantage of a little-known IRS rule. Don't miss out on advice that could help you cut taxes for decades to come. Click here to learn more.

Can Netflix Conquer Europe?

Netflix  (NASDAQ: NFLX  ) intensified its assault on Europe this month by launching in six countries, including France and Germany, its biggest ever expansion push.

The launch also included Austria, Switzerland, Belgium, and Luxembourg, which marks a change to how Netflix has approached expansion. In the past, the video service has added new territories at a more measured pace, minimizing how many languages it has to deal with each time. The company added Canada in 2010, Latin America in 2011, the United Kingdom, Ireland, and Scandinavia in 2012, and the Netherlands in 2013.

Jumping into six new territories at once, which speak multiple languages, is a new type of challenge. Austria and Germany speak German, France speaks French, while Swittzerland counts German, French, Italian, and Romansh as official languages. Belgians speak Dutch, French, and German, and the majority of Luxembourg's residents speak Luxembourgish, though French and German are the official languages. That, plus dealing with a variety of cultures, and some resistance to American-owned companies, makes the expansion a potentially profitable, but risky gambit.

This has not stopped Netflix CEO Reed Hastings from being very excited about the company's ability to woo a significant portion of the 63 million broadband homes the company says are in the six countries combined.

"We've received a very warm welcome throughout Europe," said Hastings in a Sept. 19 press release. "Consumers love choice -- in series and films and in when and where they watch. We are delighted people are embracing Netflix in our newest territories and, particularly, the incredible viewer enthusiasm for our original series."

Hastings is also realistic and knows how big the challenge is telling Reuters that Netflix will focus on getting it right in these six countries before rolling out to any more." 

Technical and financial hurdles
A huge positive for Netflix is that American movies and television are popular around the world and the company has rights to an enormous amount of those. What it does not have is localized content.

As Toby Syfret of Enders Analysis pointed out to Reuters, when Netflix enters a new market it needs to cover significant costs for content and other investments before it begins making a profit.

That means creating new shows, something it is already doing in France, and licensing market-specific content -- all of which adds to the cost.

Netflix also needs to make deals, Hastings told the news service, to get on set-top boxes. To do that the company has to make deals with Internet service providers and cable companies, a set of businesses the company has struggled to deal with in the U.S.    

These are all solvable problems in theory, but they are costly hurdles.

France is a special problem
France is extremely protective of its culture and language, and there has been a bit of a backlash to Netflix's arrival. 

When a group of company executives visited Paris earlier this year, they were welcomed by an open letter from a group of French film producers warning of an "implosion of our cultural model," The Wall Street Journal reported.

The company has responded by being very friendly, pointing out that it has a lot of French language content, though it won't specify how much, and announcing the production of Marseille, an original show set in the country.

Along with the charm offensive, Netflix has been tactical, as it's European headquarters is in Amsterdam, which allows it to skirt French laws which require 40% of programming on television and radio to be of French origin.

A screenshot of the Netflix France user interface. Source: Netflix 

Big losses
International streaming has so far been a money loser for Netflix and the company forecasts that loss will increase due to this expansion.

International Streaming Q2 '13 Q3 '13 Q4 '13 Q1 '14 Q2 '14 Q3 '14 Forecast

Revenue (in millions)	$166	$183	$221	$267	$307	$347
Contribution profit (loss)	($66)	($74)	($57)	($35)	($15)	($42)

As you can see in the chart above, the company had almost reached breakeven on its international efforts before forecasting a greater loss due to adding the six countries. Netflix has been profitable overall and it can afford to fund this expansion out of its operating profits. 

Will it work?
While Netflix has proven its model in the United States it has yet to do so globally, but the fact that international streaming nearly broke even in the second quarter of 2014 suggests that it's possible. Entering six countries with disparate cultures and languages at the same time is a risk and it does raise the question of why Netflix would not pick off low-hanging fruit in the English-speaking world first. The company, for example, has yet to launch in Australia, an English-speaking country with American sensibilities that is used to paying for TV.

Ultimately, while each country will be its own battle, Netflix has such an impressive array of content that it should be able to overcome cultural resistance, distribution challenges, and local knockoff services. It won't be a quick path to profitability, but Netflix has shown that it can manage costs while getting bigger. By keeping losses tight, the company will eventually conquer these six countries, paving the way for further expansion.  

Warren Buffett: This new technology is a "real threat"
At the recent Berkshire Hathaway annual meeting, Warren Buffett admitted this emerging technology is threatening his biggest cash-cow. Buffett's fear can be your gain. Only a few investors are embracing this new market, which experts say will be worth over $2 trillion. Find out how you can cash in on this technology before the crowd catches on, by jumping onto one company that could get you the biggest piece of the action. Click here to access a free investor alert on the company we're calling the brains behind the technology.