Spirit Airlines Incorporated Earnings: Pilot Problems Undermine Profit Growth (MotleyFool.com)

The fast-growing budget airline would have posted strong profit growth last quarter, but for a surge in flight cancellations caused by a management-pilot dispute.

On Thursday morning, Spirit Airlines (NASDAQ:SAVE) posted a modest increase in earnings per share for the second quarter, boosted by the timing of the busy Easter travel period.

That said, earnings could have been much higher had Spirit Airlines not suffered a spike in flight cancellations in early May, related to a dispute between management and many of Spirit’s pilots. Looking ahead, Spirit Airlines hopes to quickly put this unfortunate incident behind it. Doing so will require finalizing a new contract that gives pilots much-deserved raises.

Spirit Airlines results: The raw numbers

Metric Q2 2017 Q2 2016 Year-Over-Year Change
Revenue $701.7 million $584.1 million 20.1%
Total unit revenue 9.62 cents 9.10 cents 5.7%
Adjusted cost per available seat mile excluding fuel 5.83 cents 5.30 cents 10%
Adjusted net income $79.1 million $78.5 million 0.7%
Adjusted pre-tax margin 17.9% 21.3% N/A
Adjusted EPS $1.14 $1.11 2.7%

Data source: Spirit Airlines Q2 earnings release. Chart by author.

What happened with Spirit Airlines this quarter?

In the second quarter, Spirit Airlines posted unit revenue growth for the first time since 2014 and EPS increased for the first time in several quarters. But unfortunately, the highlight of the period was a labor dispute that spiraled out of control in early May.

Like many airlines, but to an even greater extent, Spirit Airlines relies on pilots picking up “open time” (essentially overtime work) outside of the normal scheduling process. But in early May, most of Spirit’s pilots started refusing the extra work — despite being offered bonus pay for those flights — in what seemed like a coordinated labor slowdown.

Indeed, many Spirit pilots are furious that they continue to work under an old labor contract with significantly below-market wage rates. While management has offered raises of up to 30% in return for productivity enhancements, most of the pilots think they deserve a better deal.

A Spirit Airlines planeSpirit Airlines pilots want bigger raises than what management has offered. Image source: Spirit Airlines.

At the height of this crisis, Spirit had to cancel 18% of its schedule due to pilot availability issues. Ultimately, management had to get a court order to force its pilots to start picking up open time again. Even so, Spirit Airlines canceled nearly 6% of its scheduled flights in May and 4% of its scheduled flights in June.

The spike in cancellations drove a 10% jump in Spirit’s non-fuel unit costs last quarter. It also reduced unit revenue growth. Based on management’s estimates, adjusted EPS might have been around $1.50-$1.55 (instead of $1.14) if operational performance had been normal last quarter.

What management had to say

In the earnings release, Spirit Airlines CEO Bob Fornaro apologized to customers for the spate of flight cancellations in Q2 and he called it a disappointing quarter. However, Fornaro also took note of the strong underlying demand and strategy changes that salvaged the company’s profitability:

Despite our financial and operational challenges in the second quarter 2017, the changes in our pricing and revenue management strategies helped to drive year-over-year improvement in passenger and non-ticket revenue per segment — this is the first time in over two and a half years either of these metrics increased year over year.

CFO Ted Christie was equally blunt about Spirit’s failures during the quarter, as well as its ability to bounce back. “While our cost performance for the second quarter was not satisfactory, we do not believe it materially changes our long-term cost outlook and are confident that we will continue to maintain, or grow, our relative cost advantage,” he said.

Looking forward

While flight cancellations have decreased significantly compared to the highs of early May, pilot availability continues to be an issue. Some pilots may still be protesting their below-market contract by refusing to work overtime. However, Spirit Airlines may also be genuinely understaffed: something that the pilot union has been warning about for a while.

Getting a new pilot contract ratified is the only way for Spirit Airlines to get its pilots motivated again — and to ensure that the company can continue to recruit new pilots to support its growth. Achieving a new contract that is fair to the pilots but affordable for the company thus ought to be management’s highest priority right now. After all, having pilots available when they are needed is a precondition for any airline to succeed.

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