The underlying assumption I made when analyzing Spirit was that it’s true value or prospective value had changed marginally in the pandemic. Warren Buffett’s announcement of selling all airlines lead me to question this belief. Here is a seasoned investor with a time horizon that is quite literally indefinite. If he doesn’t see a quick or inevitable return in demand, clearly something has fundamentally changed in the market. Another critical error in my analysis is ignoring Spirit’s high fixed operating costs. Reading a seeking alpha article that used Delta and United Airlines operating cost to measure what the fixed cost for an airline is, made me realize that although Spirt and Southwest are highly capitalized it will not be enough. There is no way they can be agile and maintain enough liquidity given their business models. Additionally with such a dramatic and sustained drop in demand it will be impossible to be agile and profitable. With this high level of uncertainty I believe there is not, currently, a sufficient margin of error for a purchase to be made.
So what could change that would make me buy Spirit? Firstly some evidence that the depressed demand will not last and high volumes may return within 12 months. It’s key, especially for Spirit, that volume returns within a year. If demand does not return within a year the company will need to issue significant equity financing. This issuance of stock will dilute shareholders’ stakes considerably. The other airlines will have to take this action significantly earlier than Spirit, but even this well capitalized company might need to as well. The macroeconomic trends will also affect Spirit’s equity price considerably over the next few years. If the country enters a prolonged period of slow or negative economic growth it may take more than a decade to recover volume levels.
Given all of this uncertainty there are clearly better areas to deploy capital. JPM and Google are two of the best managed companies and have exceptionally high returns on equity. JPM is consistently averaging 10%, Google is also boasting some of the largest growth and margins. Both of these companies are much more certain and definitely better areas to deploy wealth than airlines currently. However given the fluid nature of the crisis, airline stocks especially Spirit and Southwest warrants a close look if the market becomes extremely pessimistic about their prospects.