Spirit Airlines has spun an interesting story in recent years, reporting regular profits and double-digit operating margins annually.
This has attracted investors to the Miramar, Florida-based ultra low-cost carrier (ULCC), whose stock price has outperformed the Standard & Poor’s (S&P) 500 index by nearly 200 percentage points during the past five years.
Spirit has diversified its balance sheet throughout this period. It moved away from an all operating lease-financed fleet to a mix of commercial bank and capital markets debt beginning in 2014, and even purchased three aircraft off lease earlier in 2016.
“The company had to go through a lot of phases to get where it is today,” said Edward Christie, chief financial officer of Spirit, in an interview in Chicago earlier in June. “[It’s] hard work prior to the IPO [initial public offering] turning it into the business that it is, then you have to get public and your principal shareholders have to monetise their investment and get comfortable with that… Then you can start thinking strategically long-term about what’s important to your shareholders.”
“These are the phases this business has gone through in the last 10 years,” he continues.
Private equity firm Indigo Partners bought Spirit in 2006 and, after turning it into a successful ULCC, took the company public in 2011. Its adjusted operating margin increased 9.6 percentage points to 23.7% in 2015 compared to 2011, while at the same time Spirit more than doubled its fleet to 87 aircraft, from 35.
Up until 2014, Spirit financed its Airbus A320-family fleet with operating leases. Christie says the mechanism allowed the airline to grow when it did not have access to a “tremendous amount of capital”.
“Lessors are successful at giving you access to capital, they are good residual managers, they have a healthy tax appetite and they generally price that in,” he says. “When you’re young and don’t have those things, lease financing is a good alternative.”
Spirit’s leased fleet peaked at 61 aircraft, including 29 Airbus A319s, 30 Airbus A320s and two Airbus A321s, at the end of 2014.
The airline closed its first commercial debt financing, an up to $379 million syndicated facility for 10 A320s and A321s, in the third quarter of 2014. The variable rate debt was split between a 12-year senior tranche and a seven-year junior tranche with proceeds disbursed upon delivery of each aircraft.
Spirit took the first aircraft, an A320 registered N629NK with MSN 6300, financed by the facility in October 2014.
BNP Paribas, Natixis, Helaba and KfW were the joint arrangers of the senior facility and Investec the junior debt participant.
“Making that evolution in 2014 was about the cost of capital,” says Christie. “It was about all of those things – cost of capital, tax deferral, the fact that we want to continue to control the residual in some cases rather than leave it in the hands of a third party – that’s about us being just a little bit more sophisticated asset managers.”
One drawback to lease financing is how it amortises on the balance sheet, he says. Where on-balance sheet obligations decrease over the life of the facility as they get paid down, leases do not regardless of when the aircraft is in the lease term.
This amortisation shortcoming with leases can result in an artificially elevated debt-to-EBITDAR leverage ratio.
Spirit’s average debt-to-EBITDAR ratio was in the 1.3x to 1.4x range in 2015, says Christie. He expects this to remain stable or to improve slightly over the medium term as Spirit's on-balance sheet debt amortises.
At the end of March, the carrier’s long-term debt net current maturities stood at $655 million and its minimum future lease contributions at $1.51 billion.
“We’re strategically in a position where we’re going to maintain more – on a metric basis – cash on our balance sheet than, say, a significantly larger carrier would,” says Christie. “We have a pretty large orderbook for our size so we want to be in a position where we can take advantage of optimum financing structures, and having a lot of cash around gives you that flexibility.”
Spirit had $903 million in cash and cash equivalents at the end of March, up 12.3% from three months earlier and 21.7% from a year earlier.
The airline has firm orders for 84 aircraft, including 10 A320s, 55 A320neos and 19 A321s, Flightglobal’s Fleets Analzyer shows.
Spirit returned to the commercial bank market with a $185 million secured facility for five A320s in February 2015. Similar to its first deal, the variable rate debt was split into 12-year senior and seven-year junior tranches with proceeds distributed upon delivery of each aircraft.
Chatter began to spread that Spirit was looking at the capital markets shortly after its second commercial debt deal. It wasted no time getting a BB+ rating from Fitch Ratings that July and issued its inaugural enhanced equipment trust certificate (EETC) notes later that same month.
Spirit’s $577 million 2015-1 EETC was split into a $456 million A tranche due in 2028 with an initial loan-to-value (LTV) ratio of 54% and a $121 million B tranche due in 2024 with an initial LTV of 66.7%. The A notes priced at 4.1% and the B notes at 4.45%, in line with other first-time issuers LATAM Airlines Group and Turkish Airlines at the time.
Proceeds financed three A320s and 12 A321s, including all Spirit's deliveries in 2016.
“Part of the reason we went through the exercise on both sides was to give ourselves full access to all available capital, both public and private,” says Christie.
LOOKING AT 2017
Spirit recently received proposals from commercial banks, investment banks and lessors to finance its 2017 aircraft deliveries, which Christie says includes 14 aircraft.
He says all financing options are on the table, when asked what direction the carrier is leaning.
Commercial debt may come at a premium. European banks have seen the cost of US dollar funds rise about 60bps during the past six months, said Bertrand Grabowski, a board member at DVB Bank, earlier in June.
“We’ve heard of pressure on the liquidity side… that’s forcing them to build in more of a premium, either baked into their margin or, in some cases, they’ll just call it out and say this like a liquidity premium,” says Christie, who declines to comment on how this could impact the all-in margin for Spirit.
Christie is “cautiously optimistic” about the capital markets, he says citing “noise” during the past six months. He points to United Airlines $1.05 billion 2016-1 notes that priced between 3.1% and 3.45% as a potential sign that the market disruption has passed.
Leases, while on the table according to Christie, would not appear to fit with Spirit’s recent shift towards on-balance sheet debt, especially if its goal is to balance its sources of funds.
Spirit is also buying aircraft off lease. It has purchased three A319s from lessors with cash since the beginning of the year and is weighing whether or not to purchase more, says Christie.
“The A319 is still a decent-sized piece of our fleet and quite a few of them start to reach their maturity, from an end-of-lease standpoint, from now to, call it, the end of the decade,” he says, adding that Spirit will likely extend leases on some, buy others and let some expire.
How many A319 lease extensions, purchases and aircraft Spirit returns to lessors will depend on the number of aircraft its board of directors and new leadership under Bob Fornaro, who became chief executive in January, decides it needs.
Fornaro has said the airline plans to keep a number of A319s longer than previously planned.
The number of A319s that will remain in Spirit’s fleet has yet to be set, says Christie.
Source: Cirium Dashboard
