ULCCs — Allegiant, Frontier and Spirit:
the appeal of Point-to-Point Apr/May 2021

The last cyclical crisis in the aviation industry — the 2008 Global Financial Crisis — paved the way for consolidation in the USA. By the end of 2019 the top four airlines — Southwest, Delta, American and United — between them controlled 78% of the domestic market. But this very consolidation allowed for the entry and growth of the ultra-low cost carrier (ULCC) business models, and in the year before the coronavirus pandemic hit, three such airlines — Spirit, Frontier and Allegiant — had built a combined share of the market of 10%, more than double that of five years earlier.

The low cost airline model, as it spread through Europe and the Far East from the noughties, was primarily based on the KISS principles ("Keep It Simple Stupid") developed by Southwest from the 1970s: direct point-to-point flights, secondary airports, single aircraft type, single fare class. The concept was designed to maximise aircraft and crew scheduling efficiency minimise cost and provide the lowest fares in what is essentially a commodity market.

As time has gone on, there has been blurring at the edges with some LCCs exhibiting some of the characteristics of the network legacy carriers, such as intra-line connections and premium fare classes. Two of the top ten passenger airlines in the USA identify themselves as low cost carriers: Southwest and Jetblue; and three as ULCC.

The ultra-low cost business model developed by Ryanair in Europe took this a stage further: a focus on increased aircraft utilisation, increased seat density and the unbundling of revenue sources aside from ticket prices with multiple products and services offered for additional cost. It was also based on a high rate of growth to develop incremental capacity at reducing marginal costs, combined with an obsessive command over all costs.

Looking for a moment at the history of the sector’s development, the ULCC model had gained little headway in the US market in comparison with Europe and Asia — but then this was partly because of Southwest’s significant market presence.

Spirit and Frontier both evolved from the same stable, Bill Franke’s Indigo Partners: a serial ULCC incubator with current investments in Wizz Air in Europe, Volaris in Mexico and JetSMART in Chile. Having established Spirit as a ULCC in 2006, Indigo sold out to acquire and transform Frontier in 2014. Both exhibit the same ULCC characteristics, high utilisation, modern aircraft fleet (of A320s), a large order book of aircraft and high growth ambitions.

Allegiant follows a somewhat different model. Based on a fleet of mid-life or older equipment it follows a relatively low utilisation but highly seasonal model — accepting that there is no point in flying on a wet Tuesday in February when none of its leisure oriented passengers want to travel. Many of its routes are from small airports and operate on a less-than-daily basis.

In contrast to Spirit, Frontier has positioned itself a little closer to the Allegiant model: many routes operated on a relatively infrequent basis, and a significant network presence outside of the large metropolitan areas.

The three have been strongly profitable since inception (in Frontier’s case since its rebirth as a ULCC in 2014). Allegiant in the five years before the pandemic averaged an operating margin of 22% and a net margin of 13% while revenues had grown by an average of 10% a year to $1.8bn (and this achieved in a period it had transited from MD80s to A320 family aircraft).

Frontier produced an average 16% operating margin and 11% at the net level increasing revenues by an annual average 9% over the period to $2.5bn.

Spirit over the same period had grown its top line by a compound 15% per annum to $3.8bn while averaging operating margins of 17% and net margins of 10%.

And the three of the carriers are definitely ultra low cost. As the graph shows, in 2019 their stage-length adjusted unit costs excluding fuel (CASMex) hovered round the 5.5¢/ASM mark (Allegiant higher at 6.5¢) — on average half that of the network legacy majors and 40% below those of the LCC paragon Southwest. (The 2020 figures are possibly irrelevant being heavily distorted by the effects of the disruption caused by the pandemic travel restrictions, although it is interesting to note that Allegiant only seems to have incurred a modest 7% increase in CASMex in 2020 compared with an average 50% increase for the rest of the industry.)

Covid-19 impact

The three ULCCs did not escape damage from the effective closure of travel during 2020, but the damage was limited in comparison with their larger peers. Between the three total net losses for 2020 totalled $923m — but this is equates to only 2% of the US industry’s losses of $45.4bn in the period.

They each saw revenues down by around 50% from 2019 levels, somewhat less than the 63% decline for the industry as a whole: Frontier and Spirit reported adjusted operating loss margins of 41%-45%, Allegiant only 14%. They reported adjusted net loss margins of 20%-25%.

The three ULCCs all took part in the federal payroll support programmes (PSP) — with everybody else in the industry benefitting from the funds, it would have been churlish to refuse the handouts — but only Frontier applied for, and was granted, a loan facility under the CARES Act; and it had only drawn $150m of the $574m available at the end of December.

Balance sheets deteriorated (see table). But they had started the year 2020 in reasonable health. Each survived the year with positive equity and gearing levels, while elevated, at not too disturbing levels.

Frontier and Spirit both suffered severe cash outflows (see table). In 2020 Spirit’s cash from operations saw a deficit of $225m reversing the prior year healthy inflows of $551m. Frontier saw $557m go out the door. Allegiant, perhaps showing the resilience of its highly flexible low utilisation model only experienced a halving of operational cash flows to $235m.

Capex was highly restrained at both Allegiant and Frontier; but Spirit maintained its predelivery payments on its aircraft order book and continued to take new deliveries. Perhaps because of this strategic decision, it raised $1.3bn in long term debt and over $350m in new equity, to maintain its liquidity.

The $150m increase in debt at Frontier, not too dissimilar from prior year figures, equated to its draw-down from the Treasury facility and the implied debts from the PSP. But this left it with a weak cash position at the end of the year. Subsequent to the year end it revived its IPO plans delayed from 2017, successfully raised $270m through the sale of 15m new shares (Indigo Partners raising a similar amount from the sale of part of its holding) valuing the company at $4bn; and, demonstrating superlative chutzpah, initiated a new quote on the NASDAQ exchange using the ticker ULCC.

Allegiant’s CEO, Maurice Gallagher, proudly boasted at the 2020 full year and Q1 2021 results announcements, that Allegiant alone in the industry through this crisis had neither bloated its balance sheet by taking on excessive debt nor had to resort to shareholders to introduce new equity. Indeed, he stated that its cash and debt position was better than it had been before the pandemic. But then the day after the Q1 results he announced an issuance of 1.5m new shares to raise $340m, taking advantage of the all-time high rating of its shares on Wall Street. In early March the share price had touched $250, 50% above the level in February 2020 just before the crisis hit: the only other airline to have seen its equity rise above prepandemic levels is Southwest, and that by 5%.

Growth plans unabated

The three ULCCs have each expect to be able to recover profitability and be the first in the industry to return to normality: the recovery to be fuelled by domestic leisure, VFR and short-haul national park and beach seeking holiday-makers. And even if expecting an increase in competitive pressures from the major network carriers, they have an advantage, to quote Maurice Gallagher, in providing direct non-stop flights to wilderness.

As such medium term growth plans remain much in place.

Frontier has 156 aircraft on order including 89 A320neos and 67 A321neos (and it has the option to convert 18 of the A320s to A321XLRs). (This was part of a massive order with Airbus — its largest single aircraft order agreement — orchestrated by Indigo Partners in 2017 for 430 A320 family aircraft on behalf of its ULCCs Frontier, Wizz Air, JetSMART and Volaris.) Originally planned for delivery by 2026, Frontier last year negotiated a deferred delivery schedule out to 2028 and currently plans to take 13-14 aircraft a year in the next two years before ramping up to 20 aircraft a year — suggesting a medium term growth rate of around 10% a year.

Spirit at the end of 2019 had signed an order with Airbus for 100 A320 family aircraft plus options for upto a further 50 for delivery by 2027 (of which it has confirmed 27). It also has ten A320s due into its fleet in 2021 (of the 16 planned for delivery) from operating lessors. Its medium term fleet plan suggest a total complement of 190 aircraft by end 2022 up from the 158 in 2020.

Allegiant only bought 13 of its 100 strong A320 family fleet new direct from the manufacturer. Typically though this was an opportunistic deal in 2016 for end-of-line A320ceos as Airbus transitioned to production of the new engine variant, and they were delivered in 2017 and 2018. It has no aircraft on order. However, it has taken advantage of the availability of equipment and the weakness in demand to pick up extra lift very cheaply: in the first quarter it paid cash for three used 9-year old A320s for an average $16.5m each all in (and noted that it has been able to pick up spare parts for half the usual price). The company’s current guidance points to it having 108 aircraft in its fleet by year end up from 98 at the end of 2020 (although the fleet databases currently show it having 111 tails on its books).

Viewing the events of 2020 as “taking a year off” from its long term growth plans Allegiant noted in the Q1 results that it has “never been more excited about the growth opportunities in 2021 and beyond”, and that it intends to grow the airline by the end of 2024 to “north of 145 planes”.

The US ULCCs are no longer a niche sector, and are showing that there is a value to point-to-point services that go beyond price. But this does not necessarily signal a cosmic shift in the shape of the US domestic industry.