Spirit Airlines, Inc. (NYSE:SAVE) Shares Could Be 29% Above Their Intrinsic Value Estimate
Key Insights
The projected fair value for Spirit Airlines is US$2.36 based on 2 Stage Free Cash Flow to Equity
Spirit Airlines' US$3.05 share price signals that it might be 29% overvalued
Our fair value estimate is 34% lower than Spirit Airlines' analyst price target of US$3.57
Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Spirit Airlines, Inc. (NYSE:SAVE) as an investment opportunity by taking the forecast future cash flows of the company and discounting them back to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.
We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
See our latest analysis for Spirit Airlines
Step By Step Through The Calculation
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To begin with, we have to get estimates of the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) estimate
2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | 2034 | |
Levered FCF ($, Millions) | US$9.50m | US$13.5m | US$17.5m | US$21.3m | US$24.6m | US$27.5m | US$30.0m | US$32.1m | US$33.9m | US$35.5m |
Growth Rate Estimate Source | Analyst x2 | Est @ 41.68% | Est @ 29.89% | Est @ 21.63% | Est @ 15.86% | Est @ 11.81% | Est @ 8.98% | Est @ 7.00% | Est @ 5.62% | Est @ 4.65% |
Present Value ($, Millions) Discounted @ 12% | US$8.5 | US$10.8 | US$12.6 | US$13.7 | US$14.2 | US$14.3 | US$13.9 | US$13.4 | US$12.7 | US$11.9 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$126m
The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.4%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 12%.
Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = US$36m× (1 + 2.4%) ÷ (12%– 2.4%) = US$395m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$395m÷ ( 1 + 12%)10= US$132m
The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$258m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of US$3.1, the company appears slightly overvalued at the time of writing. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.
The Assumptions
Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own assumptions. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at Spirit Airlines as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which accounts for debt. In this calculation we've used 12%, which is based on a levered beta of 2.000. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
SWOT Analysis for Spirit Airlines
Strength
Debt is well covered by earnings.
Weakness
No major weaknesses identified for SAVE.
Opportunity
Forecast to reduce losses next year.
Has sufficient cash runway for more than 3 years based on current free cash flows.
Good value based on P/S ratio compared to estimated Fair P/S ratio.
Threat
Debt is not well covered by operating cash flow.
Not expected to become profitable over the next 3 years.
Next Steps:
Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn't be the only metric you look at when researching a company. It's not possible to obtain a foolproof valuation with a DCF model. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. What is the reason for the share price exceeding the intrinsic value? For Spirit Airlines, we've put together three relevant items you should further research:
Risks: Case in point, we've spotted 2 warning signs for Spirit Airlines you should be aware of, and 1 of them makes us a bit uncomfortable.
Future Earnings: How does SAVE's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
Other High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!
PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NYSE every day. If you want to find the calculation for other stocks just search here.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com