Another Ultra-Low-Cost Carrier Gears Up for Big Growth

Recently, the four big U.S. carriers have reduced their growth rates to a crawl in order to keep ticket prices (and thus, profits) high. As a result, the recovery in travel demand has outpaced capacity growth. This has created big opportunities for ultra-low-cost carriers. or ULCCs, like Spirit Airlines to expand and capitalize on the demand for cheap plane tickets.

Despite the abundant opportunities, capacity growth at Allegiant Travel has been slowing down. However, last week, Allegiant announced plans to purchase another 14 Airbus aircraft for growth purposes. This suggests it is ready to become more aggressive about adding capacity.

ULCCs have been growing quickly
Ultra-low-cost carriers like Spirit Airlines and Allegiant Travel almost always have opportunities for profitable growth. Both have unit costs of about $0.10 per available seat mile, which is 10%-20% better than most "low-cost carriers." Legacy carriers have even higher cost structures. This means Spirit and Allegiant can under-price the competition and still make plenty of money.

Spirit Airlines has grown rapidly by under-pricing competitors. Source: Spirit Airlines.

Spirit Airlines has become the largest ULCC in the U.S. by using its industry-leading cost structure to reduce fares and thereby stimulate demand. Many people who will buy plane tickets at Spirit and Allegiant fares simply can't afford the prices charged by other carriers.

Last year, Spirit grew capacity at a 22% clip -- faster than any other U.S. carrier. Favorable industry conditions allowed it to grow net income 71% year over year. This year, Spirit expects to grow capacity "only" 18%, before growth peaks at nearly 30% in 2015. Spirit executives think the company can sustain a 15%-20% growth rate for many years to come.

Allegiant's growth profile
Allegiant Travel had a similarly high growth rate in 2012, when it grew capacity nearly 18% because of the combination of adding 16 seats to most of its MD-80 planes and starting service to Hawaii. In 2013, its growth rate fell to less than 9% as it found it could not support many flights to Hawaii during the off-peak season.

Allegiant  opportunistically buys used planes to keep costs down. Source: Wikimedia Commons.

Allegiant's business model is also partially responsible for this uneven growth. Allegiant only operates older aircraft, which it tries to buy (or lease) opportunistically. In 2012, it signed a letter of intent to lease and eventually purchase 10 Airbus A319s from Cebu Pacific. However, the deal fell through when the two companies could not agree on the price. This led to slower growth for Allegiant.

Ready for more capacity
Tepid revenue trends may have also encouraged Allegiant to moderate its growth rate. For example, as recently as mid-May, Allegiant expected that total unit revenue would rise just 0.5%-2.5% in Q2. However, Allegiant revised that estimate earlier this month because of stronger demand trends, and it now expects a 3.5%-4.5% increase. With demand holding up better than expected, it makes more sense for Allegiant to grow.

Last Friday, Allegiant announced it had reached agreements to purchase 12 used Airbus A319s that will enter its fleet in 2018. It is also buying an additional A319 and an A320 that will arrive in the next two years.

Allegiant President Andrew Levy also stated that the company remains active in the used aircraft market and hopes to find other Airbus A320-series planes to provide growth in 2016 and 2017. This is supported by the company's decision to issue $300 million of debt this week -- more than needed for its current aircraft order book.

The company is likely to find plenty of used Airbus A319 and A320 aircraft available at good prices. Airbus has already begun final assembly of the first A320neo planes, which will offer significantly lower fuel consumption than current generation A320s.

A320neo production will ramp quickly in the next two years. Many airlines will try to capitalize on this new technology by upgrading from current generation A319s and A320s. This will likely cause a glut of used A319s and A320s on the resale market, which is an ideal situation for an opportunistic company like Allegiant.

Foolish bottom line
Ultra-low-cost carriers like Spirit Airlines and Allegiant Travel have big growth opportunities as airline consolidation has led to higher ticket prices that many Americans cannot easily afford. Spirit Airlines has used this opening to expand rapidly, but growth has been lumpier at Allegiant.

With its recent aircraft purchase agreement, Allegiant has now extended its order book through 2018. However, the airline still has very few deliveries coming in 2016 and 2017 to keep growth at a steady 10%-15% pace. Fortunately, a steady stream of used Airbus A319 and A320 planes with low asking prices have been hitting the market. After the A320neo arrives, that steady stream could turn into a flood, propelling Allegiant's growth.