Cheap Stocks Are Cheap For a Reason: Especially Stocks Like This

What Happened?

Yesterday, Spirit Airlines [SAVE] filed for Chapter 11 bankruptcy protection.

Spirit Airlines was the trailblazer for cheap flights. It turns out that reputation is partly to blame for its downfall.

The short story is that chapter 11 bankruptcy is a court-approved process that allows a company to continue trading as a business while it goes through a reorganization.

The benefits are that rather than winding up the business right away, the company has an opportunity to make changes, that will hopefully result in at least a slimmed down version of the business continuing.

It also means customers can continue to use the company’s services, and in this case, customers will still be able to use loyalty points and travel on already-booked flights.

Good news for fliers. For shareholders, on the other hand, even chapter 11 bankruptcy protection rarely ends well.

Why it Matters

According to the Washington Post, Spirit Airlines has $9 billion in debts, with just $9.5 billion in assets. And revenue growth has lagged that of its larger competitors.

Over the past 12 months, United Airlines [UAL] and American Airlines [AAL] have both managed to eke out small revenue gains, on top of larger gains for the year through the end of 2023.

Meanwhile, Spirit has struggled. It barely grew revenue by 5% in 2023, while United’s revenue increased nearly 20% and American’s revenue grew almost 10%.

The fact is, the North American airline industry is incredibly competitive. Look at any flight radar map, and on any given day, you’ll see the greatest concentration of commercial aircraft is flying over the U.S.

Despite that, it’s hard to think of a worse business to invest in than the airline industry.

Take the U.S. Global Jets ETF [JETS]. It’s an exchange-traded fund (ETF) that owns shares in all the U.S. listed passenger airline stocks.

Over the past five years, the industry combined (as measured by the JETS ETF) is down 24%. Compare that to the S&P 500 which is up 89% over the same timeframe.

Sure, airlines took a big hit with the COVID-19 pandemic. And airline stocks have rallied over the past year, despite slowing revenue growth. But overall, betting on airlines has been, well, a bad bet.

And the current trend isn’t likely to make it’s prospects any better.

How it Affects You

Airlines are the ultimate cyclical industry. When the economy is going great, people travel and airlines generate a lot of revenue.

But when the economy turns, people travel less, revenue falls, and the airlines are faced with having to make repayments on aircraft they can no longer afford.

The problem for Spirit in particular, was the ‘hangover’ from the pandemic. As the Washington Post notes, when people started traveling again, they didn’t necessarily want the ‘budget’ experience.

They still felt like they didn’t want to be crushed together in uncomfortable seats. They wanted more seat width and more legroom. That’s something generally not configured into the budget airline experience.

In summary, we know from experience that many investors will see any ongoing weakness in airline stocks as an opportunity to ‘buy cheap’. But the history of airline investing suggests investors are better off keeping their distance.

If the economy does take a turn for the worse, Spirit won’t be the last airline to file for chapter 11 bankruptcy protection.