Why Is JPMorgan Buying Spirit, But Selling Virgin America?

• Spirit Airlines Incorporated SAVE shares have declined 11 percent since December 14, which shares of Virgin America Inc VA are down 18 percent.
• JPMorgan’s Jamie Baker initiated coverage of Spirit Airlines with an Overweight rating, and of Virgin America with an Underweight rating.
• While Spirit’s margins could be almost industry-leading, Virgin America’s margins may lag, Baker stated.

Analyst Jamie Baker wrote, “These are good days to be a US airline. But not all operating models are created equal, and opportunistic skimmers face differentiated challenges and earnings trajectories.”

Spirit Airlines

The price target for the company is at $52. Baker said that Spirit’s costs and margins are likely to continue to be “at the outer extremes of the industry.” He added that future expansion and pricing may “prove more dexterous of competitive ramifications” under new management.

Baker said that the ULCC model is “parasitic in nature,” since it depends on “debilitated hosts.” Spirit’s competitors today are healthier than they have ever been, and they continue to launch inflight products and lower fares.

The analyst pointed out, however, the Spirit’s shares were under pressure last year. In view of the stock valuation, “still-washed out” sentiment and the CEO transition, Spirit’s shares are likely to “respond enthusiastically” to any marked reduction in “competitive hostilities” or RASM improvement.

Virgin America

The price target for the company is at $31. Virgin America’s margins may lag, albeit remaining respectable, Baker mentioned. He also pointed out the company’s “insufficiently diversified (hence vulnerable) network” as well as gradually increasing labor and maintenance costs.

“Virgin’s network figures paint a risky picture, in our view,” Baker wrote. Virgin America’s SFO share of 11 percent is low and has not moved since 2012, while most successful hub-and-spoke airlines have demonstrated concentration in excess of 50 percent.

Almost a-third of Virgin America’s revenue is generated by merely four markets, where the company has a share of only 16 percent. This leaves Virgin America dependent on the behavior of United Continental Holdings Inc UAL.

“Ex-fuel margins and fuel retention metrics trailed those of other Discounters last year. And unlike Spirit, Virgin’s costs are more representative of youth rather than structural design, which limits future margin expansion, in our view,” the JPMorgan report noted.