Why Frontier Airlines Stock Doesn't Belong in Your Portfolio

Frontier Group Holdings Inc. (NASDAQ: ULCC) pulled off an IPO last week in spite of the weakness of the airline industry.

But with travel demand bouncing back, investors are taking a closer look at Frontier Airline stock as a potential recovery play.

The Frontier IPO launched at the low end of the price range and slipped even further the first day of trading. The prices have since recovered a bit, and the shares currently trade just above the IPO price. That means investors who missed the IPO still have a chance to get into the stock near the IPO price.

That doesn't mean you should, though.

Here's why the stock is attracting some attention - and why it doesn't stand out among the rest...

Why Frontier Airlines Is on Investors' Radars

Frontier Airlines is an ultra-low-cost carrier that offers economy flights. It has been very smart about the way it runs its business. It only uses the super fuel-efficient and relatively inexpensive to maintain Airbus A320 aircraft.

In 2019, Frontier had the most fuel-efficient fleet of all U.S. carriers of significant size as measured by available seat miles (ASM). Its ASMs per fuel gallon consumed were 97.5 as compared to the weighted industry average of 68.1.

That's a significant improvement in mileage.

It increased flight capacity on all its planes starting in 2015. As a result, its planes take off with 32% more people on board than its competitors. It has the highest seat density of any airline in the United States.

If you care about comfort and amenities, Frontier is not the airline for you.

However, its fares are much lower than its competitors. If you are just trying to get to spring break on the cheap or are a cost-conscious parent just trying to the get the family to Disney World without breaking the bank, Frontier just might be the airline for you.

Frontier is well aware that its customers are leisure travelers looking to save money. That's the whole reason that the airline's three biggest hubs are Denver, Orlando, and Las Vegas, three top tourist destinations.

Frontier has benefited greatly from the 2013 deal that allowed Indigo Partners, a private equity firm, to take over the airline. Indigo owns a stake in several ultra-low-cost carriers around the world. Indigo was also an investor in other low-cost airlines, including Spirit Airlines Inc. (NYSE: SAVE), Tigerair, Volaris, and Wizz Air, that had an IPO while Indigo was a major shareholder.

It has installed new management and practices that have helped Frontier remain competitive.

With low airfare costs attracting leisure customers and leisure travel set to explode this summer as more and more Americans are vaccinated, it's easy to see why investors are so excited by the stock.

But there's more that goes into a great stock to buy than a good story.

Let's take a look at the fundamentals...

Why Frontier Airlines Stock Doesn't Make the Cut

Frontier isn't a bad stock, but it's hard to see the upside.

The offering adds $265 million in cash to Frontier's balance sheet. At the end of December, it had $378 million. Assuming that the $2 million a day burn rate continued in the first quarter, it probably has about $200 million of that cash remaining.

That gives it a total of about $465 million of cash, leaving it in great shape financially.

There is no doubt that air travel is trying to return in the United States right now. The Transportation Security Administration (TSA) said that last Friday it screened more than 1.5 million people.

That was the most since the pandemic began.

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That is an encouraging sign for the airline industry, but the travel increase can be derailed quickly if we see an increase in coronavirus cases. The hope is that vaccinations spread faster than new cases so travel can continue to increase.

Once we reach something close to full vaccination, we should see pent-up demand lift air travel to 2019 levels and possibly even beyond very quickly.

Frontier is a well-run airline with strong management and a solid balance sheet. We should see demand continue to increase in the second half of 2021. That would be a promising combination on paper, but that doesn't mean you should run to buy shares of Frontier Airlines. When an IPO prices struggles right away, the markets are telling you something very important.

That's especially true when the deal priced at the low end of the range as was the case with the Frontier offering.

If we annualize the first quarter of 2020, Frontier should have something around $2.2 billion of revenue under normal conditions. The stock is trading with a valuation of a little over $4 billion, or almost two times sales.

At the current price, it is trading at about 17.25 times what it made in 2019.

It is something of a stretch to think it will do that in 2021.

It is also in line with other discount airlines, and we see no strong reason for Frontier to trade at a premium to the industry.

Right now, the big carriers are offering deeply discounted fares to offset the pandemic slowness. That wipes out Frontier's single biggest advantage over major carriers. That will likely be the case until late in the year at least.

Given the weakness of the IPO and the fact that the shares appear to be fully valued, we would avoid the stock for now.

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