Can Frontier convince financial markets that it's a 'premier ULCC'?
Frontier Airlines has remained unabashedly bullish about the ultra-low cost business model in the US during the past year, as the weaker performance of budget airlines has triggered questions about their long term viability.
After several product pivots and a network revamp, Frontier is declaring itself as "the premier ULCC," and believes that it can deliver double digit margins by mid-2025.
It's a big gap to close, considering that Frontier's forecast adjusted pre-tax margin for 4Q2024 is 0-2%.
Given the ample progress the airline needs to make, markets are likely to adopt a wait-and-see approach before rewarding Frontier with higher valuations.
- US ULCCs have faced increasing scrutiny regarding the viability of their model.
- Frontier has introduced a raft of changes to challenge that narrative.
- The Denver-based ULCC believes that significant opportunities exist for boosting loyalty revenue.
- Frontier also touts its continued cost advantage in the US market.
- Although Frontier is confident in its prospects, financial markets are likely to take a more cautious approach to its transformation.
US ULCCs faced significant headwinds in 2023 as market dynamics flipped
During late 2023 United Airlines executives concluded that an inversion of the industry structure had occurred - with large network airlines performing better than ULCCs.
For United, specifically, that flip in performance stemmed from focusing on its competitive advantages, including cabin segmentation, driving business through the company's direct channels, driving costs down by focusing on hub connectivity, and upgauging aircraft rather than adding frequencies.
See related report: US legacy airlines enjoy a heyday while ULCCs face margin pressure
At that time ultra-low cost airlines were facing cost convergence, air traffic control constraints, and a growing preference for premium products and weaker sales (due, in part, to oversupply in the domestic market).
Frontier has worked to combat headwinds, including a network overhaul
Over the course of 2024 Frontier has instituted several changes, to adapt to a changing marketplace and challenge the narrative that ultra-low cost airlines had a questionable future in the US.
The Denver-based airline has pulled capacity from saturated markets - namely Florida and Las Vegas - and redeployed it elsewhere.
Frontier executives explained during a recent earnings discussion that new bases opened in 2024 at Cleveland, Cincinnati, Tampa, Chicago and San Juan were maturing, as were other new markets the airline had introduced during the past year.
Data from CAPA - Centre for Aviation and OAG show that Frontier is the second largest airline in Cleveland measured by seat deployment, with a nearly 24% share.
Cleveland Hopkins International airport: system seat share, as of late Oct-2024
And by that same measure, Frontier is the third largest operator at Cincinnati, with a 16% share.
Cincinnati/Northern Kentucky International airport: seat share by airline, as of late Oct-2024
The airline's simplified out-and-back operating schedule is also entering its second year of operations, which should bolster its financial position.
New premium-like products from Frontier appear to be performing well in the early innings of deployment
Frontier believes that the network overhaul it has undertaken during the past year will help drive increases in revenue during 2025, but the airline is also confident that its new product offerings have substantial upside.
The airline has introduced product bundles, premium options, and blocking the middle seat on certain rows in its new "Upfront Plus" option. It has also launched "BizFares", that include priority boarding, premium seating, and guaranteed overhead bin space.
Frontier chief commercial officer Robert Schroeter said the utilisation rate of BizFares was more than 250 basis points higher in 3Q2024 quarter compared to 2Q2024, "...and [with] a revenue premium nearly 50% higher than basic fares".
He also highlighted previous comments from Frontier executives that Upfront Plus was approaching 70% paid load factor. He added that the product was generating 30% more ancillary revenue per passenger "compared with the previous 'Stretch seating'", he explained. Stretch seating features more legroom and a more comfortable seat.
Over the longer term, Frontier also sees significant upside from loyalty revenue.
During the earnings discussion the airline's CEO Barry Biffle said that the airline was seeing the highest rate of credit card applications in its history, "...and they've jumped massively year-over-year because of all the revenue initiatives that we've done".
Flowing that out over the next few years is "massive" to Frontier's loyalty programme, Mr Biffle said.
He noted that the airline's loyalty revenue per passenger was a "couple of bucks", compared with range of high teens to USD20 for some US airlines.
Frontier's CEO believes the airline could push loyalty revenue per passenger in the USD5-USD7 ranges in the "several coming years".
Frontier's CEO continues to tout cost advantages, and sees capacity discipline continuing
Mr Biffle also explained that while cost convergence was "true across most of the industry...that's not the case with Frontier, and I think that's misunderstood[,] and not really highlighted".
He explained that in the 3Q2024 Frontier had a 40% cost advantage per passenger compared with the rest of the industry, "...and it looks like, based on the guidance that we're seeing," Frontier will maintain that advantage into 2025.
More broadly, Frontier and other US airlines are benefitting from a pull-down in domestic capacity, and Mr Biffle believes that rational behaviour will continue. He explained that deployment in supply had slowed to its lowest rate post-pandemic, and for the first time in a decade that growth was "trailing gross domestic product, excluding the COVID [pandemic] years".
Mr Biffle said that there had been too much narrowbody capacity, in particular, and those aircraft were often pushed out on similar types of routes.
"We are seeing the market push capacity out, and I think you're going to continue to see that happen", he added.
He believes domestic capacity will continue to fall until airlines reach their target margins, "...and I would argue you're a long way from that".
Frontier arguably also has a long distance to go in reaching its margin goals in a relatively short period of time. Even as the airline has declared a cost advantage and laid out a plan to reach its margin targets, at this point its valuation reflects a cautious approach from the markets.
At the time this report was written - one day after Frontier's 29-Oct-2024 earnings discussion - its stock price was (at midday EST) USD6.28, according to Yahoo Finance, and the 52-week range for the stock was USD2.79 to USD8.33.
Financial markets may take more time to validate Frontier's new revenue initiatives
Most of the transformational building blocks that Frontier has created to bolster revenue and margins have just been introduced, and need some time to mature.
These changes are also neither novel nor occurring in a vacuum, as larger competitors continue to grow premium and loyalty revenues with a much broader network scale.
Yet, it's not surprising Frontier's management is exuding confidence that the initiatives under way will produce margin expansion. Indeed, Mr Biffle declared, "…we think we've validated our model".
But Wall Street may need to see more evidence of that validation.