Shares of Spirit Airlines (NYSE:SAVE) skyrocketed yesterday, ending the day with a 10.2% gain. The fast-growing budget airline updated its second-quarter forecast after the market closed on Wednesday, and the news was good.

Spirit Airlines is now in position to exceed analysts' most recent second-quarter earnings per share estimates by a country mile. Clearly, that's great news for investors. Nevertheless, the company needs to return to consistent unit revenue growth in the second half of 2018 to keep this rally going.

The second quarter was better than feared

In late April, Spirit Airlines provided downbeat guidance for the second quarter, undermining a nascent rally for the stock. Management projected that revenue per available seat mile (RASM) would plunge 6.5% to 7.5%, while rising fuel prices would more than offset an impressive 7.5% to 8.5% year-over-year improvement in non-fuel unit costs.

Based on this forecast, analysts were recently projecting that Spirit's second-quarter adjusted EPS would fall to $0.92 from $1.14 a year earlier, despite the benefit of a lower tax rate.

On Wednesday evening, Spirit updated its second-quarter guidance. The company estimates that RASM fell 6.8% year over year, despite capacity growth coming in 1.5 percentage points higher than previously expected, at 30.5%. On the bright side, non-fuel unit costs plunged by about 11%. A shift in the timing of some expenses to the fourth quarter accounted for 1 percentage point of the improvement, but the rest reflected strong cost control.

A yellow Spirit Airlines jet

Spirit Airlines dramatically reduced its non-fuel unit costs last quarter. Image source: Spirit Airlines.

Fuel efficiency also improved significantly, as Spirit Airlines has been adding more fuel-efficient aircraft to its fleet. In fact, fuel consumption was 2.3% below Spirit's original forecast, despite capacity growth coming in higher than expected.

In total, fuel efficiency improved more than 5% year over year, from 85.3 available seat miles per gallon to 89.7 available seat miles per gallon. This was incredibly important, as fuel prices rose even more than expected last quarter.

Spirit is poised for an EPS beat

Spirit Airlines does not provide formal EPS guidance, but the company's forecasts include enough information to create good estimates. Spirit's capacity growth of 30.5%, offset by its 6.8% RASM decline, implies that total revenue rose approximately 21.6% last quarter to $853 million.

Meanwhile, fuel consumption of 106.1 million gallons and an average price of $2.32 per gallon translate to total fuel costs of $246 million. The company disclosed net interest expense of $13.8 million. Lastly, Spirit's adjusted non-fuel operating expenses came in at $425 million in the second quarter of 2017. Based on a 30.5% capacity increase and an 11% decline in non-fuel unit costs, adjusted non-fuel operating expenses increased to around $494 million last quarter.

Totaling up the numbers, Spirit's new forecast implies an adjusted profit of around $99 million before tax and $75 million after tax. That would imply EPS of $1.10: down just slightly year over year, and well ahead of analysts' current estimates.

A return to unit revenue growth is still essential

While investors' current excitement is understandable, it's important to note that non-fuel unit cost improvements will be far more modest going forward at Spirit Airlines. As of late April, the carrier expected a mid-single-digit decline in non-fuel unit costs for the third quarter, followed by a low-single-digit increase in the fourth quarter. Furthermore, fuel costs are set to remain a major headwind at least through the end of the year.

This highlights the importance of Spirit Airlines returning to unit revenue growth. Without unit revenue growth, the recent increases in jet fuel prices will cause severe margin erosion.

Fortunately, Spirit's unit revenue trajectory could be about to improve dramatically. First, the carrier will face much easier comparisons going forward. Spirit Airlines posted a 0.9% RASM increase in the first half of 2017, including a 5.7% increase in the second quarter. By contrast, RASM fell 6.3% in the third quarter and 1.8% in the fourth quarter.

Second, Spirit Airlines' growth rate will slow dramatically toward the end of 2018. In April, management estimated that Spirit would increase its capacity 26% year over year in the third quarter and just 13% to 15% in the fourth quarter.

Other airlines are equally motivated to boost unit revenue growth and have started to trim capacity in September and beyond. That could pave the way for Spirit Airlines to achieve the unit revenue growth it so desperately needs in the second half of 2018.
