What a fantastic six months it’s been for Frontier. Shares of the company have skyrocketed 65.1%, setting a new 52-week high of $7.81. This was partly thanks to its solid quarterly results, and the performance may have investors wondering how to approach the situation.
Is now the time to buy Frontier, or should you be careful about including it in your portfolio? Get the full breakdown from our expert analysts, it’s free.
Why Do We Think Frontier Will Underperform?
We’re happy investors have made money, but we don’t have much confidence in Frontier. Here are three reasons why ULCC doesn’t excite us, plus one stock we’d rather own.
1. Long-Term Revenue Growth Disappoints
A company’s long-term sales performance can indicate its overall quality. Any business can have short-term success, but a top-tier one grows for years. Over the last five years, Frontier grew its sales at a 31.7% annual rate. Although this growth is acceptable on an absolute basis, it fell slightly short of our standards for the consumer discretionary sector, which enjoys a number of secular tailwinds.
2. New Investments Fail to Bear Fruit as ROIC Declines
We like to invest in businesses with high returns, but the trend in a company’s ROIC can also be an early indicator of future business quality.
Unfortunately, Frontier’s ROIC has decreased significantly over the last few years. Paired with its already low returns, these declines suggest its profitable growth opportunities are few and far between.
3. Short Cash Runway Exposes Shareholders to Potential Dilution
As long-term investors, the risk we care about most is the permanent loss of capital, which can happen when a company goes bankrupt or raises money from a disadvantaged position. This is separate from short-term stock price volatility, something we are much less bothered by.
Frontier burned through $468 million of cash over the last year, and its $5.25 billion of debt exceeds the $772 million of cash on its balance sheet. This is a deal breaker for us because indebted loss-making companies spell trouble.
Unless the Frontier’s fundamentals change quickly, it might find itself in a position where it must raise capital from investors to continue operating. Whether that would be favorable is unclear because dilution is a headwind for shareholder returns.
We remain cautious of Frontier until it generates consistent free cash flow or any of its announced financing plans materialize on its balance sheet.
Final Judgment
We cheer for all companies serving everyday consumers, but in the case of Frontier, we’ll be cheering from the sidelines. After the recent rally, the stock trades at $7.81 per share (or a forward price-to-sales ratio of 0.4×). The market typically values companies like Frontier based on their anticipated profits for the next 12 months, but it expects the business to lose money. We also think the upside isn’t great compared to the potential downside here - there are more exciting stocks to buy. We’d suggest looking at the most dominant software business in the world.
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