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No. of Recommendations: 2
Is Frontier Airlines an up and coming low cost airline with bright growth prospects? Or is Frontier Airlines just another air carrier doomed to have lack-luster performance over the long run?  Here's one fool's view:

I should say that I have a "growth at reasonable value" bias in my investment choices, and I invest for the long run (I expect to hold a stock for three or more years).

Lets paint a likely scenario for the next five years:

- All of Frontier's major employee groups will unionize, but the labor relations will remain good, and its employees will enjoy pay raises consistent with the rest of the industry.

- Operating margin will be a challenge in FY2002 due to lack of price control (soft economy) and the additional cost of the Airbus transition. Through cost cutting initiatives and realization of savings from the Airbus conversion, operating margins level off around 13%. (As a comparison - Southwest operating margin is 15%, recently Frontier's has been 17%. I think long term Frontier margins will remain less than Southwest due to high operating cost in Denver.

- Outstanding shares grow at 10%/year (same rate as 1999-2001).

- Other expenses (promotion, G&A, etc) remain at same levels relative to revenues.

- Load factor remains close to 2001 level of 65.1%.

- Airbus conversion happens close to plan (see recent 8K)

- Frontier expands to cover all 25 top destinations from Denver and serves a total of 29 cities by 2005.  Connection opportunities increase modestly. Departures/city also increase modestly.

Here's my EPS forecast all dollars in millions. All airbus savings are net out in Other Exp (so operating margins are probably a bit understated):

                     FY01  FY02  FY03  FY04  FY05  FY06
Total Revenue       472.9 510.9 592.1 689.5 773.8 846.6
Operating Cost      392.1 457.8 524.4 597.9 676.1 735.7
Operating Income     80.8  53.1  67.7  91.6  97.7 110.9
Operating Margin    17.1% 10.4% 11.4% 13.3% 12.6% 13.1%
Other Exp (Sav)      26.0  28.4  24.7  15.2   5.4  (4.8)
Net Income           54.8  24.7  43.0  76.4  92.3 115.8
Diluted Shares       29.1  30.9  33.9  37.2  40.8  44.8
EPS                  1.90  0.80  1.26  2.05  2.26  2.58
Analysts                   1.21  1.70

My EPS estimate is less than the analyst forecast. In fact, my five year growth forecast is 6.3% vs. an average analyst growth forecast of 15.7%. My forecast yields an intrinsic value based on future earnings per share of $21.59.  I require at least a 2/3 safety margin (1/2 is better) so I set a buy level on Frontier at $14.39.  At 50% safety margin, buy would be at $10.79. Given the shakiness of the economy, and a pretty good chance for Frontier to dissappoint on the analyst expectations (although it should remain profitable), there should be some pretty good buy opportunities during FY2002.  For the patient, this could eventually pay off big.

Before getting too excited, however, there are some pretty substantial downside risks.  If labor isn't happy, and a strike happens, this estimate goes negative on growth, and Frontier probably looses money during the strike year, and at least one year after. Also, if significantly more shares are floated than 10%/year growth, the 6.3% growth in EPS I have forecast rapidly goes to zero. Other risks include: Airbus conversion is more costly than expected and slower to realize savings, economy doesn't snap back, severe congestion in the friendly skies caps Frontier's growth potential, to name a few.

Even though I believe the expected value I calculated is reasonable vs. the current price of the stock, an investor has to be sure they can endure a worst case scenario, which probably has less than 15% chance of happening, but if it did, it would be devastating (lose 50% or more of invesment).

By the way - I recently flew Frontier from LA to Denver. Service was good, plane was comfortable, and we got muffins instead of peanuts - made me happy!

Happy investing!

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