source: Bloomberg

Will Nasgovitz of the Heartland Value Fund thinks ultra-discount carrier Spirit Airlines will benefit from its low costs.

By Ryan Derousseau
March 21, 2013

Will Nasgovitz’s boyhood chats with his dad were unusual: The two would talk stocks, with the father, mutual fund manager Bill, preaching the importance of companies with little debt, strong cash flow, and a catalyst for growth. Will, now 34, embraced the philosophy, joining his dad’s $1.1 billion Heartland Value Fund as a co-manager in 2009. Together they’ve averaged annual returns of 8.5% over 15 years (vs. 4.5% for the S&P). A recent favorite: Spirit Airlines.

1. Low prices, low costs

Spirit’s ultracheap fares — the typical ticket goes for $75 to $85 — are catnip to bargain-seeking customers. Spirit can pull this off because it’s deeply frugal. It pays 13% less than discount powerhouses Southwest and JetBlue to fly one seat one mile, a common airline metric. And unlike the so-called legacy carriers, Spirit has a fully funded pension plan and only one critical drag on profits (see No. 4). “They have this advantage,” says Nasgovitz, “which means they can go into new cities and offer fares that stimulate traffic immediately.”

2. Let feedom reign

The other reason Spirit is able to offer outlandishly low fares: its outlandishly high fees. From charging for checked luggage to dunning people as much as $100 for carry-ons checked at the gate because they’re too big to fit onboard, the airline nicks its average passenger $51 per flight. It’s lucrative for Spirit — and it hasn’t deterred customers. Spirit’s flights are even more full than those of JetBlue and Southwest. “It’s not for everybody,” Nasgovitz says. “It’s for someone who knows they will get charged for any extras.”

3. A merger means opportunity

Another catalyst working in Spirit’s favor, Nasgovitz says, is the pending merger of American Airlines with US Airways. The new combined airline will probably need to eliminate a number of its routes as it awaits federal antitrust approval for the $11 billion deal. Nasgovitz believes that will benefit domestic carriers, including Spirit. Indeed, 60% of the discount carrier’s routes overlap with American’s, according to Spirit’s 10-K, creating plentiful opportunities for new business.

4. Cheap, even for an airline stock

A potential stumbling block: the cost of Spirit’s airplane leases. Nasgovitz says they’re the equivalent of a 66% debt-to-capital ratio (similar to JetBlue’s but loftier than other rivals’). Still, he says Spirit generates more than enough cash to cover the leases. More important, Spirit boasts a 12.7% profit margin, which trounces that of most airlines. Nasgovitz contends the market isn’t recognizing the 19% growth in earnings per share expected in 2014, leaving Spirit’s stock underpriced. He thinks the shares, now $23, are worth $28.

This story is from the April 8, 2013 issue of Fortune.

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