SkyWest: A Business Under Threat

It's no secret in the airline industry that 50-seat jets are on their way out. These little airplanes became very popular among U.S. carriers in the 1990s and early 2000s, as they are faster than turboprops and small enough to offer frequent service between hubs and small cities. However, they burn far more fuel per seat than larger regional jets and mainline aircraft, and also cost more per seat to maintain.

These were reasonable trade-offs in the 1990s, when jet fuel prices were well below $1 per gallon. In today's environment, when jet fuel routinely costs $3 per gallon, the additional fuel expense makes it uneconomic to fly these planes.

For that reason, Delta Air Lines (NYSE: DAL  ) announced a plan last year to reduce its 50-seat regional jet fleet to no more than 125 aircraft by the end of 2015, down from a high of 550 planes in 2008 and 2009. It is replacing that capacity with larger regional jets (mostly seating 76 passengers) and small mainline aircraft (110 seats). United Continental (NYSE: UAL  ) is also replacing many of its 50-seat jets with larger regional jets, although it remains well behind Delta in that process.

SkyWest: rolling with the punches
One of the big potential victims of this switch is regional carrier SkyWest (NASDAQ: SKYW  ) . Regional carriers fly regional jets and turboprops for legacy carriers, and SkyWest is the biggest player in this market. In fact, it is the largest operator of 50-seat (and smaller) regional jets in the world, with more than 500 such aircraft in service. With so much of its business tied to a disappearing market segment, it's clear that SkyWest is in a delicate situation.

It's particularly critical for SkyWest to adapt because while it does some flying for all of the legacy carriers, 97% of its capacity was allocated to United and Delta in 2012. Since both of these carriers are looking to dramatically slash their 50-seat jet fleets, SkyWest needs to move quickly into more stable market segments.

Moving up
SkyWest hopes to make the best of a bad situation by growing its fleet of large regional jets. The legacy carriers like these aircraft a lot more, because they have lower unit costs than 50-seat jets but are more comfortable for passengers and can accommodate a first-class cabin, which attracts business travelers. Since large regional jets provide higher value to the major airlines, they are willing to pay a premium for them, allowing the regional airlines to improve their operating margins.

Indeed, in the past year SkyWest has signed contracts with its top two customers, Delta and United, to operate large regional jets for them. However, other regional airlines may be positioned to gain share from SkyWest during the transition to large regional jets. For example, top competitor Republic Airways (NASDAQ: RJET  ) operates a similar number of large regional jets and turboprops as SkyWest; SkyWest currently has 199, versus 183 for Republic.

By contrast, Republic operates just 70 small regional jets, compared to SkyWest's more than 500. As a result, SkyWest is not likely to replicate its dominance of the 50-seat-jet market in the 70- to 76-seat-jet market. Moreover, since large regional jets have significantly more seats than the 50-seat jets they are replacing, airlines do not need as many of them. This means that SkyWest's fleet size will shrink dramatically, as will its need for pilots.

The company may be able to manage this downsizing through attrition, as the major airlines (which offer higher pay than regional airlines) have begun hiring again. However, it remains a significant potential risk factor to be aware of.

Long period of transition
SkyWest's heavy reliance on 50-seat jets means that it is a business facing significant threats. While the company has long-term contracts to fly these small planes for major airlines (primarily United and Delta), in some cases the contracts end before the aircraft are scheduled to be retired or returned to the lessor. This creates a risk of future write-downs if SkyWest is unable to dispose of these unwanted assets. Moreover, while the company dominated the 50-seat regional airline business, it is unlikely to replicate that dominance in the large regional jet category.

Republic Airways, which has lower exposure to the 50-seat-jet market, therefore seems like a safer bet for investors. Although, SkyWest does have the ability to manage this transition to make the best of the situation. In a companion piece that I will publish later this week, I will assess some of SkyWest's opportunities to fly into a better future.

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Editor's note: A previous version of this article misstated the number of large regional jets and turboprops that SkyWest operates. The Motley Fool regrets the error.


Read/Post Comments (3) | Recommend This Article (2)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 20, 2013, at 1:56 PM, eightballfreight wrote:

    Shockingly bad financial advise.

  • Report this Comment On June 20, 2013, at 2:20 PM, trophicthunder wrote:

    While it is true that the major airlines are reducing their capacity in the 50 seat market your analysis of SkyWest and their business model is flawed. You assume that SkyWest owns the aircraft that are operating under their company banner, or control the lease in some way but this is only true for 50% of the aircraft. SkyWest is the direct lessor a little less than half of the aircraft they fly. They chose to lease aircraft when there were opportunities for large gain due to an oversupply of serviceable aircraft for which the lien holders would accept pennies on the original lease price. The other aircraft are leased by Delta, United, and Alaska Airgroup, and operated by SkyWest with the fee-for-departure model that has proven to be so profitable. SkyWest has a very diversified business plan when it comes to the manner in which it receives compensation for operating flights. They recently announced a sizable acquisition of the Embraer 175, a very well-received (from the standpoint of passengers) aircraft that has fuel economy on par with or exceeding the current Canadair aircraft depending on the length of flight. SkyWest has been working hard to mitigate changes to the business model necessitated by the increase in fuel costs and the shifting relationships with major partners after recent mergers. SkyWest is one of the only regional partners with a large piggy bank and wide-ranging network of industry partners. They are strong and will continue to be so into the future.

  • Report this Comment On June 21, 2013, at 11:03 AM, TMFGemHunter wrote:

    @trophicthunder: You are right that many of SkyWest's planes are leased from the carriers/partners for which they fly. I'm not worried about those planes. However, that still leaves a lot of planes that SkyWest has on lease in its own name or that it owns. For example, when SkyWest agreed to take 66 50-seat planes out from Delta, only 41 of those are owned by Delta. SkyWest is responsible for selling or returning the other 25, or finding another contract to fly them.

    The other issue is that the number of regional jets flying is expected to shrink. For example, Delta is replacing 200-250 50-seat jets with 88 mainline aircraft and 40 large RJs. That's a particularly extreme example, but the general idea is that while the large RJ flying will have higher margins, there will be significantly fewer planes in service.

    In any case, I don't think SkyWest is a terrible company by any means. You may want to check out the companion piece I published this morning, which details some of the company's opportunities going forward.

    Adam

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