Republic Airways: A Value-Priced Growth Stock?

Republic Airways (NASDAQ: RJET  ) is in the midst of a significant business transition, as the company recently agreed to sell its Frontier Airlines subsidiary to private equity firm Indigo Partners. This will allow Republic to concentrate on its core business of flying regional jets and turboprops for legacy carriers.

The Frontier sale process has added a significant amount of complexity to interpreting Republic's financial results. However, beneath all this "noise", Republic is generating strong earnings per share growth that is likely to continue for the next several years. Today, investors can buy into that growth at a great price that's less than 10 times earnings.

Digging into earnings
Republic recently reported adjusted earnings per share of $0.34 for Q3. At first glance, that appears to fall well short of the average analyst estimate for earnings per share of $0.70. However, Republic classified all earnings from the Frontier subsidiary as income from discontinued operations beginning with Q3. It was therefore excluded from adjusted earnings per share. Without this accounting change, Republic's earnings per share would have reached approximately $0.90, well ahead of analyst estimates and the company's original guidance.

Looking just at continuing operations (i.e. excluding Frontier), Repubic's adjusted earnings per share more than doubled year over year in Q3 from $0.13 to $0.34. Earnings are up on a year-to-date basis as well. Republic posted $0.46 earnings per share from continuing operations in the first three quarters of 2012, compared to $0.84 year to date.

The American growth opportunity
The biggest growth driver for Republic right now is the expansion of large regional jet flying at AMR's (UNKNOWN: AAMRQ.DL  ) American Airlines. Prior to AMR's bankruptcy filing, its pilot contract severely restricted the company's use of large regional jets. However, the AMR pilot contract has since been modified, which could potentially allow AMR to add hundreds of large regional jets to its fleet over the next several years.

Republic won the first contract for AMR's expanded regional jet operations, and began operating flights under the American Eagle brand in August, flying four Embraer E-175 jets for AMR at the end of Q3. This figure will grow to 16 by the end of the year, and top out at 47 by mid-2015.

Flying these large regional aircraft is the largest and most profitable part of Republic's business. At the end of Q3, Republic's subsidiaries operated 167 aircraft with between 69 and 99 seats. Republic's new flying for AMR will grow this total by around 25% in less than two years. Furthermore, AMR can potentially add another 200-plus large regional jets to its fleet in the future, and Republic has a good chance to win some of this business.

Risk factors
Republic is on a growth path right now, but the airline business is still quite risky. The biggest risk Republic faces is that it could be forced to idle some of its aircraft next year. The company has 41 small regional jets on short-term capacity purchase agreements that end in 2014, and there is no guarantee that these agreements can be renewed. Furthermore, Republic has five 99-seat E-190 aircraft that have been flying for Frontier, a service that is already winding down.

Neither of these risks is unmanageable. CEO Bryan Bedford stated on Republic's earnings call that he believes (based on conversations with the company's partners) that it will be possible to renew all of the small regional jet contracts for another year. However, Republic may decide to reduce the number of small regional jets it operates next year in order to free up pilots for the growing American Airlines E-175 business.

As for Republic's E-190s, the company may be able to sell or sublease them to another airline. If that is not possible, Republic may be able to use them for charter service. For example, last year, Republic won a three-year contract to provide charter service for Caesars Entertainment with five E-190s that had also formerly been operated for Frontier.

The other big risk factor for Republic shareholders is that the company has heavy near-term capital commitments, relative to its size. Republic has ordered 40 Bombardier CSeries jets that will start arriving in 2015, but this plane does not fit into the company's current business model. So far, Republic has not provided much detail on its plans for these new jets, but it may operate them under its own brand in a low-cost-carrier format.

Good upside for the risk
While Republic Airways stock comes with a good helping of risk, it currently trades for just eight times forward earnings. (Its closest peer, SkyWest trades for 11 times forward earnings, and probably faces even more business risks.)

A single-digit-earnings multiple is rare for a company with as much growth potential as Republic has. With the Frontier sale nearly complete, Republic's management team can devote its full attention to pursuing growth opportunities and mitigating the major risks Republic faces. These efforts are likely to pay off very nicely for shareholders.

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  • Report this Comment On November 11, 2013, at 1:23 PM, datruthdog wrote:

    It would be a monumental mistake for RJET to take the C series and launch their own brand. They have tried that several times already and almost bankrupted the company in doing so. One would think they have learned their lesson....but lessons are rarely learned with "airline" big egos. When management's ego exceeds their business judgement, bad things happen. As we have already seen. Maybe this will be different.

  • Report this Comment On November 11, 2013, at 2:35 PM, UTNonRev wrote:

    The article overlooks one of the major costs for any airline - employee costs. The primary concern is pilot pay. Currently pilots are paid based on the 'seat' they are flying (captain or first officer). Republic's pay for a captain tops out at $119/hr while a first officer's pay is $37/hr. Republic, like most regional carriers, is being boxed in two ways - the FAA requirements for pilot hires to have an ATP to be hired has severely limited the number of pilots available for regional carriers which have traditionally been viewed by pilots as stepping stones to the majors with their greater pay and benefits. On the other side, after several years of limited upward mobility for pilots, the major carriers have once again began hiring. While it scheduled to being slowly (about 1,200 pilot hires for the 'big-3' (American, Delta, and United) in 2014, the age of pilots at the majors show that retirement numbers are swelling. Why would a pilot leave Repulic? All we have to do is look at the numbers - Republic captains max out at $119/hr and FOs are paid $37/hr. Delta's probationary pay (1st year) is $66/hr, almost double the FO pay at Republic. 2nd year FO pay at Delta for most aircraft is comparable to Republic's maximum captain pay. United's pay rates are slightly lower but are currently in negotiations. American has the lowest rates (currently in bankruptcy) but their pilot contract calls for pay rates to automatically match the average of their peers in 2 years. Are pilots interested in working for a major airline, even if it's currently in bankruptcy? American Airlines recently opened their pilot hiring division. They report that they received 4,000 pilot applications in the first 24-hours. The majority of these applications came from pilots at other airlines, primarily regional carriers. This will place regional carriers in a predicament. Just a 5% loss in pilot numbers, even the most junior pilots, severely impacts airline scheduling. If a regional carrier can't maintain its schedule then the major airline subbing out flying to them can rescind the contract. Republic, as well as all regional and small airlines) are gong to have to develop a viable plan to keep their pilots (its going to be expensive). Not only are they going to have to agressive increase their pay, but they are going to have increased training costs to replace the pilots that do leave. An additonal training cost to consider is that they will also be competing against the majors for new hires. Unless Republic and other small carriers can match pay and benefits at the majors, they will have to choose from a pilot pool that has already been gleaned by the majors. That can be expected to entail even higher training costs as the quality pilot candidates have already been taken. The best example of this is that the washout rate for pilots at the majors is very low (almost zero) because of the quality of candidate they get. On the other hand, some regional carriers have experienced double digit washout rates. Every pilot that starts training but doesn't finish is not only lost training costs but another delay to actually filling the pilot seat. Too many such delays and scheduling suffers. Your analysis of earnings and aircraft purchases are interesting, but if an airline doesn't have sufficient pilots to fly its aircraft, these aircraft sitting idle are money pits. Thank you for your consideration.

  • Report this Comment On November 11, 2013, at 4:40 PM, TMFGemHunter wrote:

    @UTNonRev: Thanks for the comment. You make some good points, but I think that Republic's disproportionate exposure to large regional jets vs. 50-seaters minimizes the impact. First, the company's management stated that the new FAA rules have a bigger impact on staffing needs for the small regional jets. (They tend to have more takeoffs and landings, and the FAA is cutting back on the number of landings a pilot can do in a day.)

    Second, and more importantly, pilot costs are spread over more passengers for a 76 seat RJ vs. a 50 seater or smaller RJ. So other regional operators like SkyWest could be in bigger trouble if pilot costs escalate rapidly, because they have far more exposure to the small regional jets.

    The other factor that a lot of people forget is that demand for pilot labor in the regional airline industry is going to shrink rapidly over the next few years. Delta is dropping about 200 50 seat jets in the next 2 years, and replacing them with 40 large regional jets and around 70 mainline aircraft. So while Delta is hiring for mainline service, it's making even more regional airline pilots redundant. United and American are also adding 76 seat RJs at the expense of 50 seaters, though not at the same pace as Delta.

    Looking at it from another angle, AA is planning to hire 1500 pilots over the next 5 years. If it received 4000 applications in the first 24 hours, that suggests that most pilots who want to move to a mainline carrier won't get the job.

    Bottom line: I agree that on the edges, Republic may have trouble recruiting pilots. But it has tons of small regional jet contracts expiring next year. If it faces a serious pilot shortage, it just won't renew all of those contracts, which barely cover variable costs anyway. In any case, most of those contracts are with Delta and will go away by the end of 2015 at the latest. The move up from 50-seaters to 76 seat jets within Republic's fleet will take the edge off the likely pay increases for pilots going forward.

    Adam

  • Report this Comment On December 03, 2013, at 4:28 PM, zblackdog wrote:

    Check out Air Canada instead-I've been in it since it was $1.98 earlier this year-now in the $7.50 range with P/E less than 10. It's a 3-bagger for me already this year.

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