Republic Airways Holdings Inc. Is a Solid Value Now

After rallying in 2012 and early 2013, Republic Airways Holdings (NASDAQ: RJET  ) stock has gone into a big slump. The stock recently hit a new 52-week low more than 40% below its mid-2013 high.

RJET Chart

Republic Airways Five-Year Stock Chart, data by YCharts

Republic Airways and other regional airlines, such as SkyWest (NASDAQ: SKYW  ) , have faced more than their share of problems recently. Legacy carriers have become less interested in using the 50-seat jets that are so plentiful at regional airlines. Meanwhile, a combination of low pay and new regulations has created a shortage of regional airline pilots. Lastly, bad weather caused airlines to cancel tens of thousands of regional flights this winter.

Nevertheless, Republic Airways looks extremely undervalued today. The company's inability to agree on a new contract with its pilots will force it to shrink in the next few years, but it will also reduce costs and free up cash that can be returned to shareholders.

Pilots fight back
Regional airline pilots have become increasingly militant as the pilot shortage has given them newfound bargaining leverage. Pilots at SkyWest subsidiary ExpressJet and American Airlines (NASDAQ: AAL  ) subsidiary American Eagle recently rejected contract proposals that entailed concessions on the pilots' part.

Earlier this month, Republic's pilots rejected a new contract offer, even though it included raises and a signing bonus. Clearly, the Republic pilots believed that the raises and work-rule changes were not good enough.

Several regional airline pilot unions have rejected contract proposals recently. Photo: Republic Airways

The contract rejection means that Republic will continue to have trouble recruiting pilots. (Since Republic's pilots are unionized, the company cannot unilaterally offer higher pay to attract new pilots.) This means that Republic will park more 50-seat jets in the next two years or so, a process it began earlier this year.

The benefits of the contract rejection
But there are compensating benefits for Republic Airways. The company had been budgeting for significant pilot raises and a signing bonus in 2014. The cost of implementing the new contract was the biggest reason why CFO Tim Dooley originally projected that EPS would probably decline year over year to a range of $0.90-$1.20.

Now that pilots have rejected the contract, Republic will not be on the hook for the raises or the signing bonus. The company has not quantified the impact of these changes yet, but they are likely to be significant.

Additionally, without a new pilot contract in place, Republic Airways cannot consider growth initiatives. As a result, it does not need to keep extra capital around to invest in future growth. Instead, the company plans to return $75 million to shareholders through a combination of share repurchases and early retirement of convertible debt. This could shrink the diluted share count by about 15%, providing a corresponding boost to EPS.

Between the lower labor costs and lower share count, Republic is now on track to post significantly higher EPS than originally expected, both for 2014 and the next few years. The average analyst estimate for 2014 has already risen from $1.04 to $1.09 in the last week, and it is likely to rise further when Republic updates its guidance later this month.

Foolish wrap
As I have noted in previous articles, among regional airlines, Republic Airways is relatively well positioned because it has fairly low exposure to small regional jets. While competitors like SkyWest are still flying hundreds of these inefficient planes, Republic is down to several dozen, compared to its nearly 200 larger regional aircraft.

It's not all smooth sailing ahead for Republic. It will continue to face a drag from the scarcity of pilots, which has forced it to ground some of its small regional jets prematurely.

But Republic Airways is arguably the strongest player in the regional airline sector. Moreover, the company trades for around seven times earnings and well below book value -- making it an attractive value investing opportunity. As a result, I increased my investment in Republic Airways last week.

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

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  • Report this Comment On April 16, 2014, at 9:01 AM, Inspectigator wrote:

    Republic will be losing pilots quickly to the major airlines and the large low-cost airlines like JetBlue, Spirit, Frontier, etc. That is happening, not something in the future, and it is accelerating, not just something simmering in the background they can adjust for. The industry will change dramatically this year and more over the next few years. There are very few young American pilots in flight schools, over 90% are foreign students, it takes at least eight years to make a pilot, and nearly every pilot at the major U.S. airlines will hit mandatory retirement age in the next 15 years. That retirement bubble hasn't hit yet, and airlines are short of pilots to hire already, not a good mix. It is too late to fix this, but good to start preparing for the changes.

    Republic will see very high ticket prices, and they will shrink to only their most profitable routes, that could be good, but they have a lot of fixed costs to shed to make this work.

  • Report this Comment On April 17, 2014, at 10:56 AM, Skyflier wrote:

    While i agree with most all of Inspectigator's comments, there is one error I noticed. Airline ticket prices and route profitability are irrelevant to Republic. They receive a fixed fee for departure. Whether they have 1 passenger onboard or have a 100% load factor,they receive the same revenue. Additionally, one of the largest expenses incurred by airlines is fuel. Since Republic is reimbursed for the fuel consumption by the airlines it operates for this helps with keeping its cost fixed.

  • Report this Comment On April 18, 2014, at 10:48 AM, TMFGemHunter wrote:

    @Inspectigator: Based on what I've read, the 3 major airlines are hiring on average maybe 30-50 pilots per month each. That's around 1,500 per year. Southwest is in the middle of shrinking its fleet count so it's hiring classes are probably much smaller. All of the smaller airlines together probably need to hire at most 500 pilots this year. (Growing airlines like Spirit and JetBlue need 8-10 pilots per airplane.)

    Meanwhile, most regional airlines (the exceptions that come to mind are Republic and Mesa) are shrinking, so they need fewer pilots. There are something like 15,000-20,000 regional pilots today. So yes, there are pilots leaving, but it's not like every regional airline pilot is going to be working at a major in 2-3 years. Over the next 10 years or so, most current regional airline pilots will get opportunities to move to mainline carriers. But there will be new pilots to fill their shoes -- the question is just what pay level is needed to balance supply and demand.


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Adam Levine-Weinberg

Adam Levine-Weinberg is a senior Industrials/Consumer Goods specialist with The Motley Fool. He is an avid stock-market watcher and a value investor at heart. He primarily covers airline, auto, retail, and tech stocks. Follow him on Twitter for the latest news and commentary on the airline industry!

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