These 2 Regional Airlines Continue to Go in Opposite Directions

Republic Airways is on the rise, but SkyWest is still floundering.

Jul 16, 2014 at 5:45PM

America's top two regional airlines -- SkyWest (NASDAQ:SKYW) and Republic Airways (NASDAQ:RJET) -- both embarked on ill-fated acquisitions in the immediate aftermath of the Great Recession. Both companies have since learned a harsh lesson: "If it ain't broke, don't fix it."

Today, Republic Airways has put its problems in the past. It is poised for a big jump in earnings this year and seems likely to become a cash cow following the delivery of its last few Embraer (NYSE:ERJ) 175 jets in early 2015. By contrast, SkyWest's problems have only gotten worse in the last couple of years. For now, Republic and SkyWest are headed in opposite directions.

Two different paths to trouble
Within a span of weeks in 2009, Republic Airways bought two small, struggling mainline carriers: Midwest Airlines and Frontier Airlines. Republic had lent money to both airlines and was also operating regional flights for both, so it wanted to protect its investments.

Eventually, Midwest and Frontier were merged under the Frontier Airlines name, but the combined airline continued to struggle. Republic realized that it did not have the financial or management resources to effect a complete turnaround. Thus, after a drawn-out bidding process, Republic Airways sold Frontier to private equity firm Indigo Partners late last year.


Republic's acquisition of Frontier in 2009 was a bust. Photo: The Motley Fool

Meanwhile, SkyWest spent $133 million to add another regional airline -- ExpressJet -- to its stable of subsidiaries in 2010. SkyWest hoped to drive a significant increase in earnings through merger synergies.

Instead, ExpressJet has become a huge drag on SkyWest's earnings power. SkyWest eventually merged its Atlantic Southeast Airlines subsidiary into ExpressJet, and this combined ExpressJet segment lost $18.5 million in 2012 and $49.0 million in 2013.

Republic Airways moves forward
Republic Airways still seemed to be in a weak position in early 2014. The company provided initial guidance for 2014 earnings of $0.90-$1.20, which would have represented a year-over-year decline at the midpoint of the range. Republic's management cited headwinds from labor costs, lack of pilot availability, and severe winter weather.

However, Republic Airways pilots overwhelmingly rejected a new contract agreement that had been expected to significantly raise Republic's costs. Furthermore, without a new pilot contract, Republic decided it was not in a position to pursue growth opportunities, and it therefore did not need as much cash on its balance sheet. Accordingly, Republic's board authorized a $75 million debt and stock buyback.

These developments -- along with additional cost savings identified -- dramatically improved Republic's 2014 earnings outlook. In late April, Republic projected that EPS would reach $1.20-$1.40 -- significantly above the original guidance range.


Republic is adding 47 higher-margin Embraer 175 planes to its fleet. Photo: Republic Airways

Republic also posted better-than-expected cost performance last quarter. In April, it planned to generate EPS of $0.30-$0.35 in Q2; however, earlier this month it raised its guidance range to $0.35-$0.40.

Good things are happening at Republic Airways, and EPS should grow again in 2015 thanks to the addition of more high-margin Embraer 175 regional jets to its fleet. Yet despite these positive developments, Republic Airways shares trade for just more than eight times projected earnings.

On the other hand...
The picture is not nearly as rosy at SkyWest. Whereas Republic Airways is rapidly phasing out its remaining 50-seat regional jets, small regional jets constitute the majority of SkyWest's fleet: approximately 500 of its 753 aircraft. This is unfortunate because these small regional jets are going out of favor in the U.S. airline industry.


Small regional jets represent roughly two-thirds of SkyWest's fleet today. Photo: The Motley Fool

SkyWest's disproportionate reliance on small regional jets can be traced mainly to the ill-fated acquisition of ExpressJet, which operated about 250 50-seat Embraer regional jets. Even worse, many of ExpressJet's contracts have been locked in at below-market rates and offer little or no compensation if partners choose to cancel ExpressJet flights.

The logical result is that when ExpressJet's partners need to proactively cancel flights due to bad weather, they cancel ExpressJet flights first. Thus, the bad weather in Q1 -- which negatively affected Republic Airways' earnings by $7 million -- dragged down SkyWest's Q1 earnings by more than $30 million, driving a net loss for the quarter.

In Q2, SkyWest has continued to experience a higher-than-normal level of flight cancellations. In May, the company projected that it would operate more than 589,000 block hours in Q2, but it ultimately came up short by about 10,000 block hours (nearly 2%).

Foolish bottom line
Despite its ongoing struggles, there are still some reasons to like SkyWest. It has a ton of cash on its balance sheet, and it should be able to boost its earnings significantly as its current below-market flying contacts expire. It also began to add large Embraer regional jets to its fleet earlier this year, which should stimulate margin growth.

But Republic Airways is way ahead of SkyWest in the transition to high-margin large regional jets. This shows up in its solid earnings power and strong future cash flow prospects. As a result, Republic is the better investment opportunity today.

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Adam Levine-Weinberg owns shares of Republic Airways Holdings and is long November 2014 $7.5 calls on Republic Airways Holdings. The Motley Fool recommends Embraer-Empresa Brasileira. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

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Jun 12, 2015 at 5:01PM

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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