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SkyWest: A Business Under Threat

http://www.fool.com/investing/general/2013/06/19/skywest-a-business-under-threat.aspx

Adam Levine-Weinberg
June 19, 2013

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 regiona