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This Underrated Airline Just Posted Another Profit

By Adam Levine-Weinberg – Aug 3, 2021 at 8:21AM

Key Points

  • SkyWest recorded a strong sequential improvement in its revenue and posted a solid GAAP profit last quarter.
  • Management expects SkyWest to remain profitable in the second half of 2021 despite heavy spending on maintenance and the upcoming end of the airline payroll support program.
  • SkyWest is poised to expand its fleet of two-class regional jets significantly by mid-2023, paving the way for record earnings within two years.

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The largest regional airline expects to be profitable in every quarter of 2021, whereas most of the industry remains early in the recovery process.

The U.S. airline industry's recovery from its pandemic-induced downturn has accelerated in a big way over the past several months. Nevertheless, most major airlines continued to lose money in the second quarter.

Regional airlines that get much of their revenue from fixed-fee contracts have fared better than the rest of the industry, though. Indeed, SkyWest (NASDAQ: SKYW) returned to profitability in the first quarter, when most airlines were still reporting massive losses. Not surprisingly, the top regional airline's earnings improved again last quarter.

A solid profit

In the second quarter, SkyWest's flight activity increased 17% sequentially and 157% year over year to 324,045 block hours. This put block hours just 13% below the level of Q2 2019. As a result, SkyWest generated $657 million of revenue: up 88% year over year and down just 12% from the second quarter of 2019. This easily beat the average analyst estimate of $600 million.

The strong revenue recovery helped SkyWest post a pre-tax profit of $81 million and net income of $62 million ($1.22 per share) under generally accepted accounting principles. A quarter earlier, its GAAP profit totaled $0.71 per share.

A SkyWest plane in the Delta Connection livery preparing to land.

A SkyWest regional jet operating for Delta Air Lines prepares to land. Image source: SkyWest.

To be fair, SkyWest's Q2 results included $114 million of payroll support grants, supporting the company's profitability. That said, SkyWest has been passing along much of the benefit from these grants to its major airline partners through temporary rate reductions. Excluding the payroll support grants and the related rate reductions, SkyWest still would have been profitable last quarter.

Expecting continued profitability

During SkyWest's earnings call last week, CFO Robert Simmons predicted that the company's GAAP results in the third quarter will be similar to its second-quarter performance. Importantly, SkyWest should remain profitable in the fourth quarter despite less-favorable seasonality and the expected end of the federal payroll support programs on Sept. 30.

This guidance appears to be conservative (as was the case for SkyWest's initial Q2 outlook). First, SkyWest plans to increase block hours 13% sequentially this quarter, which should boost its revenue and earnings. Second, strong summer leisure travel demand should drive better results for the small piece of SkyWest's business that does not operate on a fixed-bee basis.

SkyWest does face a big near-term headwind from maintenance costs. It spent $395 million on maintenance in the first half of 2021 -- up from $243 million in the first half of 2019 -- driven by deferred maintenance from 2020, a change in the mix of its flying contracts, and work needed to put aircraft in long-term storage back into service. Management expects to continue spending around $200 million a quarter on maintenance in the second half of 2021 before maintenance costs normalize somewhere between 2019 and 2021 levels next year.

Huge upside for this misunderstood stock

SkyWest stock rallied dramatically in February and early March but has since surrendered all of its gains. The stock now trades for around $40: 40% below its early 2020 high.

SKYW Chart

SkyWest stock performance, data by YCharts.

At this level, SkyWest stock appears severely undervalued. First, the company has actually strengthened its balance sheet during the pandemic, reducing net debt by over $400 million compared to the end of 2019. Second, the regional airline is seeing strong demand for its services from major airlines. Over the past three months, it has signed new contracts covering 20 aircraft and dozens of renewals.

Importantly, SkyWest's fleet transition toward larger, two-class regional jets has continued during the pandemic. Major airlines strongly prefer these larger jets for their regional operations, making them more profitable to operate than the single-class 50-seat jets that used to represent the backbone of the U.S. regional jet fleet. SkyWest ended the second quarter with 337 two-class regional jets in its fleet, up from 293 at the end of 2019. SkyWest has another 50 two-class jets under contract to enter service by mid-2023.

As a result, SkyWest's revenue is set to rise well beyond the $3 billion it generated in 2019 by 2023. With maintenance expense likely to subside from today's level by next year, adjusted earnings per share could soar past the previous high of $6.25 set in 2019. That makes SkyWest stock a steal at $40.

Adam Levine-Weinberg owns shares of Delta Air Lines and SkyWest and is short December 2021 $65.0 calls on SkyWest. The Motley Fool recommends Delta Air Lines. The Motley Fool has a disclosure policy.

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