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.
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.
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.