Regional airlines are under immense pressure today. Legacy carriers have become less and less interested in hiring regional airlines to fly fuel-guzzling 50-seat regional jets. Meanwhile, new pilot training rules and high demand for new pilots at larger carriers have made it extremely hard for regional airlines to attract and retain qualified pilots at their traditional meager wage rates.
Top regional airline SkyWest (NASDAQ:SKYW) has already projected a Q1 loss due to these issues as well as an unprecedented number of weather-related cancellations in the first two months of 2014. The company's ExpressJet subsidiary -- which flies lots of 50-seat jets -- is expected to post another big loss this year. Overall, analysts expect SkyWest's EPS to decline by a third in 2014.
Smaller regional airlines are in even worse shape. For example, Great Lakes Airlines has had to cut its schedule drastically due to a severe pilot shortage. However, one regional airline is in better shape than any of the others due to its comparatively low exposure to 50-seat jets: Republic Airways (NASDAQ: RJET).
A different model
Today, Republic Airways has approximately 248 aircraft in its operating fleet. Of those planes, 68 are the small regional jets that are rapidly going out of style. However, the vast majority of Republic's planes are larger regional jets that seat 70-80 passengers. Republic has 147 of these aircraft. The rest of the fleet is made up of 28 large turboprops and 5 99-seat jets used for charter service.
Unlike 50-seat regional jets, larger regional jets -- and to a lesser extent, large turboprops -- are as popular as ever with the legacy carriers. These aircraft have enough space for first-class and premium economy sections, which bring in extra revenue, but are much cheaper to operate than mainline aircraft on a per-trip basis.
While Republic is better positioned than competitors from a fleet-mix perspective, that does not mean it's immune to the ongoing crisis in the regional airline industry. Like other regional airlines, Republic has had trouble hiring and retaining pilots due to the increasing demand for qualified pilots at mainline carriers and Republic's comparatively low wages.
Republic has been trying to address the wage part of the equation, but for most of 2013, contract negotiations between Republic and its pilot union were stalled. However, the two sides reached a tentative agreement last month that is expected to significantly improve pilot pay. Pilots will vote on the agreement this month. If they ratify it, Republic will be better able to attract and retain good pilots.
In the meantime, Republic has had to cut back its small regional jet flying due to a shortage of pilots. Last month, the company notified investors that it would remove 27 of its 44 and 50-seat jets from service this year. This will free up pilot labor for the scheduled growth in its profitable 76-seat regional jet flying for American Airlines (NASDAQ: AAL).
As a result, Republic will end all of its small regional jet flying for American and United Continental (NYSE: UAL) by mid-August. Even though this flying barely breaks even, parking these planes will depress Republic's 2014 pre-tax income by around $18 million, since the company is still responsible for the ownership costs for these aircraft.
Managing the headwinds
All things considered, Republic is managing the regional airline industry's headwinds very well. The company expects to be solidly profitable this quarter, unlike top rival SkyWest, although it has also had to cancel thousands of flights due to winter weather. For the full year, Republic expects EPS of $0.90-$1.20. This compares to EPS from continuing operations of $0.92 last year, or approximately $1.16 excluding a one-time impairment charge.
While this implies that Republic's adjusted earnings are likely to decline, at the midpoint of the guidance range it's a very modest 10% decline. That includes three significant negative impacts: the cost of heavy flight cancellations in January and February; the cost of taking 27 small regional jets out of service; and the cost of significantly raising pilot pay.
Republic also has an opportunity to mitigate some of these expenses. CEO Bryan Bedford told analysts last week that there was a possibility that Republic could get rid of up to 15 small regional jets this year -- either by selling or by subleasing them. Additionally, if the new pilot agreement improves Republic's ability to hire pilots, the company may be able to put a few idled small regional jets back into service.
Foolish bottom line
As one of the regional airlines with the lowest exposures to small regional jets, Republic is well-positioned within an admittedly troubled sector. Despite all of the headwinds it faces this year, Republic's earnings will only decline marginally in the most likely scenario. Furthermore, Republic Airways stock trades for just nine times the midpoint of its EPS guidance.
Whereas SkyWest is coping with big losses in its ExpressJet division and many smaller regional airlines are in even more dire straits, Republic Airways will remain solidly profitable during this period of transition in the regional airline industry. If competitors falter, Republic may see new growth opportunities fall into its lap in the coming years.