Value investors often look at the relationship of a company's "book value" to its market cap as one test of whether a particular stock may be undervalued. Most stocks trade for more than book value, which essentially indicates that investors think most businesses are worth more than the sum of their parts.

Today, in the otherwise high-flying airline sector, two companies still trade for less than book value: Republic Airways (NASDAQOTH:RJETQ) and SkyWest (NASDAQ:SKYW). Both carriers have been affected by the changing economics of the regional airline industry. However, either one could turn out to be a bargain in disguise.

Understanding book value

Book value is the difference between a company's assets (e.g., cash, receivables, and property) and its liabilities (e.g., debt, outstanding bills, and pension obligations). In theory, book value is the amount shareholders would receive if the company were liquidated -- although assets often must be sold at a discount in the case of liquidation. 

Just two years ago, several airline stocks were selling for less than book value, including JetBlue Airways and Southwest Airlines. However, most airline stocks have rallied since then, leaving just Republic and SkyWest trading for less than book value.

JBLU Price to Book Value Chart

Airline Price to Book Value, data by YCharts.

These low price/book ratios mean that investors think Republic and SkyWest cannot earn adequate returns on invested capital. Furthermore, investors think the companies are unable or unwilling to shed assets that are not generating adequate returns.

Republic Airways: already on the mend

Republic Airways trades at a slight (3%) discount to book value as of September 26. Yet even this seems overly harsh on investors' part. While Republic's profitability has been uneven in recent years, the company has taken major steps to bolster its performance.

Just in the last year, Republic finalized an agreement to sell its underperforming Frontier Airlines subsidiary and took steps to simplify its regional airline operations from four aircraft types today to just one by Q3 2016. In the meantime, Republic is growing its fleet of Embraer E-170 and E-175 aircraft, which make up the most profitable part of its business.

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Republic Airways is growing its fleet of large regional jets. Source: Republic Airways.

These moves are already paying off, as Republic expects its adjusted pre-tax income to rise from $103 million last year to approximately $114 million in 2014. The benefits will accelerate in the next two years. Moving to a single fleet type will allow Republic Airways to save millions of dollars in administrative costs while also boosting pilot productivity and cutting training costs.

The major challenge for regional airlines is that it is becoming difficult to recruit new pilots at the low starting salaries typical in the regional airline industry. However, Republic is in a better position than any of its peers to raise pilot salaries. First, it already has a solid pre-tax margin above 8%. Second, its fleet strategy will boost profitability, freeing up cash for pilot raises.

In addition to trading slightly below book value, Republic Airways is also valued at just 8 times projected 2015 earnings. The stock looks like a good value play from any angle.

SkyWest: beginning a turnaround

SkyWest is a trickier case than Republic Airways. SkyWest is by far the largest operator of 50-seat regional jets in the world. These planes have gone out of favor with major airlines because of their high fuel consumption and cramped cabins. As a result, SkyWest's profitability has plummeted recently.

SkyWest reported a big loss in the first half of 2014. Some of this was caused by one-time factors such as unusually bad winter weather and training costs related to new pilot regulations. However, SkyWest's ExpressJet subsidiary also confronts structural problems: It operates the bulk of the company's 50-seat jets, and also has a number of unfavorable contracts.

Thus, ExpressJet posted a segment loss of $88.5 million in the first half of 2014, while SkyWest's other subsidiary, SkyWest Airlines, earned $42.7 million in the first half of 2014. Given the resulting loss, and the ongoing problems at ExpressJet, perhaps it's not surprising that SkyWest shares trade at a 69% discount to book value.

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Shares of regional airline SkyWest trade at a 69% discount to book value. 

In the company's Q2 earnings report, SkyWest announced that "2014 and the first half of 2015 will be a significant transition period for SkyWest." Most notably, SkyWest is adding 40 more large regional jets at the SkyWest Airlines subsidiary, while it is dumping more than 150 50-seat jets, mostly from ExpressJet.

In other words, SkyWest plans to return to profitability by winding down the loss-making parts of its business while adding more large regional jets (which generate most of its earnings). The management team has learned that "bigger isn't necessarily better," according to SkyWest President Chip Childs.

By the end of 2015, SkyWest will be in a much better position to be sustainably profitable. Furthermore, the company's cash flow is better than its earnings would suggest. Lastly, SkyWest expects to end 2014 with about $500 million in cash -- more than its entire market cap. For patient investors, investing in SkyWest today could eventually bring big rewards.

Two potential great values

Republic Airways and SkyWest have both been caught up in the broader problems of the regional airline industry. However, as two of the strongest regional airlines, they should be able to navigate these challenges. Republic has already made a lot of progress in turning its business around, while SkyWest has a fairly straightforward plan to do the same.

Nevertheless, both companies' stocks trade for less than book value, making them good targets for value investors. Investing in turnarounds is risky, but in the cases of Republic and SkyWest, the potential rewards may outweigh the risks.

Adam Levine-Weinberg owns shares of JetBlue Airways and 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.