Last week, Republic Airways (NASDAQ: RJET) finally closed its long-running labor dispute with its pilots. The pilot labor group had rejected a contract proposal negotiated last year, and union leaders refused to send a "last, best, and final offer" to their membership this summer, but the final agreement reached in late September was ratified by a solid 76%-24% margin.
That doesn't mean the company has clear skies ahead -- at least not yet. To get its profitability back up to its long-term target, Republic will need to get its operations back on track. And that means it will need to hire a lot of new pilots.
Pilot shortage snarls Republic's operations
During the first half of 2015, Republic Airways' pre-tax income plummeted to $20.3 million from $56.1 million a year earlier. About half of the year-over-year drop can be attributed to fleet transition costs as the company works through a fleet simplification strategy. The other half of the decline was caused by a severe pilot shortage that devastated Republic's reliability.
The problem is twofold. First, there is a broader pilot shortage affecting the regional airline industry, and Republic's labor dispute aggravated the situation. On one hand, Republic's pilot attrition rate increased. On the other hand, the pilot union sued to stop the company from offering big signing bonuses to new hires, which made it even harder to recruit pilots.
Second, as labor tensions heated up, Republic began to suffer from an elevated level of crew-related cancellations. According to CEO Bryan Bedford, while Republic implemented a "premium pay program" to give pilots incentive to voluntarily pick up open trips, the union discouraged pilots from doing so.
As a result, Republic had to cancel a lot of flights early in the year and therefore missed out on operational reliability incentives from its mainline partners. To address this problem, the company reduced its flying during the peak spring and summer seasons, which also damaged its profitability by affecting aircraft usage.
To afford the estimated $50 million annual cost of the new pilot contract, Republic needs to maximize its aircraft utilization and hit its reliability incentive targets. In 2014, when it did so, Republic earned a $120 million adjusted pre-tax profit -- about four times what analysts expect for 2015.
More pilots needed
With the pilot contract now ratified, Republic should have more luck using premium pay incentives to fill open shifts. That should immediately improve its reliability. Nevertheless, it still faces a significant pilot shortage. Additionally, Republic Airways' fleet is scheduled to grow by about 10% over the next two years.
Thus, the company's most important task for the rest of 2015 and 2016 is to go on a pilot hiring binge. Doing so is a tough task, because regional airlines have had trouble finding qualified pilots who meet their standards.
Republic's new pilot contract should help in a big way, because it raises first-year pay by 74% to $40 per flight hour (roughly $40,000 a year, though this figure can vary quite a bit). By contrast, No. 1 regional airline SkyWest (NASDAQ:SKYW) pays new pilots $30 per flight hour. Republic's pay rates for more experienced pilots are also now roughly in line with SkyWest's rates.
SkyWest does have the ability within its new pilot contract to raise first-year pilot pay as high as $36.50 an hour. That would make it more competitive, but it would still leave Republic with a significant pay advantage. (Starting pay tends to be even lower at smaller regional airlines.)
Another advantage Republic has in the recruiting battle is the high concentration of relatively new two-class E-Jets in its fleet. Pilots tend to prefer flying these newer planes. SkyWest's fleet is also moving in that direction, but it still has a large number of older jets, especially cramped 50-seat planes.
Looking for details this week
By getting its operational reliability back on track, increasing aircraft utilization to historical levels, and growing its fleet of more-profitable large regional jets, Republic Airways would be able to bolster its profitability. Taking these steps could offset the cost of its new pilot contract, as well as the other drivers of its steep profit decline this year.
However, all of these things depend on Republic's ability to hire and train enough pilots to fill its current vacancies, offset ongoing attrition, and prepare for growth. The company is now in a much better position from a pay and work-rules perspective to compete with top rival SkyWest for new pilots.
It remains to be seen whether that's enough to solve Republic Airways' staffing problems, given the scale of the pilot shortage confronting the regional airline industry. Investors can hope that management will be able to shed some light on that question on the company's earnings call later this week.