A few weeks ago, Republic Airways (NASDAQ: RJET) finally resolved a contract dispute with its pilots that had dragged on for a staggering eight years. The new contract implemented late last month gave Republic's pilots industry-leading pay and work rules, including a 74% jump in pay for first-year pilots.
However, the acrimonious negotiations increased the pilot attrition rate and reduced hiring this year. This undermined Republic's earnings power as it missed contract incentives and underutilized its fleet.
Last week, Republic Airways executives provided an update on their plans for the next few quarters in conjunction with the company's Q3 earnings report. The big takeaway was that Republic still has a lot of obstacles to overcome in order to get its operational and financial performance back on track.
The pilot shortage is even worse than feared
Through the first nine months of 2015, Republic's GAAP earnings per share plummeted 73% year over year. The majority of this sickening drop was attributable to a shortage of pilots, which reduced revenue production more than it reduced costs. For example, daily aircraft utilization was down 7.1% year over year in Q3.
That's why I wrote earlier this month that Republic's No. 1 task for the next few quarters is to hire and train as many pilots as possible. Republic needs to get its pilot ranks back to the level needed to fully utilize its fleet and hit its operational reliability targets.
Unfortunately, it looks like Republic's management has already conceded defeat on that front. The company entered 2015 short about 100 pilots. After losing roughly 30 pilots (net of new hires) during the first half of 2015, Republic lost about 160 pilots in the past four months as the labor tensions reached a boiling point.
Attrition has settled down and hiring has increased since the contract was signed in late October, but Republic remains approximately 300 pilots short of its goal. (That's a nearly 15% shortage.) As a result, it has asked mainline partners like United Continental (NASDAQ:UAL) and Delta Air Lines to reduce its flying schedule through the first half of 2016. This means aircraft utilization will remain depressed for at least a few more quarters.
CEO Bryan Bedford also revealed on the earnings call that Republic has a tentative agreement in place to cancel orders for 24 E175 aircraft. Those planes were supposed to be flown for United Continental. This reduces Republic's pilot needs and capital requirements, but it also implies a long-term reduction in the most profitable portion of its business.
Training bottlenecks developing
Hiring enough pilots to offset ongoing attrition and the existing deficit of 300 pilots would be challenging by itself. Republic Airways is also running up against the limits of its training resources, which adds another complication.
In addition to hiring new pilots, Republic is accelerating the process of removing turboprop planes flying for United in order to retrain pilots on the E170/E175 fleet, which will be the company's main aircraft type going forward. Based on the size of the turboprop fleet, there are probably about 200 pilots that need to be retrained by next summer.
However, Republic can only train 48 pilots a month for now. Given how many pilots need to be retrained in the coming months, that's barely enough to tread water. Republic plans to increase its training capacity to 90 per month by sometime next quarter, which will finally allow it to start cutting into its current pilot shortage. But that means the company probably won't be fully staffed until late 2016 at best.
Restructuring plans add long-term uncertainty
While the aftereffects of Republic's labor unrest will continue to be felt in 2016, the company could be back to normal operations by 2017 or so. That's comforting, but there is another wrinkle: Republic Airways is asking its mainline partners to chip in more than they are contractually obligated to pay, in order to cover the cost of increased pilot compensation.
In a best case scenario, Republic will have to offer financial compensation, such as warrants or convertible debt, to entice its mainline partners to restructure their contracts. For a company like United -- which has been asked to reduce Republic's flying over a multiquarter period, modify the turboprop retirement schedule, and sharply curtail the growth of E175 flying performed by Republic -- that compensation could be substantial.
In a worst case scenario, Republic or one of its subsidiaries might have to file for bankruptcy in order to force a restructuring of its contracts in court. Either way, it leaves a lot of risk for shareholders.
Finally, even if all of these issues are resolved by 2017, the recently signed pilot contract runs for just three years. By 2018, as the industrywide pilot shortage worsens, Republic could be forced to hand out another round of big raises.
Republic Airways stock looks extremely cheap relative to its 2013-2014 earnings power. Even if earnings only recover to 60%-70% of their previous level, the stock could make some nice gains from Tuesday's closing price of $4.57 -- if that earnings recovery were sustainable. Based on the currently available evidence, there's no guarantee this would be the case.