Last Thursday, Republic Airways (NASDAQOTH:RJETQ), the No. 2 U.S. regional airline operator, filed for bankruptcy. This might seem like bad news for Brazilian jet maker Embraer (NYSE:ERJ), because Republic is one of its biggest customers.
However, while Republic is facing some financial distress right now, it is likely to keep most or all of its outstanding aircraft orders, as Embraer's E175 jet remains profitable for regional airlines to operate. Furthermore, even if Republic had to cancel some of its orders, they would likely be picked up by other U.S. regional airlines.
Republic files for bankruptcy
Regional airlines have faced a growing pilot shortage in recent years, due in part to low starting pay. Republic Airways was particularly hard hit last year because of an ugly battle with its labor union that prevented it from raising its first-year pilot pay.
Republic finally reached an agreement with its pilot union in late 2015. However, while the resulting pay increase helped somewhat in terms of hiring new pilots, the company was woefully understaffed by that point and couldn't catch up. This made it impossible for Republic to operate all the flights it had promised to fly for mainline partners like United Continental (NYSE:UAL).
Republic hints at its strategy
Republic expects to continue business as usual while going through the bankruptcy process. To restructure successfully, it will need to match its aircraft fleet and flying commitments to the amount of flying it can handle based on pilot availability.
Given that pilot staffing is Republic's key constraint, the company has a strong incentive to keep its most profitable flying contracts (and the associated aircraft) while dumping more marginal ones.
This means that Republic is likely to accelerate its shift toward a single fleet type consisting of Embraer's E170 and E175 jets. Indeed, in the press release announcing its Chapter 11 filing, the company stated, "Our restructuring will maintain Republic as the world's largest operator of EJET aircraft."
Republic had already planned to remove all of its Q400 turboprops within the next couple of quarters. It had also intended to retire its fleet of 50-seat Embraer 145 jets by mid-2016, but last year, Delta Air Lines unexpectedly extended Republic Airways' contract to operate these marginally profitable jets until 2021.
Republic's best move is to get out of its E145 contract in order to free up pilots to fly the more profitable E170 and E175 jets. These two models are the most popular regional jets today due to their wider seats, tall ceilings, and low operating costs. They also share the same type rating, so pilots can fly either model without the need for retraining.
Republic's E175 orders are safe
At the end of 2015, Republic Airways had 28 outstanding E175 orders with Embraer, with deliveries scheduled for 2016 and 2017. Embraer has already delivered four E175s to Republic in the first two months of the year, leaving 24 firm orders in its backlog.
These orders are probably safe. The operational and financial benefits of operating a single fleet type and the relative profitability of the E175 should push Republic to keep growing its E175 fleet, even as it shrinks overall.
Additionally, it's important to remember that Republic is ultimately operating regional flights on behalf of major airlines. Its current E175 orders are part of a contract with United Continental. Even if Republic can't or won't buy the remaining E175s it has ordered, United still needs these planes to retire older, less-efficient jets in its regional fleet.
As a result, if Republic were to reject any of its remaining E175 orders, United Continental would probably find another regional airline to operate those planes. Today, Republic is one of three companies operating E175 regional flights for United. There might be some changes to the timing of the delivery schedule, but Republic's woes aren't likely to change United's long-term regional fleet plan.
No major cause for concern
In short, Republic Airways will probably restructure by moving to a single fleet type of E170 and E175 jets. While this would entail getting rid of its smaller Embraer 145 jets, that model is already out of production, so it wouldn't matter much for Embraer.
The E170 and E175 planes (particularly the latter) remain in high demand among the big U.S. airlines for their regional fleets. That means Republic is likely to keep its existing orders with Embraer. And even if it has to cancel some E175 orders, United Continental or its other regional affiliates will step into the gap in short order.
Adam Levine-Weinberg owns shares of Embraer-Empresa Brasileira and United Continental Holdings, and is long July 2016 $25 calls on Embraer-Empresa Brasileira and long Jan. 2017 $40 calls on Delta Air Lines, 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.