Readers Love Republic Airways
We have a great dialogue going here in Small Cap Investor Daily on Republic Airways Holdings (NASDAQ: RJET). You responses to this week's discussion of the pummeled small-cap airline stock keep pouring in. When there is this much interest in a particular stock, I'm going to run with it. So today I'm going to share a few more interesting and insightful responses from your fellow readers.
But before I open up the floor, take a quick look at a chart of Republic Airways stock dating back to the beginning of 2005. A brief look at the stock's historical performance will help put our discussion into context, and round out today's issue.
Of course, we want to know how this stock is doing right now too. We've been tracking the stock's performance as of the close on Friday February 19th when it was trading at $5.34 per share. As of yesterday's close the stock is down 4.3%. How does this compare to the industry? The AMEX Airline Index (AMEX: XAL) provides a nice benchmark since it tracks the aggregate performance of major U.S. and international airlines. You can find out more about the companies in the index on the Yahoo! Finance website (note that Republic Airways is not part of the index). Since last Friday's close, the XAL is essentially flat, so Republic Airways is underperforming.
One reader wrote in with these comments and questions. "I read your analysis of Republic [Airways] with great interest. The stock seems speculative but can the company go bankrupt? It has not provided financial statements for December but the upside is that it bought Frontier for [the] price of a song and could leverage its acquisitions for long run stability. Any further comments or insight might be greatly appreciated."
This writer's question about the risk of bankruptcy is sure to resonate with shareholders and potential Republic investors. It's an ugly word, but is has been so common with airlines that it bears consideration. Here's the thing, bankruptcy with airlines is almost always on the table. It might not be today, or tomorrow, but the threat is always looming. Since Congress deregulated the airline industry in 1978, hundreds of entrepreneurs have started airlines. Many of them have failed.
Take a look at the Air Transportation Association's website for a list of airline companies that have filed for bankruptcy or stopped service and you'll see what I mean. I counted over 180 since 1979, with 46 since 2000. Frontier airlines (a company Republic Airways just purchased) made the list twice. The first time Frontier failed was in 1986 when it helped to bring down one of the fastest growing airlines in history, Peoples Express.
What else helped to bring down Peoples Express? Four things: too much debt, poor integration of acquired companies like Frontier, labor struggles, and a major shift in strategy. In this case, Peoples went from being a low-cost provider to going after higher paying business travelers instead. The final nail in the coffin was a generally tough industry that was shifting to technology-based yield management schemes to better compete on price. This all served to increase competitive pressures at a point when Peoples was raising prices.
If you think the automobile industry is messy and you followed the recent shake-up with U.S. auto-manufacturers, then (to quote Bachman-Turner Overdrive) "You Ain't Seen Nothing Yet". The airline industry is worse. Granted we're talking air-travel services here, not automobiles, but many competitive pressures (labor struggles, acquisition integration, fuel costs) are the same. So again the short answer is yes, bankruptcy is always a threat. That's part of what makes this a speculative investment.
Jonathan wrote in with some valuable comments that directly relate to the risks that Republic Airway's has taken on since its acquisition of Frontier. As a prior employee of the company, his comments should be of interest to many of you. This is especially true because Republic Airways is changing its strategy for competing in the highly competitive regional market. I find strategy shifts to be some of the most interesting developments to follow, since they usually result in either a big improvement, or another big disappointment.
Jonathan writes: "I read your article on [Republic Airways]. As a former employee of [Republic Airways] and now LUV (Southwest) much of your analysis was correct, but I feel it needs some further clarification. [Republic] operates for a fee-per-departure schedule as lift for other airlines (Delta, US Airways, American, United, Continental) meaning that they are paid each time a flight departs. [Republic] does not have to worry about marketing, ticketing, baggage, or any of the parts that are inclusive of running an airline. They did not make their routes and pretty much ran an operation that consisted of just flying airplanes.
They didn't even purchase their own fuel as that was paid [for by the airline that contracted them.] Their revenues were based upon how many aircraft they were flying and how many contracts they could secure. Their increase in flying in the past is not really reflective on organic growth, but on being able to place more aircraft in service since it was up to other airlines to fill the seats. If the aircraft left the gate empty then [Republic] still made money since they were paid for the departure.
Last summer, [Republic] purchased Midwest and Frontier and ventured into running all aspects of an airline. It is [now] similar to the defunct Independence Air (Atlantic Coast Airlines) with some exceptions such as: they acquired airlines that already [have] running operations, they are flying slightly larger aircraft, marketing was already in place, and they still have fee-per-departure contracts with other airlines. The problem I see is that many of the people that ran Frontier and Midwest are no longer with [Republic] (they left within months of the purchase) and [Republic] is trying to fall back on [its] own experience … it doesn't have a track record of marketing or branding. They are also trying to compete with Southwest and AirTran in their two large hubs of branded flying (all their other flying is based on the hubs of who they contract with).
Even though many of the fee-per-departure contracts are in place for several years, I'm not sure what the future holds since they are now a competing airline with airlines they also contract with. An example is Frontier in Denver where [Republic] is flying routes also flown by United who they contract with.
All the pilots at [Republic] are in the process of being combined into one union which is causing labor issues within the pilot groups. The regional airline industry has also come under scrutiny since the Buffalo Continental Connection crash last year and [Republic] is not immune to those concerns. Given the large growth over the past few years, they may even be a target in future legislation which may drive costs up.
Bottom line is that [Republic] is not even close to the same airline they were a year ago. Much of the revenue has changed from contract to an organic attempt to increase flying. There seems to be much more risk associated when taking this path. I look forward to your future analysis of RJET and their future from a financial standpoint."
There is a lot to digest from Jonathan's comments. But his insights touch on many of the comments I made earlier. And they show why this is a speculative investment that investors need to keep an eye on.
First, Republic Airways is undergoing a major strategy shift, now trying to run a traditional airline including marketing, fuel cost management, etc. This is opening the company up to risks they don't have a track record of managing. Second, the company is having labor issues. Remember Peoples Express? It's not that easy to just merge people from entirely different companies together and expect it will work out fine. Finally, Republic is entering markets with stiff competition. Would you want to go up against Southwest (NYSE: LUV)? I wouldn't, and it appears Jonathan wouldn't either.
Now I'm not saying we should take Jonathan's words as gospel, there are always a lot of wrinkles when evaluating a company. Especially when speaking with a prior employee who may or may not have fond memories. But his contribution to the conversation is valuable, so I'd like to thank Jonathan for writing in.
I think this is an extremely interesting story of an airline that has seen its stock fall 80% amid all of the factors we've discussed. It also provides a great opportunity to cover a company that is trying to deal with both internal and external pressures, so the strategy lovers among you should appreciate it. It's a speculative investment, and the company faces significant challenges. But if it can mitigate these risks, investors could be sitting on a nice gain down the road.
