Is Republic Airways Holdings Inc. (RJET) A Buy After The Recent Volatility?

I posted this on my blog yesterday. RJET is up over 50% today!

Republic Airways (RJET, Financial), a regional flight operator, fell from 7/24/2015’s closing price of $8.50/share, to 7/28’s closing price of $3.44/share. During the last 52 weeks, the stock has fluctuated between $3.05/share to $15.36/share.

Reason the Stock Fell

• On 7/27, Republic Airways warned that its operation could be affected by a pilot shortage and labor standoff.
• The company is citing new regulations by the Federal Aviation Administration that raised training requirements for new hires as a factor in the pilot shortage.
• The company said it couldn’t determine how long the labor dispute might last.

Company background

RJET operates air carrier subsidiaries Shuttle America Corporation ("Shuttle") and Republic Airline Inc. ("Republic"). CEO Bryan Bedford has held his position since 1999 where revenue has grown from $147M in FY00 to $1.38B in FY14. The company’s business model is not what most people assume. As of its last earnings report, the company operated 1,253 daily flights to 105 cities in 39 states and Canada through fixed-fee code-share agreements with United Continental Holdings, Inc. (UAL, Financial), Delta Air Lines, Inc. (DAL, Financial) and American Airlines Group, Inc. (AAL, Financial). In other words, the company’s partners outsource regional traffic to RJET, pay them a fixed fee based on specific criteria and incur certain variable costs like fuel.

REPUBLIC AIRWAYS HOLDINGS INC ROUTE MAP.

Industry

RJET is the #2 player in the domestic regional airline space with Skywest being #1. From Skywest’s 10K FY2014:

Major airlines award contract flying to these regional airlines based primarily upon the following criteria: low cost, financial resources, geographical infrastructure, overall customer service levels relating to on-time arrival and departure statistics, low rates of flight cancellation, baggage handling performance and the overall image of the regional airline.

RJET's regional airline competitors include SkyWest Airlines (SKYW) and ExpressJet, Air Wisconsin Airlines Corporation ("Air Wisconsin"); Envoy Air Inc. ("Envoy"), PSA Airlines, Inc. ("PSA") and Piedmont Airlines ("Piedmont") (Envoy, PSA and Piedmont are owned by American); Horizon Air Industries, Inc. ("Horizon") (owned by Alaska Air Group, Inc. [ALK]); Mesa Air Group, Inc. ("Mesa"); Endeavor, Inc. ("Endeavor") (owned by Delta); and Trans State Airlines, Inc. ("Trans State").

Trailing 12 Month Financial Ratios (Per GuruFocus as of 7/28/2015)

• PE Ratio: 3.47
• Price to Tangible Book: 0.47
• EV / EBIT: 12.15
• Return on Invested Capital: -4.93 (was 5.41 last year)
• Net Margin %: 4.11
• Tangible Book Value: $7.95

Valuing the company before latest news

In starting off with a value estimate, let’s look at the earnings estimates before the 7/27 news hit. Three analysts follow the company per NASDAQ, and the consensus 2015 estimate was $1.13 EPS. If you apply conservative PE ratios of 7 to 10 to that estimate, then you assume the stock could be between $8 to $11 per share if the company returns to normalized earnings within two years.

Here’s the revenue trend for this company. You’ll notice that revenue jumped in 2010 and 2011 and then dipped in 2011 and 2012. That’s because RJET bought Frontier Airlines Holdings in 2009, and then finalized a sale for Frontier in 2013. When you look at the Net Income numbers for the last 15 years, you’ll notice that the only two years the company lost money were in 2010 and 2011, when the company owned Frontier.

From the table below (2014 10K), you can see their Code Share Agreement expiration dates and how most of the revenue is predictable.

Reviewing the Bad News

• Talks are under way with American, Delta and United airlines to possibly reduce regional flying the rest of this year and into 2016.
• RJET flew 4% fewer block hours, or the time spent in flight, than scheduled during the second quarter. Since this is a low-margin business even small percentage changes make a noticeable difference on the bottom line.
• RJET hired Seabury, a consulting firm with experience in dealing with difficult issues in the aviation industry. I visited Seabury’s website, and it says its typical assessment takes 10 weeks. Who knows why Seabury is needed? Maybe it’s purely for labor negotiations. Maybe there’s a deeper structural problem. We’re all guessing.
• Labor disputes are typical for this industry and RJET's dispute has been ongoing since 2007.
• Republic also provided preliminary Q2 results, saying net income would be $4 million to $5 million, or 8 to 10 cents a share. Analysts were expecting $0.28 per share.
• Management rescinded previous guidance and did not give new guidance for the last half of FY’15
• It earned $0.13 for Q1’15 so if you add their Q2'15 low guidance of 8 cents then you get $0.21 for the first half of 2015.
• If it earns $0 for rest of the year, that makes its FY15 PE ratio equal to 16.4
• Don’t know how long the labor dispute will be so don't know how many flights will be grounded by labor disruption.
• In its Q1`15 conference call, it mentioned that staff time-off was trending upwards which could be a result of the labor negotiations.

How low can the stock go?

• Can the stock go to $0? Yes, if the company goes bankrupt. I consider this to be a highly unlikely outcome because it's in nobody's interest. The company management and pilots wouldn't get paid if RJET goes under. The company's partners, the major airlines, would have disruptions to their service. The government doesn't want it nor does the public.
• If we assume that RJET will earn $0 for the rest of FY15 and its full-year EPS is $0.21, you could get a price between $1.40/share and $2.10/share if you used PE ratio's of 7 to 10.
• RJET's all time low is $2.57/share in 2011. The company had -$3.14 EPS that year.

Final thoughts

• RJET is a business with difficult economics as shown by its ROIC. Even if the labor problems are resolved, the airline industry is riddled with uncertainty. Events such as bad weather, an economic downturn or an epidemic scare can affect an airline’s outlook and its intrinsic value.
• It also appears that the pilot shortage is an industrywide problem that’s not going away any time soon. I don't think RJET's problems will be an opportunity for other airlines because competitors would be having similar issues ramping up operations and hiring more pilots. On the other hand, RJET won't grow if its partners won't give it new business due to the labor issues.
• Given that labor disputes are common in the industry, given that an outside consultant has been hired, and the company is discussing flight cuts with partners, the labor situation doesn't look like it will end quickly.
• If you’re willing to stomach volatility and be patient, this stock might be one to consider because it appears cheap if they can revert back to prior years' EPS in a couple of years.
• I don’t see a hurry to jump into RJET. Earnings will come out soon, and there will be more information. This upcoming conference call may be an opportunity for management to dump a lot of bad news.

Disclosure: I do not own any of the companies mentioned but may initiate a position if prices become more attractive.