Airline stocks have outperformed the market after a long curse. It was not uncommon to think about airline companies as the worst possible investment ever. However, most of them have been rallying this year, easily outperforming the S&P 500. Republic Airways Holdings Inc. (NASDAQ:RJET) and SkyWest, Inc. (NASDAQ:SKYW) are two regional airlines of roughly the same valuation by market capitalization.
Regional airlines act as little giants
Regional airlines such as Southwest Airlines Co. (NYSE:LUV) have outperformed major airlines such as Delta Air Lines, Inc. (NYSE:DAL). However, Republic Airways Holdings Inc. (NASDAQ:RJET) has almost doubled its price per share in 2013. What’s more is that the company is trading with a P/E of 9.1, and a forward P/E of approximately 6.0, which could be considered cheap on valuation terms. Southwest Airlines Co. (NYSE:LUV) is trading with a P/E of 28.2, and Delta Air Lines, Inc. (NYSE:DAL) is trading with a P/E of 17.6.
I believe the Republic Airways Holdings Inc. (NASDAQ:RJET) should continue to bring capital appreciation to its shareholders. The company had a strong first quarter in 2013 according to its most recent earnings report. Although its total revenue declined 9% to $635 million in the period, a 31% decrease in fuel-related expenses offset the losses in revenue. Its net income rose 35% to $30 million. It was the first time in four years that the company had a profitable first quarter.
Further, it is important to mention that the company was able to decrease its debt load by $80 million on a year-over-year basis. The company finished the first quarter with approximately $1.8 billion in debt, or a debt/equity ratio of 3.4.
Looking ahead, the carrier is reducing costs of operation by selling aircraft. The company sold five airplanes and returned two more to lessors. Personally, I like Republic Airways Holdings Inc. (NASDAQ:RJET)’s business model because it is returning unnecessary aircraft, and this strategy saves enormous amounts of fuel. Its load factor will increase, and the revenue per flight will jump significantly.
In addition, Republic Airways Holdings Inc. (NASDAQ:RJET) is leasing aircraft as opposed to financing new aircraft. Financing aircraft is dangerous because usually the airlines get unfavorable interest rates due to the amount of debt they carry. However, Republic Airways should not have this issue, and it makes it more competitive against other companies. Hence, this company should offer substantial value in the future.
Southwest Airlines Co. (NYSE:LUV) is another company that is leasing aircraft as opposed to financing them. The company is a customer to Air Lease Corp (NYSE:AL), and its net income will be favored due to lower payments on interest rates. Also, the carrier has the advantage of being able to break any leasing contract (with a penalty fee) if passenger traffic becomes unfavorable.
Delta Airlines, Inc. (NYSE:DAL) is also switching from owning to leasing. The carrier manages a fleet of 719 aircraft, of which 155 are leased, or 21%.
I believe these carriers are taking the necessary measures to increase their net income. Leasing future aircraft will help the airlines reduce their operating expenses and debt.
The underperformer
SkyWest, Inc. (NASDAQ:SKYW) has not fared as well as Republic Airways. The carrier has barely outperformed the S&P 500 by rallying 17%. Nonetheless, it is trading with a P/E of 13.7, and a forward P/E of 10.1. The company’s revenues declined $117 million to $803 million for the first quarter of 2013. Its net income declined $5 million to $15.5 over the same period.
The company’s cash and cash equivalents totaled $631 million, down from $709 million in Dec. 31, 2012. According to the company, the $78 million was used for debt repayment. However, its debt decreased only by $30 million.
I do not feel comfortable with the SkyWest, Inc. (NASDAQ:SKYW) purchase order of 100 new aircraft from Mitsubishi. If things do not go as they planned, it will end up with a massive amount of debt. Even if the company’s load factor remains unchanged after the huge addition in available seat miles, the company will have to pay enormous amounts of cash due to high interest rates, and it will see substantial losses in its net income. I believe it is a risky strategy from the carrier, and it may be riskier for its investors.
The foolish conclusion
Republic Airways and Skywest, Inc. (NASDAQ:SKYW) have rallied this year. Even though Republic Airways has rallied 90%, I believe the carrier offers a higher potential for capital appreciation than Skywest, Inc. (NASDAQ:SKYW). The company is decommissioning aircraft to reduce its operational expenses, and it uses leasing agreements to gain access to newer, more fuel-efficient, and comfortable aircraft.
On the other hand, Skywest, Inc. (NASDAQ:SKYW) will pay a substantial amount of cash in interest rates. Its revenue declined, as well as its net income, and I fear the acquisition of 100 new aircraft might not end up well. For these reasons, I recommend Republic Airways as a long position.
The article A New Business Strategy for Airlines to Increase Profits originally appeared on Fool.com.
Robinson Roacho has no position in any stocks mentioned. The Motley Fool recommends Southwest Airlines. Robinson is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.
