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Republic Airways profitable but down 57.5%

9-Nov-2011

While its peers posted losses, Republic Airways Holdings managed a USD9 million profit on a 7.9% increase in operating revenues to USD767.9 million during the third quarter, despite struggles with its branded division, Frontier, which posted a USD4 million GAAP loss.

Frontier was the company’s answer to revenue diversification in the changing regional airline space even as peers SkyWest and Pinnacle sought increased diversification from adding new major-carrier partners to their capacity purchase portfolios. While Frontier has been troubled since its 2009 acquisition and integration with Midwest Airlines, CEO Bryan Bedford painted a promising future for the division.

Citing the completion of its restructuring deals that will yield higher profits in the future, Mr Bedford indicated that the branded division is well on its way to self-sustainability. Even so, he said that once its cost per available seat mile ex fuel gets to the ultra-low-cost carrier level at about 6.00 cents it is still the company’s intention to separate Frontier from the fixed fee operation. This would seem an ironic move given the questionability of the future of the fixed fee business and the need for consolidation. Even so, Republic has been changing its fixed-fee fleet away from the loss-making 50-seaters to the more profitable larger regional jets.

Perhaps Republic is positioning itself to participate in any regional airline consolidation which will likely await the restructuring of the industry in, perhaps, a few years time. Even so, given the 2011 results to date, it would seem consolidation needs to happen much sooner.

Frontier now has a future

Mr Bedford explained that before it had completed the refinancing deals on aircraft and new collective bargaining agreements, there had been little to talk about in Frontier’s future since executives were unsure whether they could accomplish the USD120 million in cost cuts and USD70 million in additional liquidity. However, now that the initial restructuring phase is nearly complete, the company wants to set the stage for the spin off by hiring advisors to find the most shareholder-friendly deal possible.

He reported, the company has achieved USD110 million of the USD120 million improvement target in Republic’s business results and continues to work on gaining the final USD10 million in cost cuts as well as the new liquidity having amended the deadline past 30-Sept-2011. He still sees several opportunities for raising that liquidity including the sale of aircraft, sale-leasebacks or monetizing the slots at Washington National. He also turned to monetizing Frontier itself in those efforts saying progress to date is positioning it to be an attractive acquisition target.

He clarified that while US Airways has right of first refusal on the sale of the slots, they are owned by Republic as part of a 2005 agreement in which Republic bought assets from the legacy carrier, including the E170s that are now in service in feeding US Airways. However, even if the the Phoenix-based carrier were to re-acquire the slots they would remain part of the Republic/US Airways CPA through 2020. Even so, they can be pledged as collateral since they are worth more today, at about USD80 million, than they were in 2005.

Suit stalls liquidity efforts

Despite progress, its efforts to raise its liquidity ran afoul of the suit brought by the International Brotherhood of Teamsters (IBT) to block the new agreement with the Frontier Airline Pilots Association (FAPA)  that contributed in part to the cost cutting success. IBT claims the agreement between Republic and (FAPA) is illegal since it won the right to represent the pilots in an election in which it beat not only FAPA but two other unions. IBT contends that the new FAPA/Republic agreement was an attempt to interfere with the election and the two conspired to interfere in the 27-June election by cutting a new 17-June agreement.

Republic filed to dismiss the suit but that is pending in federal court and the uncertainty created by the suit created another casualty in the ERJ 190 purchase of six aircraft since it didn’t feel it could use scarce cash to grow the fleet. It was unable to raise USD85 million on its spares inventory and is now evaluating other sources including the spares deal of the sale or monetization of assets. Failing that, its unrestricted cash balance will decline by the end of the fourth quarter to between USD150 and USD160 million.

It is taking two 190s before the US Thanksgiving holiday and deferring the balance of four aircraft indefinitely resulting in the return of USD2.8 million in deposits. However, Embraer is retaining another USD2.2 million in deposits as penalties and another USD12 million against future deliveries.

The company is unclear as to whether the company will be spun off or sold to another airline and it is up to advisors to help it chart its new course. Mr Bedford indicated that the work accomplished to date and that ahead will make the company an attractive acquisition target to “a private equity holder or strategic investor.” 

Assessing the future of Frontier and fixed-fee operations

Mr Bedford provided a stark assessment of both branded and fixed-fee futures and, now that the path is clearing for Frontier restructuring which yielded USD26 million in savings annually. The company will turn its focus on doing a similar restructuring on the fixed-fee side.

The Frontier restructuring was aided by the purchase of Seabury’s Airline Performance Analysts System (APAS) which gave the company deeper insight int the strengths and weakness of its network and unique clarity on aircraft costs which helped it pinpoint the changes necessary. It will now be applying APAS to its capacity purchase programs.

The APAS program prompted more changes in capacity and is now expected to result in fourth quarter capacity to be down 2-3% on more aggressive day-of-week adjustments and changes to Milwaukee. The first quarter capacity is expected to fall 8-9% year on year.

“The substantial completion of restructuring is a significant milestone,” he told analysts. “But it is not the end of a journey but the start of a new direction. It is clear from the third quarter reports of the three publicly traded regionals that their fixed-fee agreements are not producing the financial results that investors have historically enjoyed.”

He explained that is because the compensation rates are tied to “very benign CPI (Consumer Price Index) inflator” over the past several years meaning only small increases in compensation levels where granted even as costs far outpaced those increases. This is being compounded by consolidation which has led to downsizing of marginal hubs resulting in lower 50-seat aircraft demand.

Along with other regionals, Republic has been reducing its 50-seat fleet from 120 in 2007 when the type accounted for 50% of fixed-fee revenues. It sold, subleased or returned to lessors almost 50 units and 50-seaters will account for only 20% of revenues in 2012.

“The bad news is we still have 32 RJs coming off contracts over the next three years at a rate of 10 per year,” he said, signaling the company will be negotiating with stakeholders on the 50 seaters. “It is difficult to see how we will continue to operate them unless we obtain significant operating cost reductions.”

That means it will be going after the same type of concessions stakeholders at Frontier made. Mr Bedford said he remains convinced the 50-seater can be used profitably in the domestic market but it must achieve the success of its Frontier results on the CPA side.

The company announced it completed its deal for 60 A320 neos and 20 A319 neos. Powered by the CFM LEAP-X engines, the aircraft is set to begin delivery in 2016.

Differing strategies yield different results

Interestingly, the strategy for increasing capacity purchase (CPA) portfolios followed by SkyWest and Pinnacle is clearly not working, while Republic’s strategy has, at least, resulted in a profit, albeit a 57.5% drop from the USD21.2 million posted in 3Q2010. It can easily be presumed that the changes in fortunes seen in the publicly held regionals are playing out at those regionals that are privately held.

Consolidated operating revenues reached USD767.9 million, up 7.9% year on year on the 10% increase in Frontier unit revenues. Its fixed fee operations posted a GAAP profit of USD17.3 million. The company cited USD19.3 million in integration, fuel and storm impacts for the results noting that the branded operation, ex items earned USD15.3 million in income.

Its Frontier strategy is building Kansas City, which has already received additional Delta capacity. The city will become the second largest in terms of capacity on the network, second only to Denver, as it reduces Milwaukee relegating it to 50-seat aircraft service by the first quarter. Denver accounts for more than 80% of Frontier’s capacity. Total domestic capacity out of Denver is expected to be down 2-2.5% in the fourth quarter and fall by 2% in the first quarter.

Fourth quarter same store capacity will be down 4% in the fourth quarter and 4-6% in the 1Q2012, the sharpest declines in some time. In Kansas City same store will be up 6-7% in the fourth quarter and 7-9% in the first quarter on Delta’s increases. Total domestic capacity at the hub is expected to be flat in the fourth quarter.

Milwaukee is experience falling total domestic capacity which is expected to be down 9-10% in the fourth quarter and 11-13% in the first quarter. In an effort to improve profitability, same store capacity will fall between 12-14% and between 13-15% in the fourth and first quarters, respectively.

The addition of two seats to its A319s have already resulted in revenue paying back that project two times over. The company is now looking into increasing seat density on other fleet types. In addition, it’s exit row strategy is expected to earn USD 5 million on an annualised basis.

Frontier’s new revenue management tool, bid-price optimization, installed earlier this year, is showing promise and a third of markets have already been converted with the rest expected by year end. One, low-demand market’s overall revenues went from a deficit of 7% pre conversion to a premium of 11% post conversion on a better mix of connecting revenues even as local traffic remained flat.

It is also tweaking ancillaries eliminating the change fee on its classic bundles which resulted in increasing frontier.com share three points to 45%.

Fourth quarter is continuing strong with October traffic resulting in a five-point increase in load fact on declining ASMs while TRASM is expected to exceed Oct-2010 levels by 11%. November bookings have added 4-5 points of load factor on a 2% capacity reduction and December is 3-4 points ahead of last year’s 80% on a 2% capacity drop. In total, forward booked load factor is moving toward 85% load factor and running four points ahead of 2010.

Mr Bedford reported that its year-to-date cost per available seat mile at Frontier ex fuel is 6.5 cents with the lease restructuring and other benefits accruing from the restructuring efforts. Some 95% of 2012 capacity at the airline will be on Airbus and E190s but will result in a smaller footprint on the removal of the smaller jets which have moved over to the fixed-fee operation.

Capacity in 2012 will be down 10-12% from 2011 at 15 billion ASMs, he said.

Fixed fee performance

Revenues jumped 5.9% to USD277.1 million during the quarter.

Capacity purchase revenues, ex fuel, rose 1.2% to USD247.8 million on flat block hours and a 7.6% drop in available seat miles (ASMs) to 2.8 billion in the quarter not counting the fuel reimbursement from partners. Load factor also dropped, by 3.5 points to 73.8%.

Cost per available seat mile (CASM) including interest expense but excluding fuel, rose to 7.95 cents in the third quarter while total cost per available seat miles including interest rose 10.9% to 8.96 cents. As with its peers, it cited higher maintenance for all aircraft and engine restoration costs on its 50-seat fleet.

Republic reported completion of the 14 E170 transition from Frontier to Delta Connection service. At the same time it removed three E145 aircraft from its Continental program. The company is now operating 58 44- to 50-seat aircraft and 126 70- to 86 seat aircraft in fixed fee service.

It also began the installation of first-class seating on 58 E170/175s in its US Airways program during the quarter which has caused a significant reduction in operations for the carrier to allow for the transition. However, the effort was completed in October returning the operation to full schedule with 20 dual-class, 69-seat E170 aircraft and 38 80-seat E175 aircraft.

Branded revenues up

Including operations from both Frontier and Frontier Express, branded revenues rose 9% to USD485.9 million during the quarter on a 0.9% drop in capacity to 3.9 billion. Load factor reached record levels at 89.7% up 2.3 points. Total revenue per available seat mile (TRASM) was 12.26 cents, up 10% as passenger RASM rose 9.9% to 11.83 cents.

Cost per available seat mile (CASM), however, rose 15% to 12.19 cents on an 8% drop in block hours.

All-in fuel costs rose 45.7% in the quarter to USD196.5 million raising the per-gallon cost to USD3.38 versus the USD2.32 in 3Q2010 which increased fuel costs by USD61.6 million.

Unit costs, ex fuel, dropped 0.8% to 7.23 cents in the quarter, negatively impacted by fleet transition costs and the hailstorm in Denver last July which damaged 22 Frontier aircraft, forcing the cancellation of 250 flight during repair which was estimates to cost USD10 million including the insurance deductible. The company said integration synergies were minimal.

Branded restructuring included increasing seat density by transferring 14 E170s back to fixed fee operations reducing such branded aircraft to five shells which is expected to decrease unit costs and improve financial performance in 2012.

Republic Airways Holdings ended the quarter with a USD40.8 million reduction in its cash balance to USD389.5 million compared to year-end 2010. Restricted cash increase USD65.7 million to 204.8 million on the seasonality of advanced bookings. Unrestricted cash declined USD106.5 million from 2010 to USD184.7 million.


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