01-Oct-2009 1:35 PM

Frontier Airlines emerges from bankruptcy under Republic Airways’ wing. Can the good times last?

Analysis

Frontier emerged from bankruptcy protection on 01-Oct-2009 as a wholly-owned subsidiary of Republic Airways Holdings Inc, following the approval of the carrier's reorganisation plan. At the time of the plan's approval, Frontier President and CEO, Sean Menke, stated, "this is an extremely proud day for everyone in our Company. Many people doubted that we would even survive, let alone accomplish a successful reorganisation, provide a recovery for our creditors and emerge a stronger competitor and company".

Mr Menke added, "upon consummation of our Plan of Reorganisation with Republic, we will be a successfully restructured airline, well positioned to be a competitive, successful, sustainable airline for years to come."

The Plan of Reorganisation had previously been approved by the necessary majority of the airline's creditors, with 92.58% of the voting creditors approving the plan and 99.84% of the dollar amount of voting claims approving the plan.

And now the hard work of integration begins?

Frontier will emerge as a Republic Airways subsidiary, after Republic was declared the winning bidder in the auction to acquire Frontier on 13-Aug-2009, fending off Southwest Airlines. Republic has previously stated that Frontier Airlines and Lynx Aviation would maintain their current names and continue to operate as usual.

There have been some moves to integrate Frontier with Midwest Airlines, to reduce some duplication of resources. For example, Frontier has announced plans to close its Las Cruces (New Mexico) reservations operation by the end of 2009, in an effort to optimise operations and eliminate operational duplication that exists with its Midwest Airlines partnership.

But there has been no discussion of a larger integration agenda within the Republic stable. The key question remains; are they just going to be a collection of airlines, or is there some grand integration plan brewing at Republic?

Frontier reports tenth consecutive month of operating profits in Aug-2009

Frontier Airlines reported an operating profit of USD10.9 million in Aug-2009 - the carrier's tenth consecutive month of operating profits and a significant improvement from an operating profit of USD3.3 million in Aug-2008. Excluding special items, the operating profit for the month was USD11.9 million (compared to USD3.4 million in Aug-2008).

Frontier Airlines Holdings operating profit: Apr-2008 to Aug-2009

Frontier reported a net loss of USD2.0 million (compared to a net loss of USD5.6 million in Aug-2008), after four months of net profitability between April and July 2009, due to expenses associated with its bankruptcy case.

Frontier added that, excluding special items (which included USD10.5 million of reorganisation expenses), the company would have reported net income of USD10.2 million, or a net margin of 10.0% in Aug-2009, compared to net income of USD1.2 million (and a 0.9% net margin) in Aug-2008.

Frontier attributed the performance to its restructuring and cost cutting and revenue enhancing initiatives. CEO, Sean Menke stated, "it is impressive that, even with more than USD10 million in expenses related to our bankruptcy case, double-digit reduction in revenue due to the continuing weak economy and constant competitive pressure, we still managed a USD10 million operating profit in August".

He added, "this and our financial performance over the past ten months is validation of our laser focus on cost, our continuing revenue development efforts and our constant attention to providing the highest levels of service to our loyal customers."

It must be noted however that Frontier's return to profitability over the past ten months coincides with the big drop in fuel prices, which raises questions over the sustainability of its profitable streak if oil prices continue to rise, particularly as revenues and yields remain very weak.

Operating costs falling faster than revenue reductions

Frontier reported USD102 million in revenue in Aug-2009, down 19.6% year-on-year, but the second highest level, after Jul-2009, since Dec-2008.

Frontier Airlines Holdings revenue and operating expenses: Apr-2008 to Aug-2009

Operating costs decreased at a greater rate, by 25.7%, to USD91.8 million.

Frontier Airlines Holdings operating expense breakdown: May-2008 to Aug-2009

Unit revenue weakness continues

The LCC also revealed a mainline unit cost (excluding fuel) of USD 5.81 cents for Aug-2009, an 8.4% year-on-year increase. Clearly, more work needs to be done on non-fuel cost items.

Mainline total unit cost falling 16.3% to USD 8.96 cents, thanks to sharply lower fuel prices.

On the revenue side, mainline passenger revenue (PRASM) slumped 12.6% year-on-year to USD 9.31 cents, while mainline total unit revenue (RASM) fell 8.2% to USD 10.17 cents.

Separately, in its Aug-2009 preliminary traffic release, Frontier estimated that its mainline passenger unit revenue decreased by 11-13% year-on-year in the month. The carrier, which usually reports its exact revenue figures, in addition to its monthly yield levels, did not present this information for the month of Aug-2009.

Frontier Airlines passenger revenue (per ASM) growth (% change year-on-year): Jun-2007 to Aug-2009*

In an attempt to boost revenues, Frontier announced it would change its checked bag fee from USD15 to USD20 for the first checked bag and from USD25 to USD30 for the second checked bag for tickets book from 08-Sep-2009 and for travel from 01-Oct-2009.

Frontier's capacity cuts the most significant among the major North American airlines

Frontier is also losing market share faster than any other US carrier. During Aug-2009, Frontier continued its deep capacity (ASMs) cuts, of 13%, in Aug-2009. This resulted in a 9.5% reduction in passenger numbers, but a 2.7 ppt load factor improvement, to 88.7%.

Frontier Airlines traffic highlights: Aug-2009

	Aug-2009	% change
Passengers	915,970	(9.5%)
Traffic RPMs (mill)	826.8	(10.3%)
Capacity ASMs (mill)	932.6	(13.0%)
Load factor (%)	88.7%	+2.7 ppts

The capacity reductions enacted by Frontier in Jul-2009 were the most significant among the major North American carriers.

North American carriers' domestic passenger capacity growth (% change year-on-year): Aug-2009

Frontier, which reduced capacity by 20.3% year-on-year in 2008, plans to continue cuts of this magnitude for the remainder of 2009, although some targeted route expansion is planned.

Frontier capacity growth (ASK): Aug-2004 to Aug-2009

Cash and cash equivalents stabilise around USD70 million

Meanwhile, the LCC's cash and cash equivalents increased slightly from Jul-2009 levels to USD70 million in Aug-2009, although the balance decreased 5.7% year-on-year.

Frontier Airlines monthly cash and cash equivalent levels (USD): Apr-2008 to Aug-2009

Continues selected route network expansion

Frontier Airlines announced plans to add one more daily frequency each to Bozeman's Gallatin Field Airport, Durango-La Plata County Airport and Oklahoma City's Will Rogers Airport through its subsidiary, Lynx Aviation.

Lynx recently took delivery of its 11th Bombardier Q400 aircraft, allowing Lynx to expand its service and continue with its growth strategy.

In further network news, Frontier Airlines announced plans to offer, for the first time, a fourth daily Denver-Portland service, over the Winter season. The carrier also announced plans to increase the number of Denver-Tampa services and launch daily Denver-Southwest Florida, Indianapolis-Cancún and Lambert-St Louis-Cancun services. The carrier will also add a third weekly Kansas-Cancun service.

Outlook: Fragile

Frontier may have a new owner, but its outlook remains fragile, with a toxic combination of weak yields and falling market share. Frontier is also subject to forces beyond its control, namely higher fuel prices, and a probable harsh competitive response from failed bidder, Southwest Airlines.

The best way Frontier (and its new owners) can respond is via further cost cutting. This should involve a comprehensive integration process with partner airlines. More details on this should hopefully be imminent.

Background Information:

Currently in its 15th year, Frontier is the second-largest carrier at its base at Denver International Airport;
With 51 aircraft in its mainline operations (including 38 A319s, 11 A318s and Airbus A320s.), Frontier offers routes linking its Denver hub to over 50 destinations in the US, Mexico, Canada and Costa Rica;
Frontier is a wholly-owned subsidiary of Frontier Airlines Holdings, which commenced trading of common stock on Nasdaq National Market on 03-Apr-06;
Filed for Chapter 11 Bankruptcy Protection on 11-Apr-08, although the LCC stated it would continue normal operations during the reorganisation process, which is expected to last up to 18 months. Signed an investment agreement in Jun-2008 with Republic Airways, under which by which Republic plans to serve as equity sponsor for Frontier's reorganisation and purchase 100% of the equity in the reorganised company.