Independents hold steady as majors reel from fiscal fallout

 - July 11, 2008, 8:15 AM

While the traffic slump that beset the U.S. airline industry as a result of September 11 certainly manifested itself in fourth-quarter financial results across sector lines, an ability to adapt quickly to changing market conditions mitigated the damage to the regional airline business, which showed remarkable resilience in the face of potentially devastating losses. In fact, the three independently owned, publicly traded regional airlines to release their results by press time all escaped the quarter with a relatively sound financial base, while all of the “big six” major airlines registered losses in the hundreds of millions and, in the case of US Airways, more than $1 billion.

Traditionally, regionals have weathered economic squalls with such risk-avoidance mechanisms as fixed-fee code-share contracts, designed to limit their exposure to traffic fluctuations. During this most recent crisis, however, capacity reductions meant fewer departures, and fewer departures mean less revenue. Fortunately for regionals flying RJs, another phenomenon took hold: as major airlines parked single-aisle airplanes in the hundreds to effect an industrywide 20-percent drop in capacity, their regional airline affiliates used smaller, more cost-effective jets to fly routes that may have otherwise lost service altogether. As a result, revenue declines did not approach the level suffered by the mainline carriers, which in most cases failed to extract service rate concessions from their regional partners.

Meanwhile, regionals experienced some positive byproducts of the industrywide slump, most notably a lack of pilot attrition and, consequently, a drop in flight-training costs. In a sector that routinely endured 20- to 30-percent turnover rates, regionals across the U.S. saw virtually no pilot attrition and, hence, no need for new-hire training classes. Lower fuel prices helped cushion the cost burden as well, judging by the reports issued by Mesa Air Group, Mesaba Airlines and Atlantic Coast Airlines.

Notwithstanding the heavy losses suffered by the likes of wholly owned Alaska Air Group subsidiary Horizon Air and the blow Great Lakes Aviation will likely absorb as a result of its pared-down code-share relationship with United Airlines, regional airlines as a group showed their unique capacity to act as a sort of safety net for the air transport system, in the process keeping their own balance sheets relatively healthy.

Of the three independent publicly traded regional airlines that published their quarterly results by press time, Mesa Air Group emerged as the only money-maker, registering a net profit of $3.7 million without the benefit of government grant money. (Mesa booked its share of the $5 billion disbursed by the Air Transportation Safety and Stabilization Act in the previous quarter.) During the quarter, the Phoenix-based airline secured financing for 20 Bombardier CRJ700s, scheduled to enter service this summer under a separate operating certificate. Registered as Freedom Air, the new subsidiary will take sole responsibility for flying Mesa’s 64-seat CRJ700s and 86-seat CRJ900s on order from Bombardier.

Mesa chairman and CEO Jonathan Ornstein said the airline’s decision to establish the new subsidiary centered on the restrictions to large regional jets within the US Airways Express network and the potential for new scope-clause barriers at its America West code-share affiliate. However, Freedom Air could eventually absorb more 50-seat jets as well, said Ornstein, as the need for more diversification arises.

Despite Mesa’s comparatively successful financial showing during the quarter ending December 31, Ornstein continued to complain about the cost of his 19-seat operations. Although the company has drastically reduced the number of Beech 1900s and Jetstream 31s in its fleets, Mesa reckons its 19-seat operations reduced pre-tax profits during the quarter by $7 million. Mesa closed an agreement last month with Raytheon to lower the ownership and lease costs of the Beech 1900s. Bound by a confidentiality agreement, Ornstein would not reveal the value of the deal, but said it would result in savings in lease rates, interest expense, maintenance costs and depreciation expenses amounting to “in the multiple millions of dollars.” The airline will consider further capacity reductions, he added, and also bid for new Essential Air Service contracts to reduce the fleet’s cost burden still further.

Perhaps the most significant cost-saving measure will come when the company sells its in-house engine overhaul facility in Farmington, N.M., said Ornstein. Stressing that overhauls represent “by far” the company’s largest expense, Ornstein said he has entered “more than preliminary discussions with the usual suspects” to sell the facility and return to outsourcing those services.

Meanwhile, Mesa has taken a charge on the last nine of its Jetstream 31s flown by its CCAir subsidiary out of Charlotte, N.C. Before Mesa bought CCAir in 1999, its pilots negotiated one of the most lucrative labor contracts in the turboprop/commuter industry. In an effort to lower those costs, Mesa plans to retire the last of the Jetstream 31s by next month and replace them with Beech 1900s flown by lower paid pilots from fellow Mesa subsidiary Air Midwest.

Ornstein lamented the apparent fact that his cost-cutting successes and resulting profits have earned Mesa relatively little recognition among prospective code-share partners, notwithstanding a recent deal with Frontier Airlines that allowed Mesa to reenter the Denver market last month. Even more perplexing to the CEO, Mesa’s common stock performance remained comparatively sluggish. Opening at $9.72 a share on February 11, Mesa’s stock continued to trade “at a fraction of the level of its peer group,” complained Ornstein, who vowed “to do whatever it takes to rectify that situation.”

SkyWest Stock Soars

One of those peers to which Ornstein referred–St. George, Utah-based SkyWest
Airlines–saw its stock value rise 51 percent over a three-month span entering
February, while Sterling, Va.-based Atlantic Coast Airlines watched its market cap increase 41 percent during the same period. Perhaps the most consistently profitable regional airline in the industry over the past five years, SkyWest at press time had not yet released its financial results for the quarter ending December 31 due to a change from its fiscal year to a calendar-year reporting cycle.

During the Raymond James Growth Airline Conference held January 31 in New York, SkyWest CEO Jerry Atkin reported that the airline “made it through the quarter quite well,” despite the presence of some residual risk flying associated with its Delta contracts. Since September 11, SkyWest has added another 19 CRJs to its Delta
Connection network and another three for United Express, and has shed virtually all its pro-rate flying in favor of fixed-fee contracts. Load factors in the RJs dipped for about a month, but quickly rebounded to historical levels, while its Embraer Brasilia flying for United dropped 19 percent to coincide with its major partner’s 20-percent capacity reduction. As a result, it retired six Brasilias and moved six more from Los Angeles to its growing United Express hub in Denver.

Atkin said that SkyWest surrendered “a few short-term concessions” to its major partners related to cost guarantees, but that its long-term fixed revenue percentages remained intact. Calling cost pressures this year “extremely intense,” Atkin said he did not see any room for residual cost-saving revenues within either of SkyWest’s contracts, both of which now stand subject to rate renewals.

Tight Belt at ACA

Meanwhile, Atlantic Coast renewed its own fee-per-departure code-share contract with United Airlines. According to ACA executive v-p Richard Surratt, the contract assumes “relatively aggressive” cost assumptions for the coming year, requiring ACA to “keep its belt tight” during a period in which it expects higher insurance costs and airport fees. Another concession involved ACA’s decision to forego a contractually guaranteed rate adjustment as a result of its lower-than-projected use rates for the past quarter. ACA plans to begin rate negotiations with Delta early this month.

Costs for the quarter ending December 31 included a pre-tax charge of $23 million for the early retirement of nine leased Jetstream 41 turboprops, scheduled for service removal by the end of this year. Excluding those charges and a $5.1 million special gain from its federal grant authorized by the Air Transportation Stabilization Act, the company recorded net income of $9.7 million.

Overall the company logged a net loss of $1 million for the quarter, compared with a $1.8 million loss during the same period a year earlier. Expressing a sentiment shared by SkyWest’s Atkin, ACA chairman and CEO Kerry Skeen referred to his fleet of Bombardier CRJs and Fairchild Dornier 328JETs as “a major part of the solution in terms of getting this industry back on track.”

“I think most everyone agrees that RJs are more important today than they were before September 11,” said Skeen, who reported that by the first of this year 27 percent of all of ACA’s flying served in mainline complementary roles, compared with just 3 percent at the start of last year. Fifteen percent of ACA’s capacity has completely replaced mainline flying.

Now flying 30 of its 32-seat Fairchild jets for Delta Connection out of Cincinnati, New York La Guardia and Boston, ACA began taking delivery of more 328JETs for its United system in Washington Dulles last month. Through the end of next year ACA expects to take delivery of another 32 of the airplanes, two of which it plans to use in a new corporate shuttle business established on February 15 and a third for ad-hoc charter.