Is It Time to Get On Board this Regional Airline?

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We all know of the problems and risks associated with legacy airlines. From labor negotiations, to massive debt loads, to volatile fuel costs, these legacy airlines carry many risks most investors would rather not deal with. But for these investors there is a way to invest in a rebound in air travel while at least lessening their exposure to these risks.

The Airline You May Have Unknowingly Flown On

If you have flown on a regional flight under the name of United Continental (NYSE: UAL), or Delta Air Lines (NYSE: DAL), there is a good chance SkyWest (NASDAQ: SKYW) was the operator of your flight. While the plane probably had the colors of the major carrier, SkyWest flies many of these planes to and from such airports as Chicago O'Hare, Atlanta Hartsfield, Denver International, and Washington Dulles. You may notice that these are hubs for United Airlines and Delta Air Lines. These major carriers rely on SkyWest to carry passengers from smaller cities and non-hubs to hub locations that major carriers can operate from.

Growth Through Acquisitions

Over the last several years there has been a rising trend in airline M&A, demonstrated by Delta's takeover of Northwest Airlines, United's merger with Continental Airlines to form United Continental Holdings, and the potential merger between US Airways and bankrupt American Airlines. SkyWest has not ignored this trend; in fact it was airline shopping before this round of legacy carrier mergers even began.

SkyWest acquired Atlantic Southeast Airlines from Delta Air Lines in 2005 for a cost of roughly $1.5 billion in cash and debt assumption. This gave SkyWest an advantage in serving Delta and expanded its network. In 2010, SkyWest acquired rival ExpressJet for $136.5 million in an all-cash deal. Through these acquisitions, SkyWest has become a monster of a regional airline, serving both United Continental and Delta, the two largest American carriers.

Not Your Typical Legacy Carrier

Unlike the major carriers, which must constantly contend with volatile fuel costs, SkyWest passes these costs through to their partners. As a result, SkyWest does not feel the same short-run pain that a spike in fuel prices would cause. However, SkyWest still carries the risk that major carriers may cut back the number of regional flights if fuel rises too high for too long. Yet regional flights are essential to the networks of major carriers, and the hiring of SkyWest to fly these routes is unlikely to cease. Even bankrupt American Airlines has now signed a deal with SkyWest to operate certain regional flights previously operated by long time American Airlines affiliate American Eagle.

Also unlike many major airlines, which trade far above their book values, SkyWest currently trades for less than half of its own book value. In fact, it even trades for less than half of its tangible book value. The current price may be restrained by the high P/E ratio compared to other airlines, but earnings are expected to grow for the year 2013, making for a lower forward P/E ratio. Additionally, SkyWest has about $14 in cash per share, which provides flexibility going forward for acquisitions, debt reduction, or fleet expansion.

As part of a cost reduction strategy, SkyWest is cutting the number of less economical 50 seat aircraft in its fleet, according to the Centre for Aviation. While the majority of its 50 seat fleet are being leased to other carriers, SkyWest has been working to further reduce its exposure to these planes. The airline has already signed a deal with Delta to terminate leases on many 50 seat aircraft early and replace them with more economical 70 seat aircraft. At the same time, Delta is trying to drastically cut its own fleet of 50 seat aircraft by around 400 planes from 2008 levels. Delta is currently providing financing to Pinnacle Airlines while it is in bankruptcy, and has extended Pinnacle's lease of 145 50 seat aircraft for another decade as part of the deal. With a reduction in uneconomical 50 seat aircraft, SkyWest is demonstrating how cutting costs will prevent it from following in Pinnacle Airlines' footsteps.

As a bonus, SkyWest even pays its shareholders a small dividend of $0.04 per share quarterly. This may not seem like much, but when compared to other airlines, of which hardly any pay dividends, SkyWest shines for returning profits to shareholders. The paying of this dividend has been quite consistent, stretching back many years before the recession. While this yield may not appeal to pure dividend investors, those looking for a hybrid between a value stock and a dividend stock may be interested in SkyWest.

Final Thoughts

Through a series of acquisitions, SkyWest has become one of the largest regional carriers and is now serving such airlines as United Continental, Delta, and American. Trading at a fraction of tangible book value makes SkyWest a potential value play, and its cash pile creates the opportunity to grow through acquiring other regional carriers. SkyWest has shown its ability to survive and turn a profit again in an environment that has seen the bankruptcies of regional carriers American Eagle and Pinnacle Airlines and the shuttering of Comair. While risks do remain in major carriers cutting back regional flights or carriers choosing to operate these flights themselves, regional flights remain essential to airline networks and are likely here to stay. In the mean time, SkyWest shareholders can continue collecting their little dividend while they wait for the airline's continuous cost cutting efforts to (hopefully) grow earnings.

TulipSpeculator1 owns shares of Delta Air Lines. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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