This Airline Could Fly High

Vladimir is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

This year has been a good one for the airlines. Most airline stocks have enjoyed a healthy upside.

Among regional airlines, the best performer to date has been Republic Airways Holdings (NASDAQ: RJET), the owner of Frontier Airlines and Republic Airlines. The stock is already up a whopping 104% this year, but I think that it has even more room to grow.

Relatively cheap

Despite the recent rise in price the stock is still attractively valued at 6.52 its forward Price/Earnings (P/E) multiple. Compare this to two other regional airlines. SkyWest (NASDAQ: SKYW) trades at 9.53 forward P/E, while JetBlue Airways (NASDAQ: JBLU) trades at 9.02 forward P/E. One can argue that the reason for the discount is Republic’s debt, which stands at $1.76 billion and leads to an uncomfortable 3.94 debt-to-equity ratio.

Debt is the reason why Republic is seeking a buyer for its Frontier Airlines unit. At the latest report, Frontier Airlines had $801 million in total assets. If Republic were able to sell this unit for the price of its assets, it would be able to reduce its debt load by almost half. Still, it is unclear what exact price does the company want to get for this unit. As the airline is profitable, it has time to wait for a good offer.

Good environment

The fact that oil prices have been stable throughout the year has led to stable aircraft fuel prices. As airline industry has not been a land of big margins for a long time, airlines are sensitive to oil price fluctuations. Republic is operating at an 8.75% margin, which look high enough when compared to SkyWest’s 4.72% operating margin and JetBlue’s 6.62% operating margin.

Back in June, the International Air Transport Association has boosted its 2013 airline industry forecast by almost 20%, expecting better traffic and lower fuel prices. The recent numbers confirm this thesis. Republic has reported that its load factor in June has improved by a full percentage point to 87% compared to a year ago.

Airlines continue to become less dependent on ticket prices, which account for only 70% of revenue. Back at the beginning of the century, this figure stood at 84%. Additional services help airlines draw more money from their customers without hurting their feelings.

Recent developments

Republic Airways continues to tighten its capacity. Its revenue passenger miles have dropped 4%, following similar cuts at the beginning of the year. These measures have enabled Republic to report a first quarter profit for the first time ever, as the first quarter has historically been the toughest one.

As Republic gets rid of excess aircraft to boost profitability and repay debt, SkyWest was active at the Paris Air Show in mid-June. The company has ordered 100 planes from Embraer. SkyWest has a relatively low debt load in comparison with Republic, so it can freely proceed with expansion. The stock has underperformed this year, up 13%.

JetBlue has been an underperformer too, up only 11%. Recent buyout talks did not help to lift the stock. David Neeleman, who left the company in 2008 and is currently working on the IPO of his Azul Linhas Aereas, was told to express interest in JetBlue. However, at the same day the rumor was announced, David Neeleman denied the rumor. The stock has been traded flat since then, and the rumor seems to be unfounded.

Bottom Line

Republic Airways Holding is an attractive buy. The company is undervalued relative to its peers. The momentum for airline stocks is good, and the macro environment supports this momentum. The main risk is the rise of the oil prices, that showed some movement in recent days. Still, there are no major catalysts for a significant rise in the oil prices, and, hence, the aircraft fuel. By operating in a healthy industry, Republic Airways has more profit to deliver to investors.

SkyWest looks reasonably priced. Analysts suggest a 14.83 target price, a 6% upside from current levels. However, if the general market goes lower as we head into the earnings season, SkyWest could experience downside of the same size as the possible upside. The stock yields 1.14%, which does not make it a dividend play. 

I am neutral on JetBlue as well. I think that the company needs more catalysts to grow. The buyout talk proved to be just a rumor. More initiatives on how to grow revenue are much appreciated. Analysts mean target price suggests a 21% upside, but there's a long way to go to reach it. 

Vladimir Zernov has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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