RJET - Republic Airways Holdings

[turar]

Is anyone familiar with RJET or holding it? Sold off today on news of dilution.

 

There's a write-up on VIC. Also, was mentioned in the latest Graham-Doddsville newsletter as one of Donald Smith's picks. A lot of short interest as well.

[StubbleJumper]

Rule #1: Don't lose money.

Rule #2: Never forget rule #1.

 

 

Personally, I have a Corollary of Rule #1 (let's call it 1a): Never invest in airlines or automakers!

 

 

SJ

[onyx1]

The branded carrier (Frontier Airlines) half of this holding company is going to receive a huge tailwind from lower oil prices in the sweetest time of the year for air travel.  The Fixed Fee business will continue to enjoy their CPA contract cashflows out at least 6 years.  At current jet fuel prices, I estimate annual FCF at $2.90/share.  Not bad for a comapny offered at $3.60/share.  At 10% higher fuel, I see FCF at $1.60/share.

[17thstcapital]

I own this p.o.s. based on the theory that I'm only paying for the fixed fee biz and getting the branded for free.  However, with the branded biz burning cash the way they have been, not sure if the full value of the fixed fee will ever be realized.  How do you get to your FCF/sh number?  Seems very high even with the decline in fuel - which btw, we don't know will last.  And its not just fuel related issues on the branded side from my understanding - seems like they're less and less competitive in their larger markets. 

 

My hope is that someone buys the branded biz even if its for very little or nothing - there were other bids at the bankruptcy auction.....

[PlanMaestro]

Why not PNCL that does not have the Frontier issues and prices will increase next year?

[rranjan]

Why not PNCL that does not have the Frontier issues and prices will increase next year?

 

PNCL is definitely safer bet than Republic and in my opinion it's very cheap. It does have some risk but I think people see airline in the name and run away.

[17thstcapital]

I don't know much about PNCL.  I own RJET (a couple of dollars higher unfortunately) and recently bought some UAL and DAL.  What's the general thesis on PNCL?  How cheap is it vis-a-vis the other airlines?

[rranjan]

I don't know much about PNCL.  I own RJET (a couple of dollars higher unfortunately) and recently bought some UAL and DAL.  What's the general thesis on PNCL?  How cheap is it vis-a-vis the other airlines?

 

PNCL businesses is not similar to airline business so I would not clasify them as an airline if you want to compare. They don't have same risk of regular airlines. They have different set of risk. Their business is tied to them and you can argue that risks are somewhat related but it's selling very cheap in my opinion.

 

About general thesis, PNCL has debt, asset and free cash flow numbers working for them over next 2-3 years. Contract termination risk is kind of over blown because last time they made money in same situaion. Yaah, there is risk but it's very cheap. I feel it's less risky than RJET. You need to pick your spot based on how you see fit though.

[PlanMaestro]

I don't know much about PNCL.  I own RJET (a couple of dollars higher unfortunately) and recently bought some UAL and DAL.  What's the general thesis on PNCL?  How cheap is it vis-a-vis the other airlines?

 

PNCL is a fixed pice business, RJET w/o Frontier. They have negotiated long time delayed price increases with Delta for next year. And at today's prices, 1x cash from ops.

[17thstcapital]

Thanks, will take a look. 

[onyx1]

I own this p.o.s. based on the theory that I'm only paying for the fixed fee biz and getting the branded for free.  However, with the branded biz burning cash the way they have been, not sure if the full value of the fixed fee will ever be realized.  How do you get to your FCF/sh number?  Seems very high even with the decline in fuel - which btw, we don't know will last.  And its not just fuel related issues on the branded side from my understanding - seems like they're less and less competitive in their larger markets.  

My hope is that someone buys the branded biz even if its for very little or nothing - there were other bids at the bankruptcy auction.....

 

   17th, very good points.  Your scenario of a slow bleed is valid risk, but I think management will shut down the branded carrier before it can do long term damage to the fixed fee business.  Management has made some great strides in the last 90 days to make Frontier profitable.  They are planning to spinoff/sell a majority stake by the end of 2014.  If not, they will shut it down as they made it clear they view their work as that of asset management and they will not hold on to a loser.

 

The FCF/share comes directly from the management guidance given on the 8/3/11 CC, adjusted for current jet fuel prices.  I used the following assumptions for the branded carrier (Frontier) 2012:  

 

• Flat capacity.  This is consistent with recent capacity discipline across the domestic industry and one of the reasons Frontier and other airlines have enjoyed record load factors in the last few years.  Frontier had a record load factor of 87% last quarter and expects as much as 90% next quarter.

 

• TRASM of 11.70.  This may be conservative.  With good capacity discipline, the industry doesn’t need to cut fares to fill empty seats.  Further, they can respond to market conditions by raising fares, as they have done 7 times this year.   I am assuming no additional fare increases.  If the 2011 were annualized, this number would be around 11.85.

 

• Cost (ex-fuel) 7.35.  

 

• Fuel consumption of 244mm and interest expenses of $26mm same as 2011.

 

• Additional savings from cost reduction program $120mm.  Management used the Rahm Emanuel strategy and didn’t let a good crisis go to waste when oil jumped to $115/barrel.  RJET successfully executed a cost reduction program with counterparties and employees.  By reducing union wages and benefits ($25mm), reducing aircraft rents ($30mm), normalizing network and fleet ($25mm), and others ($40mm) Frontier will have the full benefit of $120mm annual savings for the year 2012 (as of August 2011 they are over 80% to completion).  The savings will further advance Frontiers cost advantage vs. its largest competitor Southwest , and place it among, if not, the lowest cost carrier in the industry.  

 

• Fuel Cost.  The guidance given on the CC assumed all-in jet fuel of $3.30/gallon as of market close on 7/25.  Oil is down as much as 10% since then.

 

• Fixed Fee business pre-tax profit, $75mm.  This is the better of the two businesses.  FF produces predictable cashflows through its long-term contracts that go out until 2019.  Profitable in 34 out of the last 36 years.

 

    So putting it all together, you have RJET earning $80 pre-tax profit at $3.30/gal fuel.  With 50mm shares that is 1.60/share pretax and $1.00 after tax.   Since RJET pays no cash taxes (and will not for the foreseeable future due to accelerated depreciation), I agree with the argument that EBIT = FCF, since D&A = debt principal payments + maintenance capex.  See this VIC write-up for additional information (requires guest registration).

 

     With all-in jet fuel now at $3.11, I see pre-tax profit at $2.45/share (70% FCF yield).  In another recession there will probably be some demand destruction, but not as much in the low cost space vs. legacy carriers and if 2009 is any indication the benefit of lower fuel will overwhelm lower demand for Frontier.  

 

     What could go wrong?  First and foremost, sustained oil prices without the ability to raise fares would be the death of the entire industry.  Wouldn’t be the first time this has happened.  However, industry behavior regarding capacity has been rational in the last two years and should help to keep fares somewhat consistent with fuel.  Personally, I don’t see the world economy supporting significantly higher fuel prices unless we have a meaningful recovery.   But opinions aside, if the worst case for Frontier occurs and you see BK 11, RJET can walk away.  RJET specifically addressed this on the CC:

    Q: What would be the impact of Frontier bankruptcy?

    CEO: Frontier’s operation is a separate entity and there are no cross guarantees that would impact the holding company.  We continue to run the business as two separate units and while our belief is that we’re going to have a successful Frontier, we still have the [fixed fee] business if that turns out not to be the case.

 

    The fixed fee business alone makes $75mm pre-tax or $1.5/share, and given the stable nature of the cashflows is worth $9/share, a far cry from Friday’s close of $3.50.  The thesis boils down to a valuable fixed fee business worth considerably more than the current price of the stock, with levered option on a branded carrier which adds an additional $1 to pre-tax profit for every drop of $10 for a barrel of oil from here.

 

[PlanMaestro]

     Q: What would be the impact of Frontier bankruptcy?

     CEO: Frontier’s operation is a separate entity and there are no cross guarantees that would impact the holding company.  We continue to run the business as two separate units and while our belief is that we’re going to have a successful Frontier, we still have the [fixed fee] business if that turns out not to be the case.

 

     The fixed fee business alone makes $75mm pre-tax or $1.5/share, and given the stable nature of the cashflows is worth $9/share, a far cry from Friday’s close of $3.50.  The thesis boils down to a valuable fixed fee business worth considerably more than the current price of the stock, with levered option on a branded carrier which adds an additional $1 to pre-tax profit for every drop of $10 for a barrel of oil from here.

 

Great summary Onyx, thanks

[17thstcapital]

Great summary indeed.  Thanks.

 

I think everyone agrees that the fixed fee is worth at least 2-3x the current price.  But I'm not really sure how much the branded is worth even if oil stays at around today's levels.  At the very least, I hope mgmt is being more aggressive with its hedging program than it has been in the past.

 

I've heard some folks suggest that Southwest could take the branded biz off RJET's hands, and maybe even pay $1-2/sh, just to shut down Frontier.  This would obviously help their competitive position.  But not sure how realistic that would be outside of a bankruptcy given the # of jobs that would be lost and the union aspect.

[onyx1]

I've heard some folks suggest that Southwest could take the branded biz off RJET's hands, and maybe even pay $1-2/sh, just to shut down Frontier.  This would obviously help their competitive position.

 

    If Southwest wants to get rid of Frontier, buying them may be their only option.  Southwest (LUV) has been trying to get rid of Frontier for years through aggressive, money losing pricing, but this is a strategy doomed for failure as Frontier is the lowest cost provider in the Denver market (they fly 80% of their business in Denver).   With another $120mm in annual cost savings, Frontier will dominate.  Here is the 2010 cost per average seat mile (CASM) ex-fuel for the three major carriers in Denver:

 

         United 8.89 cents

         Southwest 7.63 cents

         Frontier 6.93 cents

 

    With the cost savings program complete beginning in 2012, Frontiers CASM will be further reduced by .79 cents.  

 

    Southwest is a bigger airline and up to now has been able to bury their Denver losses, but that may be coming to an end.  Southwests labor costs have been steadily rising and their 737 fleet is now over 11 years old vs. Frontiers more fuel efficient 5 years.  The LUV CEO just announced a capacity cutback, and on the last weeks conference call they admitted (1) their recent margin was the lowest in 20 years, (2) they are not only short of their 15% targeted ROIC, they are not even earning their cost of capital, and (3) they “need every dollar they can get”.  With TTM EBIT of $500mm, does LUV sound like a firm willing to pour another $120mm/year (on top of current losses) down the drain?  When reality sets in, Frontier will enjoy a revenue boost in addition to their cost advantage.

 

[king888]

The fixed fee business alone makes $75mm pre-tax or $1.5/share

Does it really pre-tax income? In 2010, the fixed-fee segment has $1 billion revenue which is comparable to PNCL. But PNCL has pre-tax income for only $21mm.But it might because of different capital structure.

 

Enterprise value for PNCL is $773.22mm = 66.88mm(mkt capt)+795.07mm(total debt)-88.73mm (cash and equivalent)

And for RJET ,it is $2,430.73mm = $144.88mm+$2577.68mm-$291.15mm 

So buying RJET today, it seem like we pay $1.6B EV for Frontier.

 

I used data from Google finance.

 

From the EV standpoint, at $3.00 for RJET ,it is not that cheap comparing with PNCL.

Am I getting it right ?

[PlanMaestro]

The fixed fee business alone makes $75mm pre-tax or $1.5/share

Does it really pre-tax income? In 2010, the fixed-fee segment has $1 billion revenue which is comparable to PNCL. But PNCL has pre-tax income for only $21mm.But it might because of different capital structure.

 

Enterprise value for PNCL is $773.22mm = 66.88mm(mkt capt)+795.07mm(total debt)-88.73mm (cash and equivalent)

And for RJET ,it is $2,430.73mm = $144.88mm+$2577.68mm-$291.15mm 

So buying RJET today, it seem like we pay $1.6B EV for Frontier.

 

I used data from Google finance.

 

From the EV standpoint, at $3.00 for RJET ,it is not that cheap comparing with PNCL.

Am I getting it right ?

 

8%margins is what should be expected from fixed-fee. PNCL has been dismal in protecting its margins. It is expected that they will go higher next year but it has to proven yet.

[onyx1]

The fixed fee business alone makes $75mm pre-tax or $1.5/share

Does it really pre-tax income?

 

King888, thanks for your question.

 

Yes, RJETs fixed fee business earns $75mm ($1.50/share) pre-tax annually: 

 

Q2, 2011  $17.6mm

Q1, 2011    $19.6mm

Q4, 2010  $22.1mm

Q3, 2010  $22.7mm

Q2, 2010  $20.8mm

Q1, 2010  $18.3mm

 

    As you can see, income is steady because of the nature of the long-term fixed fee capacity contracts where RJET takes no fuel, ticket price, or passenger load risk.  Keep in mind these numbers are adjusted for “one-time” items (e.g. severe weather) that may not be “one-time”.  Also, RJET is adding another 17 E170 (70 seat jets) to the Continental contract on October 1st so I expect the $75mm to grow by $5-10mm or more.

 

    As far as leverage, the GAAP financials are very misleading.  98% of RJETs balance sheet debt is asset-backed with no refinancing risk and no covenants.  Regionals like RJET appear to be much more levered than they really are.  Additionally, GAAP rules force asset-backed debt on to the balance sheet and reporting of long-term lease obligations, but shows no value for the long-term (10 years or more) low risk contracts they have in place.  This is the source of much misunderstanding and is the primary reason Mr. Market periodically assigns a price to regionals like RJET/PNCL that is completely disconnected from intrinsic value.  Consider:

 

• In March 2009, PNCL shares under pressure from the market generally, and concerns about liquidity to meet a convert put payment in one year, crash insurance, pilot salary negotiation, and an a sour ASR investment portfolio traded as low as $1/share when TBV was $10 and TTM FCF was $2.65/share. One year later, shares rose to $8/share.

• In fall 2005, PNCL shares under pressure due to Northwest bankruptcy, concerns about the viability of their margins, and the ASA contract negotiations, traded at $6/share or less than 3x FCF. By spring of 2007, shares were at $20.

• In mid-2009, RJET shares were under pressure as well due to overall market conditions, concerns about legacy carrier bankruptcies and reductions in capacity. Shares traded at $5 while the FF business earned over $2 in FCF annually. TBV was well over $11. Share recovered to $10 in Sept 2009.

 

      Where are we today?  At current fuel prices, assuming the full $120mm cost savings program in place and managements mid-point TRASM guidance of 11.85, I see the Frontier's pre tax earnings at $57mm in 2012. Add fixed fee pre tax earnings of $75mm and you have $132mm or $1.71/share EPS, and $2.64/share FCF.  RJET closed Friday at $3.00. 

 

    What about BK risk for the Frontier part of the business?  You still have a $1.50/share FCF fixed fee business that is ring fenced as confirmed on the most recent CC:

 

            Q: What would be the impact of Frontier bankruptcy?

      CEO: Frontier's operation is a separate entity and there are no cross guarantees that would impact the holding company.  We continue to run the business as two separate units and while our belief is that we're going to have a successful Frontier, we still have the [fixed fee] business if that turns out not to be the case.

 

 

 

[onyx1]

 

Up 62% today on a profitable Q3.  The announcement that the restructuring program for Frontier is finalized and news that RJET is explicitly taking steps to spin off the branded operations have shorts scrambling to cover...

[PlanMaestro]

Congratulations Onyx!

 

Considering the reaction to the spinoff, what can be inferred of Pinnacle's IV?

 

 

Up 62% today on a profitable Q3.  The announcement that the restructuring program for Frontier is finalized and news that RJET is explicitly taking steps to spin off the branded operations have shorts scrambling to cover...

[onyx1]

Congratulations Onyx!

 

Considering the reaction to the spinoff, what can be inferred of Pinnacle's IV?

 

 

Thanks Plan.

 

PNCL will be receive the following payments from Delta in the next 14 months:

 

January 2012,  PPI increase, appx. $13mm annually

February 2012, labor rate increase, $14-$17mm annually

February 2012, on-time payment, $14.2-$17.2mm

January 2013, 5-yr rate reset, $18-$21mm annually

 

Total of $14.5-$17.5 lump sum, plus $45mm-$50mm running; or appx $0.85/share lump sum, plus $2.4/share running to a company (a) that doesn't pay taxes, (b) has a TBV of over $11, and © closed today at $2.47. 

 

Contrast this good news with the industry headwinds that are causing current profitability to be flat to modestly negative, and that Delta is perceived to be very difficult to deal with and many believe (although I am not one of them) the contractual payments due PNCL are at risk for reduction.  Also, there are some governance issues I am not happy about.

 

My best estimate is $1.75 to $2.25 in FCF running after Jan 2013.  With contracts set to run a minimum of 5 years, and some 10 years more, I'd toss a conservative multiple of 4 and peg intrinsic value at $7-$9/share.

 

I own both PNCL and RJET.

 

 

[Myth465]

Congrats I never took management seriously when they said they would dump Frontier if thats what was needed.

[onyx1]

Congrats I never took management seriously when they said they would dump Frontier if thats what was needed.

 

Thx Myth.

 

Bedford came from the regional side of the business and twice won and award for CEO Of The Year among other regional operators.  There was never a doubt in my mind that, if necessary, he would protect his blood sibling at the expense of the adopted sibling. 

[Myth465]

Know thy Management....

[17thstcapital]

More good news out of RJET in recent days.  Still want to see Frontier gone at some point. 

[onyx1]

Indeed, RJET shares have more than doubled from the lows and Frontier is still valued at a negative number.

 

Operationally, they pre-announced an profit in a normally weak 4Q, and this is before all the benefits of the completed Frontier restructuring kick in.  With the younger labor pool and the most fuel efficient fleet, Frontier can easily go head-to-head with SouthWest and United/Conntential in Denver for years to come.  And with a new CEO moving them to a SpiritAir-like ULCC model this could be really good.  If consistent profitability lures PE firms to value Frontier at an average EV/Rev of the LCC competition, the Frontier sale/spinoff would be worth $14/share alone. 

 

What excites me also is that Bedford is now 100% involved in the FF side of the business.  With potential for AMR scope changes plus weakness at SKYW and PNCL, we could see a healthy increase in the regional business which as it stands today is itself worth $7-9/share.

 

This will always be a cut-throat industry and the weak will continue to die.  But the industry seems to be avoiding the unforced errors of the past.    Their multi-year effort to reduce capacity means they no longer need to sell otherwise empty seats for peanuts.  Even if they wanted to go back to the stupidity of the past it would take 5 years to bring in the new jets.  The other added benefit of reduced capacity is that they can continue to hike fares.  They have done it once already this year, and 11 times last year.  The downside is traveling as planes are now packed full, and fares...well, yikes!