Right time. - Regional Airline Association

FINANCIAL REVIEW
26
Regional Airlines — Where do we go from here?
By Raymond E. Neidl
Calyon Securities
Consolidation May Be in the Works as the Strong Get Stronger
Overview
Some of the US based regional carriers
with less financial resources are expected
to face an uncertain future as their
customers, the major legacy carriers,
continue to cut costs. Some industry
observers have expressed that margins
may come down to as low as 5 or 6
percent. While we believe there will be
continuing pressures on margins, we do
not expect that industry margins will be
cut to those levels, but we believe that the
regional partners will have to take on
more risk such as aircraft ownership. The
regional feeders are too important to the
legacy carriers and despite sharp costcutting;
the regional’s can still do the job
more economically. The legacy carriers will
not kill the “goose that lays the golden
eggs for them.” If margins are reduced to
mid-single digit, the regionals would not
be able to raise capital.
Airline Sector: Operating Data Totals
RAA 2006 Annual Report
The regional airlines that we follow that
have a diversified customer base such as
SkyWest, Mesa and Republic already own
and finance their aircraft which puts them
in a dominate position to retain and
obtain new business. Carriers with one
customer, such as Pinnacle, Mesaba and
ExpressJet, and do not have ownership of
their aircraft face a more difficult future in
not only trying to obtain new contracts
but also in retaining their current ones. In
the event that their larger legacy partner
wants to get out of the ownership of
regional jets (RJs), which we believe is a
distinct possibility, Pinnacle and Mesaba
have limited resources to finance aircraft
acquisitions. Asset-backed financing is
available but may be more expensive for
regional’s which would impede them in
seeking business.
Growth in the regional sector will be in
the 70-to 90-seat RJs as "scope clause"
restrictions are loosened at the major
carriers and a surplus of 50-seat aircraft
develops as some demand switches to
larger aircraft. The key beneficiary of
supplying these aircraft should be Embraer
with its new E170/190 series (70- to 110seats
depending on model) which fits the
larger sized RJ market. However, the pilots
at the legacy carriers will resist “scope
clause” liberalization” in both the number
and size of RJs allowed even when their
employers are scratching for survival in
bankruptcy which means, as can be seen
in the Northwest bankruptcy case,
progress will be slow. For distances less
than 500 miles we believe that the larger
(70-seat) new technology turboprops may
become come into demand in North
America to get around some of these
restrictions without having to fight with
their pilots unions. Even though out of
favor here since the advent of the RJ over
a decade ago because of the image of
propellers being old fashioned and noisy,
larger prop aircraft have been used in
2004A 2005A 2006E 2007E
Regional Carriers
Rev EBIT NI EPS
ExpressJet
Mesa Air Group
1,508 205 123 $2.04 1,563 156 98 $1.65 420 41 25 $0.42 1,691 163 100 $1.69 1,345 128 77 $1.32
1 Jun 2006E
Rev EBIT NI EPS Rev EBIT NI EPS Rev EBIT NI EPS Rev EBIT NI EPS
(m) 897 84 41 $1.00 1,136 128 55 $1.31 321 29 14 $0.31 1,303 119 56 $1.28 1,352 130 61 $1.36
Pinnacle Airlines (m) 635 67 41 $1.86 842 87 52 $2.38 201 20 12 $0.55 817 82 49 $2.24 820 83 49 $2.22
Republic Airways (m) 646 93 40 $1.66 905 155 58 $1.59 291 53 19 $0.44 1,191 216 78 $1.81 1,339 246 90 $2.07
Skywest (m) 1,156 145 82 $1.40 1,964 220 112 $1.90 779 91 42 $0.64 3,141 362 166 $2.59 3,440 387 183 $2.81
Total 8,859 406 171 6,845 474 129 2,011 234 111 8,142 942 449 8,296 974 459
1 Quarterly data and estimates are based on calendar year. FY05 and FY06 estimates are ending September 30, 2005 and 2006.
2 Quarterly data and estimates are based on calendar year. FY05 and FY06 estimates are ending March 31, 2006 and 2007.