Right time. - Regional Airline Association

Europe. With new technology and high
fuel costs, airlines in North America may
be taking another look at the Bombardier
product. We also believe that the traveling
public will now be more receptive to this
type of aircraft for shorter route segments.
We believe that the industry will evolve
into three or four strong regional carriers
bidding for the business from multiple
legacy carriers. Those that will win will be
the best operators with the lowest cost
structures and the best financial resources
to sustain this growth and acquire aircraft.
The major carriers, as they continue to try
to cut costs and streamline operations, will
become more dependant on the regionals
and in all probability would rather contract
this segment of the business out rather
than operate it themselves for various
reasons including the tieing up of
resources and to gain the flexibility of
changing operators if costs became too
high. Nevertheless it will remain an important
add-on to the legacy carriers systems
in that they will need the important and
frequent feed from smaller cities into their
hubs to increase traffic flow over their
longer distance routes that they will be
flying themselves.
As a result, some regional carriers will face
uncertain growth prospects and we expect
there will be a glut of 50-seat jets as larger
aircraft come more into use. In the long
run, we may be seeing the regional sector
evolve into three or four large and wellcapitalized
carriers; excluding AMR owned
Airline Sector: Operating Statistics
American Eagle and Alaska Air owned
Horizon Air. We do not expect to see
either of these regionals sold or become
independent anytime soon, although we
do expect Comair to be sold (if its cost
problems are fixed) or liquidated (if problems
are not solved).
The secret to success seems to be the size
and strength of the balance sheet of
regional carriers as well as their borrowing
capability as legacy partners may require
them to take on additional risks. We
expect many regional carriers will be
building their cash positions to participate
in this possible industry shakeout in
bidding for new business or in possibly
making acquisitions. In our opinion,
building cash reserves is critical for future
growth because we believe the trend will
be towards regional carriers being required
to finance aircraft on their own versus
ownership by their legacy partners.
A long-term threat to the future growth of
the regional industry is the probability that
at some point some of the legacy carriers
will disappear through merger or liquidation.
The country has too many large
legacy airlines with too many hubs. When
the industry evolves to fewer large legacy
carriers there will be less of a need for
regional feed since one of the benefits of
legacy airline mergers will be the elimination
of marginal hubs. As hubs disappear,
some of the regional capacity will be
transferred to larger hubs with the balance
being eliminated. We do not see major
industry consolidation, however, for at
least the next few years.
Current developments
SkyWest remains the predominate regional
airline and is aggressively bidding for business
from legacy carriers that it currently
does not do business with, particularly
Northwest and Continental. This business
would be beyond their current contracts at
United and Delta. Northwest may have
some business to auction off but in our
view the new pilot contract is a disappointment
in that the final agreement
with its pilots included only modest
changes in the “scope clause” restrictions.
The carrier, which had one of the most
restrictive “scope clause” restrictions and
the greatest need for larger RJs because of
this and the many long and thin routes
that it operates was able to only win the
usage of an additional 90 RJs of 70 seats
(none of the larger 90-seaters) which did
not come close to the hundreds many
observers, including us, were expecting.
This shows the continuing fear of this type
of aircraft and the power that the pilots
union still has in this area. At least half of
this new business has to go to a Northwest
owned subsidiary to be flown by
Northwest pilots.
In the case of Northwest's business, its
two regional carriers, Pinnacle and
Mesaba, could be at risk. We do not
necessarily believe that Pinnacle will lose
its current business flying the 50-seat
RPM ASM Load Yield RASM CASM CASM (ex fuel) Operating Margin
Regional Carriers
TTM TTM Factor 1Q06 1Q05 TTM 1Q06 1Q05 TTM 1Q06 1Q05 TTM 1Q06 1Q05 TTM 1Q06 1Q05 TTM
ExpressJet 8,939 11,973 74.7% 17.44 19.22 17.48 548.00 542.00 0.00 11.88 12.27 11.72 10.16 10.49 9.96 9.2% 10.3% 10.0%
Mesa Air Group (m) 6,566 9,069 72.4% 19.51 18.93 18.45 14.28 13.00 13.71 13.00 11.63 12.28 8.28 8.41 8.09 9.0% 10.8% 10.4%
Pinnacle Airlines (m) 4,283 5,786 74.0% 21.10 23.57 19.74 15.44 15.11 14.76 13.83 13.56 13.24 11.84 11.58 11.27 10.4% 10.3% 10.3%
Republic Airways (m) 4,929 7,086 69.6% 18.06 21.29 18.32 13.10 14.57 13.10 11.77 12.92 11.78 7.88 8.34 8.03 10.9% 11.7% 10.7%
Skywest (m) 11,553 15,191 76.1% 20.14 20.56 20.23 15.80 15.26 15.58 14.64 14.00 14.30 9.84 10.30 9.45 11.2% 10.1% 11.4%
Mean 7,254 9,821 73.3% 19.25 20.71 18.84 121.32 119.99 11.43 13.03 12.87 12.67 9.60 9.82 9.36 10.1% 10.7% 10.6%
Median 6,566 9,069 74.0% 19.51 20.56 18.45 15.44 15.11 13.71 13.00 12.92 12.28 9.84 10.30 9.45 10.4% 10.3% 10.4%
Note: Major carrier operating statistics exclude regional operations.
Note: Time period based on calendar year.
For Republic Airways, pretax margin is observed for comparison instead of operating margin due to Republic's relatively higher ownership percentage of aircraft,
which is reflected in interest expense.
Source: Company information and Calyon Securities (USA), Inc. calculations.
* These companies have not reported yet, 1Q06 statistics and estimates reflect 4Q05, 4Q04 and last 12 months ending 4Q05.
RAA 2006 Annual Report 27
FINANCIAL REVIEW