Vaughn Cordle, CFA / James M. Higgins, CFA
Republic Airways (RJET) is an airline holding company comprised of two major disparate airline businesses. The core is a group of three regional carriers serving four network carriers (plus corporate sibling Frontier) using a range of sub-100 seat regional jets and turboprops operating primarily under fixed fee (capacity purchase) agreements. The other entity is Frontier itself, a small low cost carrier utilizing Denver as its focus city.
Those two airline businesses have never offered meaningful synergies for RJET, and management appears to have reached the same conclusion: Frontier is for sale.
Although we are ambivalent about Frontier's longer-term growth prospects and strategic positioning, a restructuring in 2011 and ongoing network adjustments have returned the carrier to profitability, and 2013 appears likely to be another year of improving results. RJET's regional business has among the more attractive risk and reward profiles of regional carriers, with a recent contract to serve American under the American Eagle banner using 47 Embraer E175 regional jets (RJs) adding growth, while a restructuring of the Chautauqua 50-seat RJ operation reduces risk and operating costs.
Yet, the market does not appear to know what to do with this mixed bag of an airline holding company. As the following exhibit illustrates, the stock has soared in recent months, strongly outperforming the broader airline industry (as measured by the NYSE ARCAA Airline Index (XAL), regional peer SkyWest (SKYW) and the S&P 500. The American contract, Chautauqua restructuring and announcement of the planned Frontier "spin-off" have driven the recent strong stock price performance. However, when looked at over longer time frames going back to 2008, RJET has substantially lagged its peers' aggregate stock returns and either beaten the overall market by an unimpressive amount or badly trailed its performance (figure 1).
Figure 1: Republic Airways Relative Stock Price Performance
Monday's sell-off in RJET's stock was likely profit-taking after the recent run-up.
What is missing from an analysis of RJET's recent relative strength is an appreciation for the value of the individual piece - the regional operation and Frontier. Ionosphere Capital's analysis suggests that investors are giving Frontier no value - or even negative value. Even bearing in mind the carrier's strategic challenges and limited growth potential, we believe that assessment is overly pessimistic, and therefore believe there is a plausible scenario for meaningful upside in RJET as it works to separate its two distinct airline businesses into pure-play entities.