Frontier Airlines: There's Change in the Air

Aug. 7.07 | About: Frontier Airline (FRNT)

The airlines industry has suffered extreme turbulence since 9/11, from which it has not recovered. Toss in the rapidly rising fuel costs since the 2005 Gulf Coast hurricanes, and you have a double whammy smackdown that has brought many major carriers a trip through bankruptcy.

Frontier Airlines Holdings Inc. (Nasdaq: FRNT) and other smaller, regional carriers have fared better. But even with marketing tools such as 50 images of wildlife like grizzly bears, hares and wood ducks gracing the tails of its aircraft and the catchy slogan, “A whole different animal,” Frontier is having a bear of a time in keeping analysts from lumping it indiscriminately with some of its more troubled peers.

There are some changes in the air for Denver-based Frontier, however. CEO and President Jeff Potter announced last Thursday that he was resigning, effective September 6, to take another chief executive position outside of the airline industry. The next day Frontier's stock rose nearly 4% to $5.22, lifting the price from the $5.00 52-week low earlier in the week. A few days before that, Sam Addoms, company chairman and co-founder, said he planned to retire at the same time, when Frontier holds its annual shareholders’ meeting. Potter, 47, who rose through the ranks at Frontier, will remain on the company’s board.

Analysts had a neutral to negative view of Frontier before it reported results on July 26 for the quarter ended June 30, the first period in its fiscal 2008 year, and it doesn’t appear as if that report swayed their opinion. The company posted a net loss of $3.5 million, or $0.10 a share, compared with a profit of $4 million, or $0.10 a share, in the same quarter a year earlier. Still, sales grew 13% to $344.8 million.

Maybe industry observers need to lighten up, because Frontier is – lightening up, that is. As fuel costs continue to rise, seemingly without a pause, Frontier is in the midst of swapping out the seats in its youthful fleet of Airbus jets with a lighter variety. The company estimates that it can save $5.4 million a year in fuel costs with the switch – and it’s going to be able to add four seats to each plane. Of course, there’s a capital expenditure for the project, which cost it $1.4 million in the quarter in accelerated depreciation costs.

And the discount carrier, which has bucked the odds of competing out of its Denver base – where UAL Corp.'s United Airlines (Nasdaq: UAUA) has long been the top dog – is planning the October launch of Lynx Aviation, a subsidiary that will service such smaller markets as Wichita, Sioux City and Rapid City with turboprop aircraft. Startup costs in the quarter totaled another $2.2 million.

All told, those expenses created a $0.20 impact on its earnings per share, and without them it could have come up with results similar to the year-ago quarter. Still, the sluggish results helped push Frontier’s stock to a new low.

Reduced passenger counts in April and May gave way to improving conditions in June, and CEO Potter told analysts on the conference call that the company was optimistic that the pickup would continue into the current quarter. June saw a record load factor of 87%, up 1.8 percentage points from June 2006. Passenger revenue per available seat mile was $0.1001, up 1.2% from the same month last year.

Potter gave an expected EPS range of $0.05 to $0.09, slightly under the $0.07-$0.12 range of analysts surveyed by Thomson Financial, for the current quarter. Last year in the July-September quarter, the company reported $0.06 earnings per share.

For the full year, the Thomson consensus estimate for Frontier calls for a loss of $0.45 a share, compared with the fiscal year 2007 net loss of $0.68 a share.

With increasing competition, airlines have not been able to raise fares substantially. That’s especially true in Frontier’s hometown, where it must compete with UAL and Southwest Airlines Co. (NYSE: LUV), even as fuel costs skyrocket.

“Most airlines have tried to boost profits by scraping away at their non-fuel costs,” Ray Neidl, an analyst at Calyon Securities, was quoted as saying in a recent Associated Press story. “But this is getting harder to do.”

He said for all airlines, fuel prices are “killing them,” adding, “It's amazing that they're making money where fuel right now is about $77 per barrel.”

According to Eclat Consulting, a Reston, Va.-based air industry-consulting group, airlines saw their U.S. fuel price jump to $2.06 a gallon in July, an increase of $0.06 from June and $0.25 since January – but $0.02 less than last year.

Frontier executives told analysts that spot prices are currently around $2.42 to $2.45 a gallon and could fall into the upper end of that range in the July-September quarter. Like most carriers, Frontier does have some fuel-hedge contracts in place to guard against at least some of the price increases.

Despite the fuel woes, Neidl says the current quarter for the industry appears stronger than a year ago, “even with higher fuel prices, because traffic is stronger and yields (revenue per miles flown by passengers) should be stronger.”

With its focus on launching Lynx, Frontier won’t be taking any new deliveries on aircraft for its mainline service until next February. The company does have one of the youngest fleets around, of about two years old.

The company has a relationship with AirTran Holdings Inc.’s (NYSE: AAI) AirTran Airways, which includes sharing Frontier’s highly regarded EarlyReturns affinity program. It also has more closely aligned with Republic Airways Holdings (Nasdaq: RJET), which now is its primary provider of some regional service. Frontier also is adding flights in November to Costa Rica, in addition to successful service launches to Mexico and Canada, while dropping unprofitable flights in California.

In early May, Raymond James analyst James Parker upgraded Frontier to “market perform” from “underperform,” and suggested that any wave of industry consolidation might put the company in play. That helped the stock pop past $6.25 on May 2.

Gazing into his crystal ball, Parker wrote in a research note to clients that Frontier could be a takeover candidate. Possible beneficiaries from a merger with Frontier, he speculated, would be such low-cost carriers as Alaska Airlines of the Alaska Air Group (NYSE: ALK), AirTran, JetBlue Airways Corp. (Nasdaq: JBLU), and perhaps even Southwest Air. Parker did acknowledge that a Frontier takeover “is not highly probable,” and the company maintains that it plans to remain independent.

“We will be open to any AirTran-like relationship or code-share relationships,” Potter told analysts on the July conference call, “in finding ways that would benefit us in expanding that footprint. There are many ways of expanding that footprint … (that) doesn’t necessarily involve a strict M&A-type activity.”

Disclosure: Author has no position in stocks mentioned