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Vaughn Cordle, CFA
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Vaughn Cordle has 25 years of experience in the airline industry as an equity analyst and consultant to various institutional investors, money management firms, suppliers, and labor groups. Vaughn founded AirlineForecasts, LLC and managed airline and transportation-related investment research... More
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IONOSPHERE Capital LLC
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Ionosphere Capital HOT Topics
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  • Terrorist Attempt Impacts Airline Revenue and Earnings

    If new security concerns dampen airline revenue only .25–.50 percent, the result is a 10–20 percent hit to airline earnings and share prices, all else held constant and based on our base-case scenario for 2010.

    Smart airline investors pull the “sell” trigger quickly when any new risk factor materializes that could impact earnings. We make the case that this is the proper response when investing in the over-leveraged and high [systemic and operating]-risk airline sector. 
     
    It is reasonable to believe that enhanced security measures will result in a small percentage demand drop-off as business and international travelers, and the well-heeled, seek alternatives and substitutes to the time-killing commercial airlines. In other words, increased “security” increases the travel hassle factor, which in turn results in a drop-off in high-yield traffic. Private corporate jet travel and Internet meetings [conference calls] become more attractive to airline passengers as more time is wasted waiting in security lines and freedoms aboard the aircraft are restricted. 
     
    Any drop-off in demand is likely to be temporary and minor, but the risk aversion to airline shares likely has longer legs as it is reasonable to expect other terrorist attempts in the future. Moreover, enhanced security will result in higher costs [lower earnings] for the airlines. Given the more than $3 billion gap between what it costs for aviation security – $5.2 billion in 2008 – and the fees collected from the aviation community, it also is reasonable to expect that the government will want to shift more of the costs of security to the airline industry.

     



    Disclosure: Westjet shares
    Jan 04 9:48 AM | Link | Comment!
  • Southwest's missed opportunity: Frontier goes to Republic (part II)
    August 14, 2009 / Vaughn Cordle, CFA

    Republic will likely replace a significant number of Frontier's aircraft with new regional jets - E190s are the likely choice - to lower costs. For example, the maintenance costs on the E190s will be a fraction of those spent on Frontier's current Airbus fleet because of the maintenance-cost holiday of new aircraft.
     
    Pilot block hour crew costs are 58% lower at Republic ($100 per capita) versus Frontier ($170) and this suggests that Republic will want to reap the benefits of operating its own lower-cost crews. It’s interesting to note that Frontier's crew costs are 59% ($170 vs. $290) of those paid by Southwest, so perhaps they can accept the current labor costs for a period of time, or on some percentage of the capacity.  Frontier's stage-length adjusted seat mile costs are slightly higher (2%) than Southwest's, but 48% lower than high-cost United.
     
    Republic is a tiny bird with a $200 million market cap versus Southwest's $6.2 million. This weak financial leverage and growth capacity suggests that Republic will want to move aggressively to displace as many Airbuses as fast as practical to lower its average costs. In fact, it’s the only way Republic-owned Frontier can win a war of attrition with Southwest and United out of Denver.
     
    Eventually, Southwest must raise fares if it is to earn its cost of capital and boost the sagging share price. Based on our recent analysis, an approximate 5% average fare hike would result in a $1 per share earnings in 2010. The current consensus is $ .35. However, we would not expect this to happen before a new pilots' agreement has been concluded. After all, why produce higher earnings when negotiating with labor.  The below-cost pricing to buy market share in Denver has thus served two purposes: Southwest has grown market share in Denver from zero in 2005 to 17.5% by the first half of 2009, and the reduced earnings has likely shaped labors' views in terms of how much the company can afford to pay.   
     
    Bottom Line: Economics are significantly improved if Republic displaces a significant percentage of Frontier's current capacity with its own crews and aircraft.
     
    In our view, it's hard to make the case that a stand-alone Republic-owned Frontier (and Republic-owned Midwest) can survive over the longer term. Even if Republic displaces aircraft/crews to lower costs, its balance sheet and size may simply be too small to win a prolonged fare war in Denver and Milwaukee (Midwest).
     
    It's interesting to note that US Airways has indicated a desire to sell 25 Embraer 190s to raise cash. These aircraft could be purchased to replace some of Frontier's 10 A318s and 38 A319s. There doesn't appear to be anything that prevents Republic from doing at Frontier what they've done at Midwest, which is to displace B717 crews and aircraft with lower seat mile costs - 40% lower - regional jets and crews.  Lowering costs significantly is likely the only way Republic survives as a standalone airline.
    Tags: LUV, RJET, UAUA
    Aug 14 5:59 PM | Link | Comment!
  • Southwest bids for Frontier: Sweet Deal for shareholders
    Ideally, and from a maximize-the-share price perspective, Southwest eventually replaces Frontier with new employees and B737s.  Frontier employees would likely have the opportunity to work for Southwest, but at the bottom of the seniority list and pay scale. SWAPA would support this type of deal because it allows LUV pilots an opportunity for growth.
     
    If this is the case, and once fully implemented, Southwest's [net] annual earnings from this new component of business could exceed the current bid on the table.   A quick-and-dirty estimate implies EPS improve by ~12 to 15 cents and the share price increases $2 to $3. Basically the acquisition strategy results in a 35% boost in the share price from the pre- announcement value.  The market will quickly discount some portion of the [implied] higher earnings and cash flow. Southwest's seat capacity increases ~10% with the aquisition.
     
    The purchase price of FRNT, as reflected in the current bids from RJET and LUV, significantly understates the value of the business to LUV shareholders. Moreover, the purchase price does not include market share and earnings gains if United is forced to cede market share in DEN and related routes over time.  A quick first cut at modeling a discounted present value of the new business produces a value that exceeds the bid price by ~ 5X.  This based on a conservative 5-year projection that does not include a terminal value.
     
    Frontier is worth significantly more to Southwest than what is reflected in the current bid, but less to weaker competitors like Republic, Jetblue, Spirit, and Virgin.  Without Southwest, the airline is worth more than the current bids on the table.
    Tags: LUV
    Jul 31 1:19 PM | Link | Comment!
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