SkyWest: Captains, Not Covid-19, Is The Limiting Factor

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Robert Honeywill
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Summary

  • I did have concerns demand for airline travel would remain suppressed, as COVID-19 changed from pandemic to endemic.
  • But airline travel demand has surged despite ongoing outbreaks of new and existing strains of COVID-19.
  • A new issue has arisen for all airlines - a shortage of Flight Captains and lengthy time periods for Flight Officers to qualify as Flight Captains.
  • SkyWest is a virtual training ground for the Tier 1 carriers it is allied with. But demand for Captains by Tier 1 carriers is exceeding SkyWest's ability to qualify new Captains.
  • SkyWest has many more pilots in total than pre-pandemic, and is taking an innovative approach to getting more pilots and aircraft back in the air.
  • Looking for more investing ideas like this one? Get them exclusively at Dividend Growth Income+ Club. Learn More »

SkyWest Bombardier CRJ-200 airplane Phoenix airport

Boarding1Now/iStock Editorial via Getty Images

SkyWest Bombardier CRJ-200 airplane Phoenix airport.

Investment Thesis: SkyWest Buy, Hold Or Sell?

Back on August 1, 2021, with the share price at $45.57, I published the article, "SkyWest Stock: The Outlook Is Improving." Since then, the share price of SkyWest, Inc. (NASDAQ:SKYW) has fallen by ~54.2% to $20.87, compared to a fall of 19.3% in the S&P 500 over the same period.

How did I, and the many analysts estimating strong EPS growth back then, get it so wrong? Well it was not COVID, and what I summed up with in that previous article remains fairly much on the mark today:

"My own view is most of the COVID-19 risk is now behind us, with international travel restrictions being lifted on November 8. But even the analysts' high EPS estimates for 2023 are still below past historical levels. I expect there will be further upgrades to analysts' EPS estimates over time. SkyWest has a sound balance sheet with manageable debt levels. Due to suspension of dividends and government support, shareholders' equity actually increased from $2,175 million at December 31, 2019 to $2,249 million at June 30, 2021, with no increase in outstanding shares. It is pleasing to see warrants issued will not lead to significant dilution, if exercised. For existing shareholders, I would say now is not a time to sell. For potential investors, I would say SkyWest could be a buy with considerable upside potential, and downside risk is definitely less than when I wrote my last article on August 1."

Today, passenger demand is strong for all airlines, including Sky West. But during the pandemic, it is estimated 6,000 Flight Captains took early retirement offers or left the industry. This shortage of Captains is placing a limit for all airlines on the numbers of flights that can be conducted. SkyWest is curtailing flights, despite more than sufficient airplanes, and Flight Officers ("FO") to crew them.

Addressing the shortage of Captains -

It takes a minimum of 1500 flying hours for an FO to qualify as a Captain. The reduced number of flights due to the shortage of Captains also limits the available number of hours for FOs to gain Captain status. The Tier 1 carriers pay higher rates for pilots (Captains and FOs) than regional airlines like Sky West. Sky West has increased its total pool of pilots from 5,239 at Dec. 31, 2019 pre-pandemic to 5,705 at Dec. 31, 2021.

A potential shortage of pilots was discussed in SkyWest's earnings call for Q3 2021, when it was stated hiring and training was outpacing attrition at SkyWest. It was not until the Q4 2021 earnings call that SkyWest first indicated an issue with Captain numbers, in particular. The issue was addressed in greater detail in the Q1 2022 earnings call.

Of course, pilot attrition was anticipated and planned for in our models and strategies. However, the rapid increase in captain attrition was not... given the timing...for training and upgrade, this imbalance will likely constrain production into early 2023. This pilot imbalance is an industry-wide challenge as services in various ways and we are working together with our people to ensure that we remain in the best position to manage it aggressively.

The increase from 250 hours to 1500 hours training requirement to achieve Captain status was introduced in 2013, following the 2009 crash of Colgan Air flight 3407, which crashed primarily due to pilot error. The shortage of Captains is prompting calls for a reduction in the hours requirement. The SkyWest CEO, on the Q1 2022 earnings call, does not see this changing, and instead will address the shortage of Captains by being, "...aggressive in a multitude of other areas to address this."

Aggressive Approach To Getting More Pilots And Aircraft Flying -

By a touch of serendipity, SkyWest revealed one way they will get more pilots and aircraft flying while I was finalizing this article. The full impact will be better understood by first reading the analysis below of the issues SkyWest currently faces. The impatient can skip to the end, where this discussion continues, but will miss some valuable detail.

The impact of constrained flight hours on costs and earnings -

Table 1 below includes a comparison of Q1 2022 results to Q1 2019 results (pre-pandemic). Surprisingly, despite the shortage of Captains, revenue is higher in Q1 2022 than for Q1 2019. But operating income is well down mainly due far higher Salaries etc. and Aircraft maintenance.

Table 1

Table 1

SEC filings

To better understand what is happening with costs and revenues, I have compiled the segment analyses per Table 2 below.

Table 2

Table 2

SEC filings

The analyses in Table 2 revealed a further surprise. SkyWest's aircraft leasing business has increased earnings compared to pre-pandemic, and is the primary reason the company has remained profitable. From the Q1 2022 earnings conference call:

...we currently have 39 CRJ700s and 900s under long-term leases with third parties. This line of business has very good cash flow and strong margin characteristics. Demand for our engine leasing business is returning, and we anticipate placing several engines under long-term leases this year.

And the following Q&A on leasing:

Question -

But what is the potential pool of aircraft and engines, you're looking to lease over the next year or two look like? I'm just trying to think through like aircraft supply is also a bit tight right now, so there's more demand, but then you've got maybe some offset on pilot availability driving some decisions with some of the third-parties you look to do this with. So just any color here would be great.

Answer -

...there's a couple of new and interesting kind of opportunities. As we've kind of started to explore different opportunities out there, a of these 135 carriers are definitely reaching out to us about our existing asset base, right? As Chip said, we have over 200 -- CRJ200s that are extremely well priced. They've been maintained by the best airline in the country for 25 years. We have the best engine agreement. And so there's been very good demand from a lot of a -- lot of small airlines associated with our CRJ platforms. And I'll tell you, the engine interest in that fleet is also extremely strong, right? They -- we have a very good engine agreement with our OEM. And a lot of these smaller airlines just don't have the size and the buying power that we have associated with that fleet. And so those are probably -- those are two very good opportunities right there for us. And then as you look at the engines that are on the 700s, the 900s, there is a very large wave of engine events coming for the industry in the next couple of years. And SkyWest has invested heavily in those engines during 2019, during 2020, during 2021, we made very large investments in those, and we are very well prepared for that. And we've had a lot of interest from other airlines in potentially helping them through their wave and their model, hopefully, that they could avoid engine events by leasing from us. And so there are some pretty good opportunities out there, both on our CRJ200 and then the engines associated with the 700 to 900.

Those are a couple of quite long quotes, but that information should be of great interest to anyone considering an investment in SkyWest stock. Leasing out surplus aircraft and engines could be a profitable solution to the present under utilization discussed below. In Table 3 below I carry out further analysis, with particular emphasis on the SkyWest Airlines segment of the business.

Table 3

Table 3

SEC filings

Comments on Airlines segment comparing Q1 2022 to Q1 2021-

For the Airlines segment, revenue decreased by 1.7% but Operating Income decreased by 137%, going from $53.3 million to a $19.8 million loss. There were reduced Block hours, but this effect was largely offset by higher revenue per passenger. The decline in operating income is clearly not revenue related. It is a cost issue, and it will not be possible for Airlines segment to return to profitability unless the underlying causes are recognized and addressed.

Down under operating statistics, it can be seen average passenger trip length and average passengers per departure are similar for both periods, so these are not the cause of the excessive costs in Q1 2022. In the statistics, out of passengers carried, aircraft operated, aircraft departures, and passenger load factor, only the increased numbers of aircraft operated could conceivably increase costs. But that is unlikely, because Block hours and passengers carried would be the main drivers of costs.

Under utilization of aircraft is a key driver of poor economics at present for SkyWest -

While not the only issue, the averages per aircraft in the stats in Table 3 are most informative for understanding a large part of poor economic performance for Airlines segment in Q1 2022. The airline business is a capital-asset intensive industry, with capital assets being in the form of aircraft. Average departures per aircraft declined from 406.5 in Q1 2019 to 343.6 in Q1 2022.

But this is not the whole story. More aircraft is the reason for increased depreciation despite lesser Block hours flown. But Salaries and wages and maintenance expenses also increased, although these would be expected to be lower with lesser Block hours.

Maintenance costs -

With lower Block hours, maintenance costs could be expected to decrease in Q1 2022. Some clue to the increase to $138.4 million can likely be found in part of the answer above on the Q1 2022 earnings call:

And then as you look at the engines that are on the 700s, the 900s, there is a very large wave of engine events coming for the industry in the next couple of years. And SkyWest has invested heavily in those engines during 2019, during 2020, during 2021, we made very large investments in those...

So SkyWest may have gotten ahead of the game and will put these refurbished planes and engines to work in both the Airlines segment fleet and the Leasing segment fleet.

Impact of hiring and attrition and under utilization of aircraft on Salaries and wages expense -

Table 4 below shows employee number detail for first quarter 2019 and 2022.

Table 4

Table 4

SEC filings

  • Pilots - Increase from 5,239 to 5,705 despite lower Block hours flown. This could be said to be like over filling a leaky bucket to compensate for the leaks, in this case Captains leaking to Tier 1 airlines. As discussed further above SkyWest expects the Captain issue will be overcome, but not before early 2023. Overcoming the Captain issue also would mean SkyWest could more fully utilize its aircraft fleet without employing additional pilots. That would allow a significant increase in revenue without a corresponding increase in cost.
  • Flight attendants and Airport operational personnel - I do not really know the reason for these increases despite fewer aircraft departures. Fewer departures per aircraft might affect rostering requirements. But, I suspect it is related to staffing up for additional aircraft expecting similar numbers of departures per aircraft as for 2019. In this event, as for pilots, increasing departures would increase revenues without a corresponding increase in costs.
  • Maintenance technicians and other maintenance personnel - Little change overall and appears to be a reflection of a higher proportion of more highly qualified staff.

Aggressive Approach To Getting More Pilots And Aircraft Flying (cont'd) -

Background To The Opportunities Provided By SkyWest's Fleet Of CRJ 200 Aircraft -

  • Per above, " we have over 200 -- CRJ200s that are extremely well priced. They've been maintained by the best airline in the country for 25 years. We have the best engine agreement. And so there's been very good demand from a lot of a -- lot of small airlines associated with our CRJ platforms."
  • Smaller airlines than SkyWest, holding a Part 135 Certificate, are permitted to use Flight Officers with less hours than required for Captain status to fly CRJ200 aircraft on passenger routes. SkyWest operates under a Part 121 Certificate and is not permitted to take advantage of the Part 135 Certificate provisions.
  • Due to inability to crew sufficient aircraft with Captains, per Q1 2022 conference call, SkyWest, "...made the very difficult decision to file a 90-day termination notice with the Department of Transportation for 29 communities, as we work through our staffing imbalance. We're also evaluating the various other options to ensure these markets maintain connectivity to the broader national transportation infrastructure.

    With an investment -- with an existing investment in Southern Airways, we expect to explore more ways, including other Part 135 options to help maintain the strong and reliable air service that so many small and medium-sized markets rely on."

  • Per Reuters news report, "The U.S. Transportation Department ... barred ...SkyWest ... from ending service to 29 locales until replacement carriers can be found under the government's subsidy program to provide air service to smaller communities."

  • It appears SkyWest was hoping to lease CRJ 200s to smaller airlines holding Part 135 Certificates so service could be maintained. But that would mean SkyWest giving up routes in which it had made considerable investments.

The solution -

Per June 22, 2022 Airline Weekly article:

They say necessity is the mother of invention, and many U.S. regional airlines are desperate for an inventive solution to their pilot woes. While some are pitching a potential — but unlikely — increase in the mandatory pilot retirement age to paying regional crews the same as their mainline counterparts, SkyWest Airlines has another bold answer: start a new airline... SkyWest Charter’s answer to the pilot situation is the DOT’s “Part 135” public air charter certification that allows an airline to hire pilots with as little as 250 hours, rather than the 1,500 required for pilots at scheduled carriers like SkyWest Airlines or American Airlines. This expands the pool of eligible pilots. SkyWest Charter can do this by flying a fleet of Bombardier CRJ200 aircraft with just 30 seats — the maximum allowed under 135 rules — instead of the standard 50 seats.

This appears to be an ideal solution for SkyWest. It should allow SkyWest to:

  • Retain the 29 locales it was finding difficult to service;
  • More fully utilize its fleet of aircraft (the analyses above show the extent of under-utilization);
  • More fully utilize its existing employees - pilots, flight attendants and ground staff (the analyses above show the extent of under utilization);
  • Provide more hours for its FOs towards their advancement to Captain;
  • Retain the revenue from the 29 locales and possibly earn additional revenue from new routes with little incremental cost as presently under utilized aircraft and personnel would be used.

Summary and Conclusions

It would appear SkyWest has invested heavily in staff and maintenance to operate at a level well above current operating levels. The shortage of Captains has thrown a spanner in the works and operating assets are under utilized.

Despite this, the Lease segment is operating profitably with prospects for further profitable growth in the near term. Lease segment profits are more than offsetting the present poor results in the Airlines segment, allowing SkyWest to work towards resolving the Captains issue without undergoing financial stress. I think it is reasonable to assume SkyWest will come through this difficult period and return to more profitable levels in the next one to two years.

The emergence of the proposal for a new Part 135 Certified airline could significantly advance the return to full utilization. If that is the case, the present share price could appear very cheap in retrospect. For existing shareholders, I would say now is not a time to sell. For potential investors, I would say SkyWest could be a buy with considerable upside potential, and limited downside risk, but the stock might need to be held to end of 2023 or later to realize the returns that are possible.

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This article was written by

Robert Honeywill profile picture
7.91K Followers
I am a retired accountant with a background in large mining projects, from feasibility to full-scale operation, large scale primary industry and food processing, commercialisation of university intellectual property, and consulting to small businesses, government departments and insolvency practitioners. I have gained a wealth of experience from having the extreme good fortune to work, in a cooperative environment, with so many people far more intelligent and smarter than me; from scientists and engineers with MBA qualifications, to University professors across a range of disciplines. Through the accident of mergers, acquisitions and dispositions, I held, at various times, financial controller positions within Utah International Inc, General Electric Inc, and BHP Billiton organizations. If I have a special skill, it is in methods of assessment of projects with long lives, where costs are front loaded and/or future revenues are subject to considerable degrees of uncertainty. In relation to stocks, I have a theory, using projections to calculate a present value per share is far less useful for a share buying decision, than using those same projections for calculating future value per share for determining potential exit value and rate of return.
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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. I do not recommend that anyone act upon any investment information without first consulting an investment advisor and/or a tax advisor as to the suitability of such investments for their specific situation. Neither information nor any opinion expressed in this article constitutes a solicitation, an offer, or a recommendation to buy, sell, or dispose of any investment, or to provide any investment advice or service. An opinion in this article can change at any time without notice.

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