Mesa To Add 70 RJs To US Airways Fleet



Mesa To Add 70 RJs To US Airways Fleet
Mesa Air Group will add a total of 70 new regional jets to US Airways under two agreements signed last month. The first agreement calls for 20 50-seat RJs to be added to the US Airways network next year. The second agreement, signed just before Thanksgiving, provides for Mesa to supply another 50 regional jets to US Airways beginning in mid- to late-2003. Some of the additional 50 could include 70-seat RJs, although neither airline has announced the type of aircraft to be transferred.
The agreements, which must be approved by a U.S. Bankruptcy Court, essentially maintain an earlier contract between Mesa and US Airways without any substantial changes. This is good news for the industry, according to James Parker of Raymond James & Associates because it affirms his investment thesis for Mesa, as well as for Atlantic Coast Airlines (ACA), SkyWest and ExpressJet.
In a Chapter 11 situation, we believe the majors will need RJs more and not less because they will have an opportunity to downsize their operations by sending 100- to 130-seat narrow-body aircraft back to their lessors and replacing these aircraft with smaller and lower cost RJs, he said. Furthermore, it is important for investors to realize that the regional airlines have considerable leverage in a Chapter 11 bankruptcy filing of a major airline because the regionals control the supply of RJs.
US Airways announced on Nov. 26 that is was furloughing approximately 2,500 more employees, but that it has committed to maintain its fleet at the level of 279 aircraft, 34 more than required under the restructuring agreements ratified this past summer.
Some of the additional aircraft will be flown by furloughed US Airways' pilots under the carrier's Jets for Jobs program. About 10 pilots are allocated per aircraft, and this could result in 700 additional pilot jobs, of which half would be US Airways pilots. It is expected that these pilots would be hired by Mesa, and paid salaries at regional airline first-year captain rates, with the cost passed through to US Airways by Mesa. Mesa will become the third regional partner, together with Piedmont and Allegheny, to participate in the Jets for Jobs program.
The announcement of additional RJs comes after a disappointing fourth quarter for Mesa, in which it reported a net loss of $20.8 million. That was, however, an improvement over a net loss of $48.4 million for the fourth quarter of 2001. Excluding special items from both periods, the 2002 fourth-quarter earnings would have been a $4.4 million profit, compared to a loss of $3.9 million in the fourth quarter of 2001. Operating revenues were up 9 percent to $132.2 million. The loss included $5 million from the demise of CCAir, which shut down its operations on Nov. 4 following the Air Line Pilots Association's refusal to approve a labor contract between CCAir pilots and management (C/R News, Sept.16).
Mesa was also hurt by weak revenue from its revenue sharing operations with Frontier and US Airways, higher than expected maintenance expenses and start-up expenses related to its Freedom Airlines subsidiary and its 64-seat CRJ700 aircraft, Parker said.
However, Parker did rate Mesa as a strong buy because earnings are expected to be up 96 percent year-over-year for 2003. He also noted that the 70 new RJs being added to the fleet could add about $350 million to $400 million in revenue. Parker also noted that there is some risk to owning Mesa shares in that US Airways could declare insolvency under Chapter 7 bankruptcy. While this would entail a write-off of receivables to Mesa from US Airways, we believe other major airlines would seek to enter code-sharing relationships with Mesa in order to capture ... Mesa's earnings stream under this scenario, he said.
Mesa operates 32 RJs in US Airways Express service. Parker notes that it is not clear how many of the 20 additional RJs for US Airways Express service will be incremental to Mesa's overall operation in 2003. Some of its 50-seat RJs may be placed in operation for America West Airlines and/or Frontier Airlines in US Airways Express service, for example.
Although Parker believes that about 10 of the 20 RJs in Mesa's first agreement with US Airways will be incremental and add about $0.0075 per share per RJ to its annual earnings, he is keeping his current fiscal 2003 earnings estimate of $0.80 per share in place until he is able to determine the specific impact on earnings.
As part of the 50 additional RJ agreement for Mesa, US Airways has agreed to affirm Mesa's existing contract in bankruptcy court with no change in its profit margin. However, the RJs in the new contract are expected to operate at a slightly lower margin than Mesa's existing RJs in US Airways Express service.
Jim Higgins of Credit Suisse First Boston said the announcement eliminates the largest overhang of Mesa shares - uncertainty associated with the outcome of US Airways' bankruptcy proceedings. Beyond just the specific details of this event, which are heartening, we view this development as underscoring the importance of regional jets flown by regional airlines at economically attractive costs to hub-and-spoke airlines' networks, he said in a report. Additionally, we believe it highlights the particular attractiveness of Mesa's relatively low 8-12 percent target margins versus Atlantic Coast's and SkyWest's 12-14 percent targets, and places Mesa in a unique position to obtain additional US Airways RJ flying.
Higgins believes at least 50 percent of the 20-plane RJ flying announced will be generated by incremental jets, with the remainder coming from a reallocation of Mesa's current fleet. Mesa currently has a two to three surplus of CRJ aircraft being flown for America West, with an additional three to four becoming available via CRJ-900 deliveries (beginning in early 2003 for America West flying).
While market deployment remains unknown, Higgins estimates annual EPS accretion of $0.02-0.03 per share, for every five additional aircraft flown for US Airways' system, suggesting at least $0.04 $0.06 per share from this new flying.
We believe the current environment of low pilot turnover eliminates one of the largest infrastructure hurdles associated with adding additional regional jets for any regional carrier, placing the tight supply/demand for regional aircraft as the largest impediment to material new RJ growth in coming months.
While Mesa expects to add the 20 RJs in 2003, it is not clear where some of the jets will come from, given tight supply for those aircraft.
Although details will need to be worked out, it is likely that surplus CRJs (Mesa currently has at least three available aircraft) will gravitate to the US Airways code, according to Michael Linenberg of Merrill Lynch. Given that Mesa has some surplus CRJs, the US Airways expansion is likely to translate, on a net basis, into fleet growth of something less than the 20 announced aircraft. Overall, he views the new business as a positive for Mesa and it reaffirms his view that regional carriers are part of the solution for US Airways and other network carriers.
Linenberg is maintaining a Buy rating on the stock as well as a price objective of $8.50, which is 10X his EPS estimate for FY 200 (September year end). This is in line with the two-year average historical trading range of 9x to 10x. He said the biggest risk to the stock achieving his price objective is
the continued presence of financial difficulties at its major partners, US Airways and America West.
Mesa currently operates as a US Airways Express carrier, using a combination of regional jets and turbo-prop aircraft in 38 US Airways markets. Mesa, along with other subsidiaries of parent company Mesa Air Group, operate 32 regional jets and 41 turbo-prop aircraft as US Airways Express.