Turboprop Operators Post Lower Profits Due to Higher CASMs

In the world of regional airlines, a quick check of the hangars or the books reveals that the world is changing.

While the five publicly traded regional carriers posted double-digit operating margins in the final quarter of 2003, those with all-jet fleets performed better than their peers. All-jet Pinnacle Airlines [Nasdaq: PNCL] had the highest operating profit margin of 13.8 percent - a margin greater than JetBlue Airways [Nasdaq: JBLU], whose 13.3 percent was the highest of the network and low-cost carriers.

When the industry benchmark of cost per available seat mile (CASM) is examined, Mesa Air Group [Nasdaq: MESA] is the most efficient, holding its costs to 12.1 cents per mile. Although it has 107 jets, Mesa is still flying 54 turboprops. Mesa continues to add more regional jets to satisfy the needs of its three code- share partners.

At the other extreme, all-turboprop Big Sky Airlines, a unit of MAIR Holdings [Nasdaq: MAIR], had the highest CASM, at 29.4 cents per mile.

Pinnacle

Now an independent company, Pinnacle Airlines [Nasdaq: PNCL] reported a profit of $35 million in 2003. In 2002, the company earned $30 million, or $1.41 per share. Revenues grew from $331.5 million to $456.7 million in 2003. The former unit of Northwest Airlines [Nasdaq: NWAC], Pinnacle increased it cash balance from $4.5 million to $31.5 million. However, its debt also now includes a $120 million note payable to Northwest.

In the fourth quarter, Pinnacle earned $9.8 million, or 45 cents per share, on $127 million in revenue. In the same period of 2002, the carrier earned more from less revenue. It earned $10.6 million, or 49 cents per share, on revenue of $95.2 million.

Pinnacle did not provide operating ratios when it released its 2003 numbers.

"Pinnacle maintains an industry-leading airline service agreement [with Northwest] with the delivery of 65 CRJs under contract through 2005," said Ray Neidl, an analyst with Blaylock & Partners. "The use of 129 CRJs are guaranteed for 15 years. Pinnacle has agreed to receive a target operating margin of 10 percent through 2007, with the allowable range starting at 9 to 11 percent for 2004 and 2005."

In the next two years, James Higgins, an analyst with Credit Suisse/First Boston, sees Pinnacle growing its capacity, as measured by available seat miles (ASM), by 39.3 percent. Only Mesa will grow more, at 43.5 percent, Higgins said.

Looking beyond 2005, Higgins said, Pinnacle would grow more than any other regional airline because Northwest has a smaller percentage of its routes covered by regional jets. Compared to Continental Airlines [NYSE: CAL], which flies 16.3 percent of its seats on regional jets, and Delta Air Lines [NYSE: DAL], which flies 15.8 percent of its seats on regional jets, Northwest flies only 11.5 percent on regional jets.

After examining Northwest's routes, Higgins estimates that the mainline carrier will begin to covert more of its flights to regional jets so that by 2008 its profile will be similar to Continental and Delta. To match the other two, Higgins predicts that Northwest will exercise options to acquire 175 jets from Bombardier [Toronto: BBDb]. Pinnacle in turn will win the rights to fly about half of these new planes, he predicted.

While Pinnacle's contract with Northwest does not prohibit the regional carrier from linking up with any other network carrier, neither Higgins nor Neidl see Pinnacle forming any other code-share partnership in the near future.

ExpressJet

Although Continental still owns a substantial piece of ExpressJet [NYSE: XJT], this is the first year that the regional carrier reported its numbers apart from Continental's. In 2003, ExpressJet's net profits increased by 30 percent to $108.5 million, or $1.80 per share. The previous year, it earned $84.7 million, or $1.38 per share. Its operating revenue grew by 20 percent from $1.08 billion to $1.3 billion.

In the fourth quarter, ExpressJet posted a net profit of $27.9 million, or 52 cents per share, on revenue of $340.9 million. A year earlier, the carrier earned $22.3 million, or 35 cents per share, on revenue of $284 million. ExpressJet noted that its CASM decreased by 14 percent in the quarter as it "continued to exploit the efficiency of its all-jet fleet." Its CASM was 12.71 cents per mile for the final quarter of 2003.

In his analysis, Neidl forecasts "muted growth prospects" for ExpressJet with Continental, with only a 10 percent annual growth in capacity as measured by ASM. Furthermore, its contract terms with Continental will change in 2005 as the bar is raised for making incentive payments.

SkyWest

SkyWest [Nasdaq: SKYW], the regional carrier that flies for Delta, United Airlines [OTC: UALAQ] and Continental, reported that its 2003 net profit shrank by 23 percent.

Last year, SkyWest earned $66.7 million, or $1.15 per share, on $888 million in operating revenue. A year earlier, the carrier posted a larger profit, $86.8 million, or $1.51 per share, on less revenue -- $774.4 million.

For the year, SkyWest carried 10.7 million passengers, a growth of 28 percent. The higher passenger load resulted in 4.2 million revenue passenger miles (RPMs) in 20003, up 41.2 percent from 2.9 million RPMs. The carrier last year put more seats in the air to handle the hike in passengers. It flew 5.8 million available seat miles (ASM). The carrier filled more seats as it posted a 71.9 percent passenger load factor. The breakeven mark was 63.9 percent in 2003.

While SkyWest's CASM dipped 11 percent to 13.4 cents, it revenue per available seat mile (RASM) also declined by 15 percent to 15.1 cents. At the same time, its yield per revenue passenger mile was 20.9 cents -- down 18 percent from 25.7 cents in 2002.

In the fourth quarter of 2003, the carrier earned $17.4 million, or 30 cents per share, on revenue of $237.4 million. In the final period of 2002, SkyWest earned slightly more, $17.7 million or 31 cents per share, on revenue of $208.1 million.

In the fourth quarter, SkyWest earned 3 cents more per share than the Wall Street consensus estimate of 27 cents per share. Neidl noted that the renegotiated service pact with United reduced SkyWest's 13.8 percent operating margin in the fourth quarter of 2002 to a still impressive 12.1 percent in the last period of 2003. The new contract was cited as the cause of a 17 percent decline in fourth quarter yields, to 19.9 cents per mile. However, with the shift to more regional jets, the carrier has also been able to reduce its costs by 16 percent.

SkyWest's operating pact with Delta for the year has not been settled. The company expects to be forced to sign a less profitable contract as it did with United last year. SkyWest is also competing with other Delta Connection carriers for 45 50-seat regional jets that Delta expects to be delivered next year. However, Robert Ashcroft, an analyst with UBS, estimates that SkyWest will at best win no more than half these planes.

"For SkyWest to win all the Delta growth, they may be required to make significant concessions on rates for existing business. If SkyWest does score Delta growth, Delta's regional jet program is slowing. The proposed allocation amounts to an insignificant 11 percent increase over Delta's existing regional jet commitments over two years. Until Delta negotiates more outsourcing rights with its pilots, we think Delta will be a dwindling source of regional jet growth," Ashcroft said.

MAIR

After earning a net profit of $8.1 million in its first nine months -- a 56 percent hike in earnings over the same period of 2002, MAIR Holdings' [Nasdaq: MAIR], the parent of Mesaba Airlines and Big Sky Airlines, final quarter will be impacted by two major events in January. The pilots of Mesaba settled on a new contract that substantially raises base salaries, and the company will still fly Northwest'sAvro fleet.

In fact, a $2.7 million retroactive pay raise to the pilots reduced the third quarter earnings to $759,000, or 4 cents per share, compared to a $1.2 million profit, or 6 cents per share, recorded in the same quarter of 2002. The carrier generated a 2.2 percent increase in revenue to $115.3 million.

At Mesaba in the third quarter, the airline carried 1.4 million passenger or 466 million RPMs. The airline increased its flying capacity to 760 million miles as measured by ASMs. Its costs and revenue both decreased in the quarter. Mesaba reported 14.6 cents RASM in the period compared to 16 cents spent per mile in the same period of 2002. The cost as measured by CASM dropped from 15.7 cents per mile to 14.4 cents per mile.

At the smaller Big Sky, which flies the 19-seat Fairchild Metro III/23, comparisons to 2002 were not calculated since MAIR purchase the carrier in December 2002. It flew 25,755 passengers in the quarter ending Dec. 31, 2003. However, in the final period of 2003, Big Sky reported a 37.5 percent load factor with its RASM at 23.6 cents per mile and CASM at 29.4 cents per mile.

James Parker, an analyst at Raymond James, is estimating that MAIR will lose 14 cents per share in the quarter ending March 31. As the company closes it fiscal year on that date, Parker said its earnings would drop 13 percent to 19 cents per share.

"There is considerable uncertainty regarding Mesaba's future with Northwest since Mesaba has not placed a new regional jet aircraft in service since June 2000 and Northwest has allocated all of its regional jet growth thus far with Pinnacle," Parker said.

>>Contact: Ray Neidl, Blaylock & Partners, (212) 715-6627; James Higgins, Credit Suisse/First Boston, (212) 538-3456; Robert Ashcroft, UBS, (203) 719-6064; James Parker, Raymond James, (404) 442-5860.<<