Citing pressure from its performance under its United Express contract, Calyon Securities has lowered Mesa’s (MESA) rating to neutral. Calyon Analyst Ray Niedl, in reducing it from Add, also cited higher maintenance costs on “a generally older fleet.” He indicated it is unknown whether the problems with the United contract can be resolved. He noted that the cancellations that put the contract performance in jeopardy are beyond Mesa’s control but are still raising its costs.
“We believe that the stock price will be supported by the company as its strong cash flow will continue to be used to buy back stock at what management considers to be a low price in relation to what they believe are the its long-term prospects such as the Hawaiian operation and the Chinese partnership,” said Niedl. “However, we see no immediate action that would trigger a major move upward for the stock price. We expect the Hawaiian operation to continue to be a minor drain on the company and we see no immediate prospect of Mesa exiting the government-subsidized routes that are also currently losing a small amount of money.”
Niedl noted that most regional contracts with major carriers have been assigned and indicated pilot scope clauses will remain as is for now, resulting in restricted aircraft growth to larger RJs. In addition, he indicated U.S. regional airline growth will be limited for the foreseeable future unless Comair is spun off and sold by Delta (DALRQ) as it exits bankruptcy.
Calyon reduced its fiscal 2Q07 EPS estimate to $0.16 from $0.21, our full-year 2007 EPS estimate to $0.82 from $0.95, and the 2008 EPS estimate to $1.00 from $1.12. At the 7.2x multiple that used for Mesa, its target price is now $7.20. “We believe the best prospect for the company is the Chinese
partnership that it has entered with Shenzhen Airlines,” he said. “However, the potential for this developing into a major cash flow generator for Mesa is still uncertain and too far out (over a year) before the potential benefits can start to be realized and, therefore, would have little effect on the stock price for the time being.”
Otherwise, Niedl is bullish on airline stocks advising it is time to buy, especially since first quarter results are higher than expected. American (AMR) reported a first-quarter profit of $81 million compared to a $92 million loss a year ago. Continental (CAL) reported net income of $22 million versus a year-earlier net loss of $66 million.
“AMR Corp., Continental and Southwest (LUV), three key airline indicators, have released their results for 1Q07, beating or meeting estimates despite worse-than-usual winter storms that disrupted service, costing the airlines revenues and driving up costs,” he said. “For AMR and Continental, it is the first time that they have produced a Q1 profit since pre-9/11. However, Southwest, though it has a different model, only met estimates but was down year over year, which may make the company reluctant to increase ticket prices and thus be a possible drag on the industry, since it is a price leader. After a sharp fall-off in stock prices since early January (the airline index is off almost 17 percent), we believe that the sector is ready to rally off of its winter lows, especially among the legacy airlines.”
The industry is now going into the two busiest quarters, which, he said, will be a “gangbusters” period, especially in the international arena. “Years of cost cutting are really starting to kick in, demand remains very strong despite a slowing economy and we believe the airlines have wide latitude to increase unit revenues through tighter yield management,” said Niedl. “The real test will be the coming two quarters. The macro environment indicates slowing economic growth but so far this has not appeared in the forward demand for air travel, especially international. Capacity growth restraints are helping the equation but the key thing is remaining strong demand which, if it continues, will lead to yield and revenue increases. The dividends now being reaped after years of cost cutting, initially through labor cost cutting and the grounding of older inefficient aircraft and, more recently, through the streamlining of the operating model, make the system more efficient and increase the productivity of assets, including employees.”