Regional airlines will consolidate in the near future to four or five airlines dominating the regional market, down from the current seven that fly 80 percent of total capacity, according to predictions made by Calyon Securities Analyst Ray Niedl.

"We believe that this sector will consolidate and probably be dominated by four or five carriers. American Eagle will most likely be a survivor. The other three survivors that we see are airlines with experienced and aggressive management, market mass, and independence through aircraft ownership. These include SkyWest (SKYW), Republic (RJET) and Mesa (MESA). All of these carriers have diversified risk through contracts with multiple partners and reduced risk through aircraft ownership, which gives them an extra measure of leverage with their partners. We also believe that all three are growth stocks since more opportunities will develop as legacy carriers continue their exit strategy from regional ownership (Delta (DALQ) and Comair) and as scope clause restrictions continue to ease, which admittedly will be a long and slow process. The two other regionals that we follow, Pinnacle (PNCL) and ExpressJet (XJT), face a more uncertain future. At this time, they each only have one partner, they face potential risk to their respective contracts, and they do not have ownership of their respective fleets."

Niedl also indicated that airline bankruptcies have resulted in the modification of the regionals' long-term contracts much to their disadvantage. He also noted that growth in the sector has slowed over the past year as mainline operators trim regional capacity. Most reductions have come from Comair, Mesaba (MAIR) and Pinnacle as their legacy partners restructure in bankruptcy. He also noted Republic's contract with Delta is still under negotiation.

Aviation Consultant John Walsh of Walsh Aviation agrees with the Niedl on the fact regional traffic is softening. In 2005 monthly growth rates ranged from 13 to 30 percent. This year, he noted, monthly growth rates began with 15 percent in January and quickly dropped to half that throughout the spring and ended with only five percent by July. However, he also pointed out European regionals were experiencing a resurgence. Annual growth rates are rising, reaching 10 percent last year, significantly down from the 39 percent achieved in 1996, but well ahead of the two percent in 2000 and five percent in 2003. May and June 2006 even achieved 12 percent and 11 percent growth rates, respectively.

Walsh also indicated that regional jet orders are in a rapid decline from a high of 886 orders a decade ago. Orders have slipped every year since then and last year only numbered 186. Meanwhile, turboprop orders reached 151, up 300 percent from 2004 with another 95 ordered this year.

Walsh predicts that deliveries of 35- to 125-seat aircraft in the 2006-2010 period will include 275 turboprops and 709 regional jets and in the 2011-2015 period will be 425 and 1,301, respectively.

He also indicated the changes in scope clauses are not coming fast enough and that regional airline costs are increasing, closing the expense gap between regionals and majors

"The premium prices that once covered the high costs for short range flights have come under attack," he said, questioning whether the solution is to scale up the size of the aircraft to 70 or 90 seats or whether there are deeper problems with which the industry must deal.

"Increased airport hassle has extended the trip time for short-range flights to the point that automobile travel or just not making the trip have cut into the price that customers will pay for a diminished service. Fare transparency has led to the view that the customer is being 'screwed' when asked to pay more money for shorter flights."

Niedl's Picks

SkyWest, with 22 percent of the capacity, remains Niedl's top pick with the best chance to gain market share with new business. His only concern is the proposed USAir/Delta acquisition which, he thinks, would put Salt Lake at risk. (RAN, November 20, p.1)

Republic is his second pick largely owing to its aggressive management and broad industry contacts, he said, also citing its low cost structure, diversified customer base and its orientation toward large aircraft which all agree will be the growth segment of the regional airline market.

He is cautious about Mesa and, while citing its experienced management and diversified customer base, he said the company has not lived up to expectations in obtaining new business although many other opportunities still exist. Likewise, ExpressJet also gained a neutral rating despite its 14 percent of industry available seat miles (ASMs). Niedl cited the fact it has a single customer in Continental (CAL), which recently reassigned 25 percent of its business to Republic's Chautauqua Airlines. Niedl called ExpressJet's creation of a new corporate jet/charter unit a major risk, adding it remains uncertain as to whether it will be successful. However, he is banking on the current Continental contract staying in place. Assuming it will, he noted, ExpressJet will have adequate cash flow and has good cash reserves to fund its operations while it tries to devise new ways of expanding.

Similarly, Pinnacle has a single customer in Northwest but Niedl believes the two airlines will reach agreement for new flying and any claims the regional has against its partner will be folded into a new contract. He called Comair's future uncertain, adding if it survives it will likely be sold, with the likeliest takeover candidate being SkyWest.

Source: Airline Monitor, Company Reports, OAG data