Plenty of turbulence ahead, despite Republic's progress

November 17, 2012

The good news for Republic Airways Holdings Inc. is that the company has a proven turnaround expert at the helm, CEO Bryan Bedford. The bad news is that Republic is in an industry that always seems in need of a turnaround.

Analysts are impressed by Bedford’s cost-cutting achievements at Republic’s scheduled-service carrier, Frontier Airlines, and his early progress in restructuring its Chautauqua unit, which flies small regional jets on contract for branded carriers.

Indianapolis-based Republic transformed Denver-based Frontier into an “ultra-low-cost carrier” through a 2011 restructuring that chopped out $120 million in costs—in part by cutting workers and labor costs.

Bryan Bedford Bedford

And now it’s taking the scalpel to Chautauqua. It recently announced a series of initiatives that will save roughly $45 million annually over the next five years and is pressing for additional savings in negotiations with flight crews.

But that doesn’t mean blue skies are ahead for Republic as it narrows its focus to Chautauqua and seeks a buyer for Frontier, which it plans to divest in early 2013.

Frontier, which had been awash in red ink before the restructuring, posted pretax profit of $29.8 million in the third quarter, up from a $1.5 million loss in same quarter a year earlier. While that progress is impressive, analysts say, it doesn’t alter the reality that the vast majority of Frontier’s flights go through the competitive Denver International Airport, where it is the No. 3 carrier behind titans United and Southwest.

Indeed, Frontier is a small fry compared to most of its rivals in an increasingly consolidated airline world.

“They have done a good job in returning the airline to profitability and reducing costs,” said Ray Neidl, an analyst with Maxim Group. “But the question is, is there a niche for a stand-alone carrier in Denver?”

Republic bought Frontier out of bankruptcy in 2009 as part of a diversification push. But losses mounted as fuel prices rose, and last year Republic said it would reverse course and shed the business.

Some analysts are skeptical prospective buyers will line up to kick the tires. That’s partly because a purchaser likely wouldn’t get any of Republic’s cash in the deal and would have to make a significant working capital investment in Frontier, Evercore Partners analyst Duane Pfennigwerth said in a report.

Republic says it intends to part ways no matter what. If it doesn’t work out a sale, it says it will spin Frontier off to shareholders or launch an initial public offering.

But parting ways with Frontier won’t exactly leave Republic with the family jewels. Rising fuel and maintenance costs have undercut the economics of the regional jet business, which relies on 44- and 50-seat planes.

Rival Pinnacle landed in Chapter 11 this spring, and Comair, the regional airline owned by Delta Air Lines Inc., flew its final flight in September.

Things were so bad for Chautauqua early this year that it pulled 19 of its 73 jets from service. “We decided it made more sense to park those jets rather than fly them,” Bedford said in a conference call with analysts in April.

The newly negotiated cost savings is allowing Chautauqua to reactivate idled jets. Analysts say shifting toward slightly larger jets, 70-seaters, also will improve the unit’s economics.

But no one expects the segment to generate explosive growth.

“Probably the only bright spot is it is a shrinking industry [with fewer competitors], and it is going to be dependent on larger jets,” Neidl said.

All the uncertainty has kept Frontier’s turnaround from giving Republic’s stock price a big boost. The shares are fetching about $5.20. While that’s up from $4.45 early this month, the shares remain below their $6.33 52-week high reached in February.

Eli Lilly shares retreat

Eli Lilly and Co.’s disappointing third-quarter results have knocked the legs out from under the stock’s impressive rally.

The stock on Oct. 17 hit a five-year high of $53.99—a 42-percent increase from one year earlier. But shares have gone steadily downhill since Lilly on Oct. 24 missed analyst estimates and lowered its profit forecast. The stock now fetches about $47, down 13 percent from the recent high.

Credit Suisse analysts said in a report that the pullback provides an opportunity for bargain hunters. The investment firm has an outperform recommendation on the shares, in part because of optimism the company will be able to bring ramucirumab, an experimental stomach-cancer drug, to market.•


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