SkyWest: Consider This One Even If You Don't Like Airline Stocks (NASDAQ:SKYW) (2024)

Airlines Have A Bad Reputation With Investors, But SkyWest isn't like the others

The airline business has gained momentum in 2024 with several airlines performing relatively well on the stock exchange. SkyWest, Inc. (NASDAQ:SKYW) leads the pack.

Other than this recent performance, it's an industry that seems chronically out of favor with investors. It's said to have produced more losses to investors than gains in its decade long existence.

Even Warren Buffett has burnt his fingers on the industry. One famed investment the Oracle of Omaha made in the industry was when Berkshire Hathaway (BRK.A, BRK.B) bought preferreds in US Air in the 1980s. Not long after striking the deal, the stock tanked and the airline went bankrupt a couple of times while Berkshire was involved.

Fast forward to 2016: Buffett surprised investors when Berkshire took billion dollar positions in equities of the major US airlines: United Airlines (UAL), Delta Air Lines (DAL), Southwest Airlines (LUV), and American Airlines (AAL). This was particularly uncharacteristic as airlines are by nature very capital intensive, low margin, highly competitive ("low-moat"), and largely commodity type businesses. Pretty much the opposite of what Berkshire generally tries to buy with companies like Apple (AAPL) and Coca-Cola (KO) making up a substantial part of its equity portfolio. There's a good chance Buffett bought into airlines at the time because the industry had consolidated heavily over the years - in part because of mergers, in part because of bankruptcies - and therefore was primed to improve margins through cost efficiencies and better pricing power.

But low and behold: Enter the COVID pandemic. Perhaps the greatest challenge to modern aviation. This led Berkshire to sell all stakes in the airlines in 2020. To my knowledge, no investments in the airline industry have been made by Berkshire since.

My own personal experience in airline stocks isn't much better. I've only ever held one airline stock prior to buying SkyWest. Having just made my first ever move into merger arbitrage - betting that Microsoft (MSFT) would eventually be successful closing on the deal to buy Activision Blizzard - I was confident in my new found ability and initiated a position in Spirit Airlines (SAVE), equally betting that JetBlue would eventually work through the legal obstacles to closing on that deal. I knew the deal working out wasn't particularly likely - as was evidently reflected in a big spread between the takeover bid and the market value - but decided to go ahead anyway. The deal involved Spirit Airlines paying a special dividend to shareholders for a period of time while the airlines were working to close the deal, so it appeared that there was at least some reward for waiting. After a while, I decided to exit the position as the risk of the deal not closing appeared to grow. I'm glad I did, because as the deal fell apart the stock tanked and some argued that the airline might not survive on its own.

So while my loss on that speculation was kept at a minimum, it did underline one thing I knew in advance but didn't really keep in mind: The airline industry is brutal. Keeping the airlines just below the Big Four (American, Delta, United, and Southwest) from merging essentially insulates the Big Four from giving market share to "outsiders" trying to consolidate to become competitive in a highly competitive field. But that's policy and perhaps better suited for discussion somewhere else.

Lots of investors have hurt themselves just after uttering that "This time is different". But there are some interesting developments that point to this possibly holding true:

• The airline industry seems to have largely recovered from the pandemic, at least to the extent that now, airlines can start looking forward again and plan for the long term.
• The consolidation in the industry that may have led to Berkshire buying into the industry - which was then disrupted by the pandemic - seems to be picking up again. Weirdly, the fact that Spirit and JetBlue weren't allowed to merge - which would have been consolidation in its own right - might actually lead to consolidation in the industry anyway: Because without the merger, the Big Four airlines seem insulated from increased competition from airlines just below the Big Four, the contesters. SkyWest serves three of the Big Four airlines (Delta, United and American), and these partnerships make up a very substantial part of SkyWest's total business.
• Domestic passenger numbers are growing back to pre-pandemic levels.

Aside from these developments, something in the numbers concerning SkyWest seems to be getting quite exciting. SkyWest holds a "Strong Buy" rating from the Seeking Alpha Quant system:

The individual factors "fed in" to the Quant score are rated as follows:

Given the "Strong Buy" rating and the interesting developments in the airline industry, I decided to share what I found in my research in this analysis:

What makes SkyWest attractive at this point

SkyWest operates domestic flights for US partner carriers. These include Delta, American, United, and Alaska (ALK). According to Statista, domestic passenger enplanements were 751 million for 2023, which sits just above 2017 levels which were 741 million. This level is still some way off from the record level seen in 2019 just before the pandemic when passenger enplanements were 811 million.

An interesting trend is that passenger numbers grew rapidly in the years just before the pandemic. From 662 million in 2014 to 811 million in 2019. If passenger counts return to these growth rates once fully recovered from the pandemic, SkyWest is in for an interesting growth spurt.

SkyWest recently bought 25% of Contour Airlines in a bid to help SkyWest expand and deliver on current and future demand. According to sources, the motive of the deal is not wanting the part-ownership stake for its investment value or to seek a merger but rather to obtain certain deals with Contour: For instance, to use it as a source of pilots. SkyWest is in a quite critical shortage to meet demand with it being some 2,000 pilots short of demand according to its CEO, Chip Childs. Contour is a so-called "Part 135" operator. Operating under Part 135 regulations allow the airline to operate in a less strict regulatory environment. Pilots of Part 135 operators require less flying hours than the standard US limit (1,500 flying hours) and may retire older than the standard mandatory retirement age (age 65). SkyWest has its own "Part 135" operation which seems to be part of its broader attempt to scale pilot training:

We’re working very diligently with partners on creative ways in which we can produce captains faster than what we’re producing today - SkyWest CEO, Chip Childs

Speaking of pilots, CEO Chip Childs reported during SkyWest's most recent earnings call with investors that captain attrition had begun to improve and had reached the lowest level of attrition in two years. This follows a clear strategy laid out by management to enhance employee relations.

It also appears that launching the Part 135 operation and the pilot sourcing that may bring is starting to pay off on the bottom line. Wade Steel, Chief Commercial Officer, spoke on the issue on the earnings call:

While SWC [SkyWest's Part 135 operation] did not contribute to our Q4 earnings, we anticipate SWC will have a positive contribution to our earnings during Q1 of 2024 - Wade Steel, Chief Commercial Officer, SkyWest

In summary, the improving macro elements relating to general passenger numbers, SkyWest's strong execution on demand (pilot sourcing and partnerships) and their deal with Contour seem to add up to an interesting strategy worth following in the coming quarters in particular.

Recent Financials Demonstrated Improving Fundamentals

SkyWest reported full-year results for 2023 on February 15. While SkyWest missed slightly on revenue against consensus estimates, it confidently beat on EPS:

While revenue was not in line with expectations, it did climb 10% year-over-year for the quarter. That brought revenue to $752 million for the quarter. The growth was primarily driven by rate increases. While revenue was up by double-digits, operating expenses were only up 1% to $724 million. The main contributor to higher costs were increases in employee compensation and maintenance costs.

Turning to the balance sheet, SkyWest's liquidity appears in fine condition: It has long-term debt of just $2,562 million which is a lot against its cash position $148 million, but quite manageable compared to its TTM free cash flow of $420 million. While equity (~$2 billion) finances a minority of assets (~$7 billion), I don't find it concerning as SkyWest is a capital intensive business, and the equity would have been higher if not for buybacks which must be offset against equity according to rules of accounting.

With SkyWest's healthy financials, they can afford to reward shareholders through capital allocation. While SkyWest doesn't pay a dividend, the company maintains a progressive share repurchase program. Under the current share repurchase program, SkyWest repurchased 1 million shares during the most recent quarter reported (Q4 2023) alone. For the entire year, SkyWest has repurchased an entire 21% of shares outstanding when the year commenced. SkyWest still has almost close to $100 million of remaining authorization under the program and new programs may be authorized, so I fully expect SkyWest to continue growing EPS numbers through buybacks.

What SkyWest Is Worth

According to data from Seeking Alpha, SkyWest currently trades at a forward P/E of 10.32. This makes it "middle-tier" compared to its peers in terms of valuation by the market:

Although SkyWest trades at a lower multiple than the average of its peers, as outlined in this analysis, the company seems poised to grow in the coming years. That's confirmed by consensus estimates as presented by Seeking Alpha. SkyWest's revenue is expected to grow both for 2024 and 2025:

In 2025, revenue is expected to hit about $3.5 billion against $2.94 billion for 2023. For a short timeframe (1½ years), that's a pretty decent rate of growth. With a P/E of just ~10, SkyWest doesn't really seem priced to grow at all - especially not considering how further buybacks could boost growth on a per-share basis. Considering this, I think SkyWest should trade well above the industry average earnings multiple.

Risks

Investing in the airline industry comes with several risks that are basically inherent in a typical airline business model. One is the capital intensity and the use of vast debt that follows from this. In this lies the inherent risk of bankruptcy if and when circ*mstances change to the contrary. The fact that this business is a commodity-type business – every airline does the same thing in much the same way – adds to this, and it creates a competitive environment where margins are typically low.

Speaking of environment: In recent years, the industry has come under scrutiny for its impact on the climate. This is particularly true for short-distance domestic flights. Some European countries have moved to ban short hauls and imposed tariffs on airline tickets in general. While the industry may be able to cope and adjust, it’s another issue to juggle with.

European lawmakers are more progressive on this issue than their US counterparts, but there’s a risk these moves will inspire US lawmakers to take similar action. Any move prohibiting or taxing short hauls in particular may prove worrisome to SkyWest. After all, this is their primary market.

Conclusion

SkyWest is an airline serving as a regional carrier for major US partners. It has returned to profitability after the COVID years and is now growing alongside the industry in general.

SkyWest holds a “Strong Buy” rating from the Seeking Alpha quant system. This alongside its interesting growth prospects made it an interesting case – and a stock I recently took a position in.

Investing in the airline industry comes with a set of basic risks: It’s a capital intensive business that delivers a commodity-type service. Adding to this, the airline industry has come under scrutiny in some countries because of its impact on the environment. This is particularly true for short-haul domestic flights as alternative means of transportation often exist in this arena. Whether this increased scrutiny from some countries in particular will “spill over” to the US more so than it already has remains to be seen but is a future risk.

Regardless of the risks, SkyWest appears an attractive pick: It’s got an interesting mix of qualitative factors and quantitative factors going for it. It’s also priced at around a P/E (FW) of 10, which doesn’t appear to be pricing in much growth, if any at all. The current buyback program should further boost the attractiveness of the stock on an EPS basis.

For the reasons stated above, I rate SkyWest a “Buy”.

Martin Fjeldhoj