When it comes to SkyWest Inc (SKYW, Financial), the company currently is hard to ignore. In any case, it is doing an excellent job implementing its operational strategy this year, with a strong result in the third quarter of 2024. More appealing are the company's partnerships with some of the leading airlines. One significant advantage of these partnerships is that the company can grow its fleet without straining its balance sheet.
Furthermore, SkyWest has experienced a stunning comeback over the last five years, with its stock price rising 79.71% and regaining an incredible 838.44% from its pandemic-era low. This year alone, the stock has grown by a spectacular 110%. Nevertheless, despite the big rally, the stock has an attractive valuation.
This five-year chart below illustrates how the stock has performed in the long run. In mid-2022, the stock bottomed out and began a steady rise afterward. This recovery is consistent with the general turnaround of the airline industry and is attributed to increased air travel demand, loosened constraints, and increased consumer activity.
In 2023, the stock price surged, as did the growth rate. This momentum proves the enhancement in investors' confidence, due to improved fundamentals, solid profitability, and strong quarterly performance of the company. The pace has only accelerated in 2024, with a remarkable 19% gain following Q3 2024 earnings.
Based on what I see, the stock is not far away from breaking the $120 level in the coming months considering sector-related problems such as fuel pricing volatility and regional air travel demand don't create any disruption. Moreover, if the company remains consistent in its quarterly results and upward revisions, it will be a powerful catalyst for the upswing, and the stock can reach the $130-$150 range within the following 12-18 months.
Company overview
SkyWest is the largest regional airline in the United States. It has around 500 aircraft in its fleet, with 240 different destinations in North America, and served more than 38 million passengers in 2023. The company has partnered with major airlines such as United Airlines (UAL, Financial), Delta Air Lines (DAL, Financial), Alaska Air Group (ALK, Financial), and American Airlines (AAL, Financial) to provide an efficient travel network.
Source: Company Website
SkyWest's business is to operate regional jets for major airlines. The larger ones coordinate in the areas of marketing, scheduling, pricing, ticketing, as well as reservations. SkyWest operates these flights under the partner's branding while following the partner's operational guidelines, which of course vary from partner to partner. This model decreases SkyWest's risks while increasing profits. A significant 94% of its fleet operates under capacity purchase agreements (CPAs). Under these CPAs, major airlines are willing to pay fixed prices to cover expenses such as fuel, while SkyWest enjoys steady, long-term profitability.
Meanwhile, under prorate agreements, the remaining 6% of SkyWest's operations allow the airline to use its major airline partners' ticketing and reservation systems. Prorate agreements differ from CPAs in that airlines manage ticket sales and marketing, as well as collect passenger prices, including modifications for connecting flights. These flights give SkyWest more direct control over the flight timings and passenger fares, while at the same time, SkyWest is also responsible for maintaining and financing fuel.
SkyWest's path to sustainable growth
Investors interested in growth in the airline sector can refer to SkyWest's Q3 2024 earnings report. Its revenue increased by an astonishing 19% year-over-year (YOY) to $913 million. Also, the net income has grown dramatically from $23 million in Q3 2023 to a mind-boggling $90 million. This demonstrates how the management is able to rein in excess costs and also how it takes initiative for the benefit of the company.
A major contribution to this success is that SkyWest has relationships with top airline giants. Specially noteworthy is its agreement with United to operate 40 CRJ550 aircraft under a multi-year contract. By doing this, SkyWest improves the time utilization of its fleet and secures an opportunity to recapture markets in which they were previously underserved. Moreover, it has maximized operational profitability while satisfying partner demands by transitioning 29 CRJ700 aircraft to the CRJ550 model.
Furthermore, the expansion of 21 new E175 aircraft in 2024 also proved the company's capability to grow the fleet without extra financial pressure. The table below shows its year-to-date fleet with each of its partners.
Source: Q3 2024 Earnings Release
Meanwhile, SkyWest is reinvesting profits prudently towards capital expenditures at $97 million and reducing total debt ($3 billion at the end of 2023 to $2.7 billion on September 30, 2024). This declining debt profile is combined with the strong liquidity of $836 million in cash and marketable securities.
It looks like SkyWest will be able to continue its growth trajectory in the long run. The company will benefit from the growing demand for regional air travel by using its strong relationships with airline partners to leverage operational efficiency.
Attractive valuation and growth metrics
SkyWest's valuation is one of its strengths. Its P/E Non-GAAP (FWD) is 15.90 times, 26% below the sector median of 21.47. The fact that the market is seemingly undervaluing SkyWest's earnings potential implies a significant discount.
Another strength is in the form of operational efficiency. The current EV/EBITDA (TTM) of SkyWest is 8.57 times, which is 38% less than the sector median of 13.84 times, therefore it shows how effectively the company generate earnings in relation to its enterprise value. Besides, the price/cash flow (TTM) is at 6.31 times which is 58.2% lower than 15.31 times for the sector. This shows that SkyWest generates cash flow at a small fraction of the price investors pay for stock in this industry.
Now, let's analyze SkyWest's valuation in comparison to its peers: Frontier Group Holdings (ULCC, Financial) and Southwest Airlines (LUV, Financial). Frontier trades at forward earnings of 162.60 times, and Southwest trades at 44.22 times, significantly higher than SKYW's as well as the overall sector median.
Source: Author Generated based on Historical Data
Furthermore, SkyWest is slugging it out with Frontier's 15.5 and Southwest's 11.60 EV/EBITDA (TTM), respectively. Meanwhile, in price/cash flow terms, Frontier's negative 6.18 times is poor, while Southwest's 48.15 times is excessive. Therefore, SkyWest is the most efficient in terms of cash among the three.
Hence, it is commendable that SkyWest has its eyes set on truly profitable business considering that it operates in a more volatile regional airline sector.
Risks to the thesis
Although SkyWest's performance is strong, there are definitely a few risks to my thesis.
First off, the reliance on other airlines is a big weakness for the company. Because a major piece of its revenue base is contracts, any blips in strategy there, such as scaling back regional routes, can have a direct impact on SkyWest's bottom line. Also, the current over-demand of flights could put pricing pressures and operational constraints in check, if a major airline partner reduces routes due to capacity limitations.
Second, the ongoing fleet transition also comes with challenges. Expansion to CRJ550s and E175 aircraft undoubtedly represents a strategic initiative to satisfy market needs but comes with risks. In simple words, unexpected costs, delays, or operating disruptions during this transition could shrink SkyWest's resources and halt its ability to keep flying off on a seamless service.
Last but not least, the airline industry is a volatile business segment. Some factors including fuel costs, regional travel demand, and political instabilities are always up for debate. On the macro level, any event that would change the dynamics of air travel whether it be in terms of cost or geopolitics would definitely impact the company's performance.
Your takeaway
SkyWest leaves little doubt to investors in the air industry that it is a worthy bet. It revealed an impressive revenue increase and a staggering improvement in net income in Q3 2024 and proved that it understands well how to manage its operations efficiently. SkyWest's solid partnerships with major airlines plus its ability to expand its fleet without raising a heavy outlay of capital gives it a leg up to continue to grow. When combined with its reasonable valuation, it is not surprising that SkyWest is one of the safest bets for investors seeking long-term growth.
Yes, there are threats including dependence on airline partners and fleet transitions, however, due to high cash flow, relatively low costs, and attractive market position, even these risks can be managed. Therefore, there is no question that double-digit growth makes perfect sense for those who can commit to the stock for a considerable amount of time given all the plausible solid fundamentals.
