SkyWest, Inc.

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 2/5

SkyWest, Inc. is a regional airline company that primarily operates through capacity purchase agreements with major airlines.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

SkyWest’s business model revolves around providing regional flying services to major airlines under long-term fixed-fee contracts. This means SkyWest operates flights on behalf of its airline partners, such as United, American, Delta, and Alaska, using their own aircraft, personnel, and operational expertise, while its airline partners set fares and manage marketing. This differs from traditional airline models where airlines assume most of the risk associated with the ticket sales.

Business Overview

Revenue Distribution

SkyWest’s revenue streams are primarily derived from:

  1. Capacity Purchase Agreements (CPAs): These fixed-fee contracts account for the vast majority of revenue and are typically structured on a per-block-hour basis. These contracts can be complex and are often multi-year agreements.
  2. Other Revenue: This includes items such as government subsidies for essential air services or sales of leased aircraft.
  3. Lease revenues: Leases revenues for the parts and engines that are under long term leases.

As a regional carrier, SkyWest’s routes are generally shorter, connecting smaller cities to major airline hubs. It acts as a link between smaller and larger markets, allowing airlines to provide services to a broader customer base.

The airline industry is known for being highly cyclical and sensitive to economic downturns. It’s a capital-intensive industry with complex cost structures, high volatility in revenues, and fierce competition.

  • Consolidation: The airline industry has been consolidating for years, with major airlines acquiring regional carriers to streamline operations and reduce costs.
  • Pilot Shortage: A growing shortage of pilots has put significant pressure on airlines to increase wages and benefits to retain talent. This adds to cost pressures, especially for regional airlines that primarily rely on pilots for all of their flight operations.
  • Rising Fuel Costs: Volatile oil prices can significantly affect the cost of aviation fuel. SkyWest’s cost structure can often be quite different from other airlines because its contracts typically have a fixed-fee pricing clause.
  • Demand Shifts: The travel industry has seen a change in the demand for regional travel due to the pandemic and changing business trends. Some smaller cities have seen a decline in demand while some other cities have seen a rise.
  • Increased Outsourcing: Major airlines are increasingly outsourcing their regional flying to carriers like SkyWest to reduce costs.
  • Technological Advancement: New and modern aircraft tend to have lower operational costs.

Competitive Landscape

SkyWest’s competitive position depends upon several factors.

  • Dependence on Major Airlines: SkyWest is largely dependent upon a few major airline companies for its revenue. It lacks the flexibility to set its prices or pursue independent growth strategies.
  • Low Switching Costs: Airlines face little cost to switch to different regional carriers and are most likely to do so when profitability starts to fall.
  • Bargaining Power: SkyWest’s customers are large, with significant buying power that can threaten SkyWest’s bottom line by extracting lower rates from them, particularly with intense competition between carriers.
  • Limited Differentiation: SkyWest’s services are often seen as a commodity. It has limited ability to create differentiation and reduce competition based on product or service attributes.
  • Competitors: SkyWest faces competition from other regional carriers and potentially also from the major airlines themselves. It is competing with companies like Republic Airways, GoJet, Mesa Airlines, and SkyTeam partners in its operating regions.

What Makes SkyWest Different

SkyWest differentiates itself through:

  • Scale: They are among the largest regional airlines in the world, which allows for economies of scale.
  • Financial Resources: SkyWest has solid financials which enable it to acquire new and modern aircraft and also pay its obligations on time.
  • Operational Excellence: SkyWest is known for its robust and standardized operations, which minimize downtime for airlines, and helps them earn their fees, and thus profits on their assets.
  • Multiple Major Airline Contracts: SkyWest has agreements with all major domestic airlines, which mitigates concentration risk with a single operator.

Moat Analysis

SkyWest’s moat is limited to a 2 out of 5 rating, driven mainly by its scale and operational efficiency.

  • Network Effects (Weak): While SkyWest has an extensive network of regional routes, it primarily acts as a supplier to larger airlines. The network effect, where the value of a network increases as more users join, isn’t a strong feature of their business model.
  • Switching Costs (Weak): Switching costs are relatively low for airlines, who can easily shift between regional carriers as long as operations and pricing remain viable.
  • Intangible Assets (Weak) SkyWest lacks tangible assets, brand recognition, patents, or trademarks that provide a unique competitive advantage.
  • Cost Advantages (Weak to Moderate): Scale provides SkyWest some advantages through higher efficiency, but labor and fuel costs, which are the major costs of airline industry, can change significantly in favor or against them.
  • Size Advantage (Moderate): SkyWest’s vast network and long history provides a competitive advantage over smaller players in the industry. Its scale allows for better utilization of its fleet, personnel, and operations expertise to its customers, giving it certain advantages over smaller airlines.

Moat Risks and Business Resilience

Risks to SkyWest’s moat and business model are:

  • Reliance on Major Airlines: The fixed-fee contracts make SkyWest dependent on its partners, which limits its ability to increase prices and improve earnings.
  • Increased Competition: New regional airlines could enter the market and compete directly with SkyWest, putting pressure on prices.
  • Labor and Fuel Costs: The company’s profitability is sensitive to rising labor and fuel costs, as it struggles to pass on these costs directly to its customers.
  • Contract Renegotiation: If its partnerships see a lack of growth in the market, SkyWest may be required to take lower payments on contracts.
  • Economic Downturns: A recession could lead to reduced demand for air travel, leading to decreased flights. This would result in less revenue and strain its ability to service debt.
  • Technological Disruption: The development of new transportation modes could lead to a reduction in the demand for air travel. It could also result in higher capital expenditures as they update their fleet and operations.
  • Government Regulations: Increased regulatory oversight or environmental mandates could increase costs and make their operations less predictable.
  • Major Geopolitical Events: Major crises such as a war or a pandemic can disproportionately affect airline operations due to travel restrictions.

The business has a poor resiliency in case of the above situations. Its contracts provide some stability, however, its dependency on a small number of large airlines, sensitivity to input costs, and commoditized nature of the services makes it less resilient to the above risks.

Financial Analysis

Income Statement

Analyzing SkyWest’s financial results shows that the company is still struggling to grow its business profitably. Despite some increases in sales, profitability has decreased, mostly because of increases in operations costs.

  • Revenues: Overall revenues have steadily increased in the past, primarily due to its acquisition of more capacity purchase agreements and an increased number of block hours in their fleet. For the full year ended 2023 the total revenues was $3.31B, which represents an increase from 2.9B in 2022, and $2.5B in 2021.
  • Cost of Sales: Cost of revenues are growing at a comparable pace with revenue and has increased from $2.59B in 2022 to $2.94B in 2023. This includes the cost of labor, maintenance, fuel, depreciation, amortization, and aircraft rent.
  • Net Income: As cost of revenue increases, net income growth has lagged and the company’s net income in 2023 was $90M as compared to $177M in 2022.
  • Operating Margin: Company’s operating margins, have been decreasing and are at 6.8% for 2023, and 11.3% in 2022. It’s because of a higher operating cost due to increased fuel and labor costs, and lower pricing power due to intense competition.

Balance Sheet

SkyWest’s balance sheet is a point of concern with a lot of debt, and its decreasing cash balance, and that is mostly why it has been given an unhealthy rating.

  • Total Assets: Total assets are at $13B with around $8.3B of aircraft and related equipment.
  • Cash Balance: The cash position has been decreasing, with cash and equivalents at $177M in 2023, and $300M in 2022. It is mainly to cover short term liabilities.
  • Debt: SkyWest has a substantial amount of debt, which includes current portion of long term debt around $400M, a similar amount of long-term debt under lease obligations, and a very large long term debt of more than $7.5B in 2023.
  • Shareholders Equity: Total shareholders equity is around $2.3B in 2023, from $2.4B in 2022. The debt-to-equity ratio is very high.
  • Working Capital: It is negative at around $400M mostly due to a large amount of short-term obligations.

Cash Flow Statement

SkyWest’s cash flow from operations was around $390M in 2023, up from $320M in 2022, and down from $530M in 2021, largely due to changes in operating expenses and income. Net cash from investing activities has drastically declined, due to fewer proceeds from sales of property, and higher payments for investment. Free cash flow in 2023 is negative at $48M as the company struggles to improve its bottom line and debt payments are not decreasing.

Concerns/Controversies:

  • Employee Contracts: There are several employee contracts due to renegotiation in the coming years, which might result in higher operating costs. There are always risks in negotiations, and the company may have to pay above-average compensation to employees in order to keep them. In the last earnings call, the management also admitted that they are expecting to have a hard time recruiting new pilots if the compensation is not adjusted according to the market conditions.
  • Fuel Costs: Due to the Russo-Ukraine war, and the conflict in the middle east, the price of oil has been very volatile. SkyWest does have fixed-fee clauses in its contracts, but the change in expenses does have some impact on SkyWest’s results.
  • Rising Labor Costs: Labor cost is also an issue and is increasing rapidly. It will continue to increase in the future as the industry suffers from a lack of pilots. This will put pressure on airline companies and regional carriers both, which may force companies into renegotiating existing contracts.

Understandability Rating: 3 / 5

SkyWest’s business is relatively easy to understand, as it provides an essential service-regional air travel. However, its contracts are complex, and a complete understanding of its financials requires time and effort due to the numerous assets and liabilities involved. The airline business is inherently complex and needs some industry knowledge to analyze a company within the industry properly.

Balance Sheet Health: 2 / 5

SkyWest’s balance sheet receives a low rating due to:

  • High Debt: The company has been taking more debt over the years, and it seems it cannot bring down its current debt obligations.
  • Low Cash Balance: Low cash levels makes the company vulnerable to business conditions and external shocks and it may struggle to meet its short-term obligations.
  • Negative Working Capital: This limits their ability to meet short-term obligations.
  • Risk Aversion: As mentioned by the CEO, SkyWest has become more risk averse, which can hinder the growth potential of the company.

While these metrics are worrisome, the company is not at an imminent risk of bankruptcy. It does have some contracts that make it relatively stable for a few years, however, as the management mentioned, they need to improve their earnings outlook significantly for long-term sustainability.

In conclusion, SkyWest is a business facing several challenges, with a limited moat and a rather unhealthy balance sheet. Investors should proceed cautiously and assess the risk associated with it before considering it as a long-term portfolio choice.