Russia sends warning / Republic moves forward

Dino D'Amore
By Dino D'Amore February 26, 2016 21:11

Russia sends warning / Republic moves forward

The Russian Transport Minister Russia Valery Okulov warned a committee in Moscow this week that more airline companies could well go bankrupt saying: “Airlines are accumulating losses, and we do not rule out the risk of airlines going bankrupt if demand does not pick up and traffic does not grow as a result.”

There is no question that he is right, the Russian economy is continuing to contract fast due to sanctions and low oil and gas prices. Rosaviation, the Russian air-transport agency, reported that overall passenger traffic in January fell by another 6% year on year to 5.54 million with international traffic down a massive 26% falling back under 2 million passengers while domestic traffic increased by 11% to over 3.5m.

However, a note of caution is required at this point for Russian domestic passenger demand has been increasing in double figures now for a few years and it is highly likely that official domestic passenger figures are, shall we say, not totally accurate. International traffic has been in decline due to falls in both income and the value of the Ruble, in 2015/16 this is compounded by Russian travel advisories against Egypt and Turkey, two of the top five destinations for Russians only a few years ago.

There is no doubt that the continued status quo in Russia will eventually lead to Aeroflot completely controlling civil aviation as it once did during the days of the USSR. As such for lessors, all airlines closely associated with Aeroflot are relatively safe, while those completely independent of the same must have their risk profile reassessed. One should also worry about the ability of Western-based lessors to retrieve aircraft from Russian territory in the future.

But for most listed lessors the news is all good at the moment. Interest rates are going nowhere and Aircastle with its 25% stake in the new IBJ Leasing JV has really done well indeed. This deal will allow Aircastle to expand the aircraft types in its fleet and enter new markets. While Norwegian Air Shuttle once again stated this week that it will tip some of its older 737NGs into the leasing portfolio, and it is still looking into an IPO for its leasing unit which is likely to be an A320Neo and 737NG portfolio – that would be interesting.

Meanwhile in the USA, Republic Airways has filed for bankruptcy after labor disputes and pilot shortages cut into the company’s volumes and sales. The filing crashed shares 80% before the close yesterday and given our recent experience with other airlines in the USA filing for Chapter 11 you have to argue that this could present a fantastic buying opportunity for very brave investors. Make no mistake, Chapter 11 is the way to deal with all of Republic’s problems at once, this should be taken by the market as reasonably good news.

Indianapolis-based Republic operates a fleet of about 240 aircraft for American, Delta and United on regional flights, but the airline has a debt burden of some $2.4bn and of late has not been able to deal favorably with pilot shortages and labor disputes. Labor shortages caused block hours at the airline to fall by 15% in January and February 2016 alone.

“Our filing today is a result of our loss of revenue during the past several quarters associated with grounding aircraft due to a lack of pilot resources, combined with the reality that our negotiating effort with key stakeholders shows no apparent prospect of a near term resolution…We believe this action will allow us to restore our airline and take it to new heights,” CEO Bryan Bedford said in a statement. That will be cold comfort to the unsecured creditors named in the petition, which include Pratt & Whitney, Embraer Honeywell and GE Engine Services.

Lars Arnell, a former Republic SVP of corporate development, has been appointed chief restructuring officer. Zirinsky Law Partners and Hughes Hubbard & Reed are serving as the airline’s legal advisors, while Seabury Group is acting as financial advisor. In its bankruptcy petition, Republic listed $2.97 billion in liabilities and $3.56 billion in assets.

Chapter 11 has saved many airlines from collapse and Republic should be no different from this trend, but for sure the airline that comes out from Chapter 11 will have to be a different animal from the airline we know today. One problem with Republic is the fact that as a bargaining agreement business model running routes for other airlines Republic has very little room to maneuver in the event of a fall away in seat sales.

So should Republic look to become its own master in the future and compete openly with all other airlines? To do that effectively it will need larger aircraft, and given that it has long running agreements with the US majors one wonders how any such transformation could take place in any event, but it could on a slow and controlled basis with a ULCC cost base. All this conspires to make this Chapter 11 filing greatly different from those of other US airlines in the past, and that creates extreme uncertainty, hence the 80% fall in share price. The management at Republic and their advisors will no doubt pull out all the stops over the coming months in what will be a hard task to convince potential investors that Republic has a long term future without dramatic changes to its business model.

Dino D'Amore
By Dino D'Amore February 26, 2016 21:11