Republic Airways Holdings, Inc. (RJET)

Wise investors pride themselves on their ability to distinguish the difference between perception and reality, as well as the ability to opportunistically profit from the disconnect. Indeed they should, as the ability to do so more often than not will likely lead to tremoundous returns over the course of an investment career. For those looking to invest in a deeply misunderstood situation, where the upside is high and the downside low, then a deeper look at RJET might be in order. In my opinion, investors who do so should be richly rewarded as perception fades into reality and the market comes to its senses by giving this business the valuation it deserves.

Much to my delight, the market often offers companies with completely different and often superior risk profiles at prices that would imply they do not (i.e. have superior and unique risk profiles), and the result is that they are lumped right a long with their lesser quality peers. Crucial distinctions are dismissed, downplayed or at least overlooked, resulting in "the baby being thrown out with the bathwater" and the simultaneous creation of a compelling investment opportunity. RJET is a classic example of this common and recurring reality, here's why...

The market is currently pricing RJET as an airline, which a deeper investigation would quickly reveal as nonsensical for a variety of fundamental reasons such as
- RJET has no fuel risk, and hence will not suffer from the volatile and rising fuel prices that consantly plaque the airline industry.
- RJET has no exposure to volatile ticket prices and frequent fare wars
- RJET has no exposure to increased airport landing fee's or domestic security fee's, and does not have sensitivity to passenger load factors

Additionally, RJET benefits from a number of structural advantages in comparison to airlines. Long term contracts of generally 10-12 years provide substantial earnings visability and downside protection (which in today's environment is becoming more and more scarce (i.e. valuable). These contracts also contain fixed price escalators to help offset increasing labor or input costs as well as clauses that ensure that they are not subject to renegotiation (outside of bankruptcy). These are not minor distinctions...and in sum create quite a compelling case that the status quo of RJET generally trading in line with the mainline airlines as if it was an airline is downright ridiculous. A typical airline is exposed to considerably more risks, and at the same time does not benefit from any of the meaningful advantages embedded within RJET's model. At minimum a premium to the airlines is in order. A more appropriate valuation of RJET would be at parity with the universe of publicly traded asset lessors.

Yet another characteristic that set's it apart from the airline industry, and is quickly worth mentioning, is that RJET has an incredible track record of consistent profitability...consisting of 31 out of its 33 year history in the black. Considering that the airline industry has been one of the primary areas where capital has consistently gone to die, RJET's results are even more notable. Why does RJET trade in line with airlines again?

Did I mention RJET is cheap? For a business that generates significant levels of free cash, and which its ability to generate free cash is only getting stronger (FCF should excelerate going forward as new aircraft and the cap-ex that was necessary to bring this aircraft online begins to slow), as well as a whole host of other quantitative and qualitative factors, make RJET is a extraordinary value.

What about its favorable growth outlook? Current trends within the industry should provide insight into RJET's likely growth trajectory over the next 2-3yrs. There are two primary avenues responsible for driving this growth within RJET's end markets, both of which are listed below...

- Rising fuel prices and other issues (such as the reduced influence of unions to dictate the rules) have significantly reduced the attractiveness of the 35-50 seat jet's currently in use...and have lead the way in a multi-year shift amongst the regionals, towards larger (70+ seat), more cost effective, and higher margin jets which (outside of there considerably more attractive economics) also happen to be considerably more passenger friendly than there predecessors. This multi year trend will provide RJET with a significant and growing value proposition for its customers for years to come.

Regional operators like RJET have much to gain from the shift mentioned above, especially since they are the likely choice to source and operate aricraft of this size. The regionals who have begun and who continue to upgrade their fleets over the next few years to these newer, more profitable and cost effective airplanes will have a significant advantage when dealing with the network airlines during the next round of contract negotiations. Which leads into the second avenue driving meaningful growth over the next few years...

- In a business that is as competitive and bankruptcy inducing as the airline industry, the ability to lower costs is crucial for the airlines to maintain, if not improve profitablity over time. The shift toward's newer jet's will allow network airlines to outsource more and more of their flights to regional operators, and hence lower their costs in the process. Considering that airlines are running out of ways to reduce costs internally, it is a good bet that over the next few years they will likely continue to look externally for ways to do so.

The growing trend of outsourcing service providers within the industry, will likely lead to industry consolidation. If this trend continues as we expect it to, the primary beneficiaries would be the industries highest quality operators with the most efficient cost structures...i.e. RJET. If RJET where to roll-up it's smaller, less efficient competitors, profitability will likely improve as it's increased scale will allow more dollars to fall to the bottom line. Assuming RJET doesn't overpay for aquisitions, as well as that it will be able to integrate its aquisitions without serious difficulties, this scenario would further fuel additional upside...

RJET, at today's prices, offers investors an opportunity to purchase an outstanding business at well under half its intrinsic value looking 3yrs out. It is not an airline, and although the market currently refuses to acknowledge this fact, it eventually must. When it does, a more appropriate valuation will likely be the result. Regardless, significant upside exists outside of any potential multiple expansion. Considering today's price, and the cash this company currently generates relative to that, outsized returns is nearly inevitable. Add in what will likely be a higher normalized growth rate going forward due to a convergence of industry related factors, as well as RJET ability to redeploy its already copious free cash towards higher margin, and rapidly growing areas within its business mix, and this company has all the ingredients of spectacular returns over the next 3yrs. I expect 30%+ annualized returns from today's levels, as it's current discount to IV narrows and growth begins to take hold (and accelerate)