This Value Stock Jumped 7% After Earnings, but It’s Still a Bargain

Shares of SkyWest (NASDAQ: SKYW) lost almost half of their value in the first half of 2022, as staffing issues forced the company to reduce its near-term flying plans. A surge in pilot pay across the regional airline industry also contributed to investors’ angst.

However, last Thursday, SkyWest reported better-than-expected results for the second quarter. And while SkyWest stock jumped 7% after the earnings report, it still has tremendous upside potential over the next few years.

Earnings better than feared

Earlier this year, SkyWest’s management warned investors that the company had experienced a big uptick in attrition among its captains. While SkyWest has enough pilots in total, it has more first officers than captains, whereas each flight needs one of each.

This staffing imbalance forced it to cut back on its flying plans for 2022, negatively impacting its projected revenue and profitability. As a result, SkyWest CEO Chip Childs estimated that the company would post roughly breakeven results for the full year.

Fortunately, this guidance has proved conservative. In the first quarter, SkyWest recorded earnings per share (EPS) of $0.35, crushing the analyst consensus of $0.01. Last week, the company reported even better results for the seasonally strong second quarter. Revenue reached $799 million, eclipsing pre-pandemic levels. Meanwhile, SkyWest rang up EPS of $1.07, easily beating the analyst consensus of $0.45.

SkyWest’s earnings still fell short of its Q2 2019 EPS of $1.71, due to higher maintenance and labor expenses and reduced asset utilization. SkyWest executives also said that labor constraints and cost pressures would likely worsen in the second half of the year. Still, the company earned $1.42 per share in the first half of 2022 and expects to be modestly profitable for the rest of the year, putting it on track for much better results than it initially anticipated.

Image source: SkyWest.

Headwinds to continue

While SkyWest’s full-year forecast has improved compared to February, the company isn’t out of the woods yet. Management currently estimates that captain availability will constrain the carrier’s flight schedules until at least late 2023, if not early 2024.

Relatedly, SkyWest expects to significantly increase pilot pay soon, especially for captains. It has little choice if it wants to retain and recruit enough pilots, particularly after American Airlines dramatically increased pilot pay at its in-house regional affiliates in June. But this will put a lot of pressure on SkyWest’s cost structure. Last quarter, the company spent 36% of its revenue on labor costs.

The combined impact of staffing constraints and higher pilot pay will weigh on SkyWest’s earnings power throughout 2023. In fact, the analyst consensus calls for SkyWest’s EPS to decline from $2.06 this year to $1.34 next year.

Still worth a look

Despite these challenges, SkyWest stock could pay off handsomely for long-term investors. Most notably, the company’s market cap of $1.2 billion still represents a nearly 50% discount to SkyWest’s book value of $2.3 billion.

SkyWest market cap vs. book value, data by YCharts.

That gap reflects the poor returns SkyWest’s assets are generating right now. However, if the company can fix its pilot imbalance by 2024 (mainly by raising wages to improve retention), it will be able to increase asset utilization to around pre-pandemic levels. And since all regional airlines face similar labor cost headwinds, SkyWest should be able to negotiate higher fees for its services over the next few years to offset higher pilot pay.

Meanwhile, SkyWest plans to open a new charter subsidiary that will use CRJ200 jets outfitted with 30 seats rather than the usual 50. That will allow this subsidiary to operate under different regulations that will make it easier to recruit pilots. This initiative could put some of SkyWest’s idle assets to productive use as soon as next quarter.

Permanently higher pilot pay may prevent SkyWest from returning to its pre-pandemic earnings power for the foreseeable future. (In 2019, it posted adjusted EPS of $6.25.) But I think the company has a pretty good chance of generating annual EPS of at least $4 to $5 within a few years. That makes SkyWest an attractive — albeit high-risk — value stock based on its Tuesday closing price of $24.05.

Adam Levine-Weinberg has positions in Delta Air Lines and SkyWest. The Motley Fool recommends Delta Air Lines. The Motley Fool has a disclosure policy.

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