"Frontier Airlines Shapes Future"

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Fri 17 Jun 2011

Frontier Airlines Shapes Future

By Ed Sealover


A change in Frontier Airlines ownership will bring it short-term cash but little long-term stability -- and that will force leaders of the Denver-hubbed airline to find new ways to overcome rising fuel costs, several airline analysts say.

Frontier pilots are scheduled to complete voting Friday, June 17, on whether to purchase an equity stake in the airline from parent company Republic Airways Holdings Inc., in exchange for deferral of pay raises and more immediate cuts in benefits and leave time.

The Frontier Airline Pilots Association is expected to approve the plan. That approval would allow Indianapolis-based Republic (Nasdaq: RJET) to seek amendments to other Frontier labor agreements and to attract equity investments, Republic CEO Bryan Bedford wrote in a June 10 letter to company employees. The ultimate goal is to reduce Republic’s ownership of Frontier to a minority interest by the end of 2014.

The deal would enable Republic’s board of directors to raise its stated goal of $70 million in additional cash this year.

But it wouldn’t affect the two problems that have hurt Frontier the most, analysts say: soaring fuel prices and dilution of its brand identity at the same time it’s in a fare war at Denver International Airport.

“An airline doesn’t survive by cutting wages. You survive by bringing in additional revenue,” said Mike Boyd, president of Boyd Group International, an Evergreen aviation consulting firm. “Just going to a labor union and saying, ‘Cut this, cut this, cut this’ doesn’t bring any more revenue in the door.” But Peter Kowalchuk, Frontier’s director of corporate communications, disagreed, saying that cutting operating costs will put the company in better shape to handle the next wave of fuel cost increases without having to raise its prices significantly.

“One of the things that management is operating under is the knowledge that if we can get our costs down ... we can indeed be competitive,” Kowalchuk said.

Republic bought Frontier out of bankruptcy in 2009 and merged with Milwaukee-based Midwest Airlines . Since then, Frontier has taken steps to bring in more revenue.

In the first quarter of 2011, Frontier’s load factor -- the percentage of seats filled per flight -- stood at a company record of 78.7 percent, Bedford announced in Republic’s earnings call on May 3. Frontier followed that with an 84 percent load factor in April, a record for that month.

But fuel prices rose 24 percent -- by $30 million -- from first quarter 2010 to first quarter 2011, Bedford said. The company reported a loss of 46 cents per basic share for the quarter, with fuel averaging $2.92 per gallon in March. That rose to $2.99 by the end of April, the U.S. Bureau of Transportation Statistics reported.

Republic also operates “fixed-fee” services, flying aircraft for other airlines under those carriers’ names. In those agreements, the partner airlines, rather than Republic, pay the cost of fuel, making them more profitable for Republic, said Bill Swelbar, a research engineer for the Massachusetts Institute of Technology’s International Center for Air Transportation.

“The Republic Airways portion is generating [roughly] $50 million in after-tax income, but it is being swallowed by the Frontier losses,” wrote Dahlman Rose & Co., a New York-based investment bank, on June 13.

Roughly 27 percent of Frontier’s operating costs go to fuel -- less than many of its competitor airlines, noted Warren Chang, vice president and general manager of Fly.com, a New York-based airfare comparison website. But even with ticket-price increases, revenue didn’t compensate for the increased expenditures. So Bedford announced the company would reduce its routes to hold down costs.

“It’s a strategy of last resort in the sense that they want to grow their business ... but there’s pretty much nothing left to cut at this point,” Chang said.

Among those cuts are the recently announced end to nonstop service from Omaha, Neb., to Los Angeles and San Diego. Frontier launched that route earlier this year as it sought to expand its service in non-hub cities such as Kansas City and Omaha.

Such cuts were necessary because Frontier couldn’t absorb the fare increases that other airlines were spreading across a larger number of routes, Swelbar said. Frontier always has advertised itself as the low-cost airline, and it had to absorb a larger percentage of the increased fuel costs because it couldn’t afford to raise fares more, he said.

“If they raise their rates any higher, that traffic will more than likely find their way to a competitor,” Swelbar said.

Will employee ownership be a benefit?

An employees buy-in of company ownership will offset that some by allowing Frontier to generate more revenue. Employees’ willingness to invest in the company also may be an attractive sign if the company seeks capital from outside sources, he said.

But past employee ownership moves, such as the 1994 takeover of a majority stake of United Airlines by its pilots, have done little to turn around a company’s finances, Swelbar noted.

And in the long term, Frontier remains subject, more than other airlines, to external operating costs, putting DIA’s third-largest carrier at a competitive disadvantage with the No. 2 DIA airline -- larger and well-funded Southwest Airlines, he said.

Three days after Bedford announced the ownership-change plan, Dallas-based Southwest announced seven new round-trip flights from Milwaukee, the former home of Midwest and where Frontier has a second hub, Swelbar noted.

“Southwest is an opportunistic competitor,” he said. “I do believe they smell blood in the water in the branded business. I do believe that the market senses weakness with Frontier.” But Kowalchuk said Frontier leaders believe that cutting costs and making the company the most efficiently operated airline will let it stay competitive with larger airlines. He said Frontier also is renegotiating contracts with its parts and plane suppliers, and with online ticket sellers.

Frontier already has one of the lowest levels of operating costs per available seat mile, a key indicator in the airline industry. By raising sufficient capital and then keeping down non-fuel expenses, the company can maintain the needed cost structure to compete against deeper-pocketed companies, he said.

“While it is true that we will still be susceptible to high fuel prices, we will be no more susceptible to high fuel prices than anyone else, and we will be able to be competitive,” Kowalchuk said.

Boyd said, however, that Frontier’s turnaround will require dropping more flight routes that aren’t flown out of Denver and concentrating on its hometown market.

Since the Midwest merger, Frontier has grown its presence in other markets in the midwestern United States, such as in Kansas City and Omaha.

But Boyd said the key to its success always has been in being considered Denver’s airline. Spreading itself thinly to other places has squandered the advantage it has over DIA competitors Southwest and United, he said.

Frontier must address expense, but it already has introduced products, such as its three-tiered ticket pricing, that make it more attractive to more fliers and give it competitive advantages over Southwest, Boyd said.

By redirecting resources from Denver to other cities, it’s spending too much time going after customers who don’t know the airline, and spending too little time courting the fliers who have been its lifeline in Colorado, he said.

“Denver is where you have brand identity. Denver is where you’re strong,” Boyd said. “If they’re going to be running one-off flights from Kansas City to Cancun, that’s a waste of time ... Give up silly stuff like trying to have a presence in Kansas City.”