Looking to invest in an airline that has solid earnings growth, double-digit percentage traffic growth, good control over costs and isn't named JetBlue ( JBLU) or Southwest ( LUV)?

Consider Mesa Air Group ( MESA), a small regional carrier operating out of Phoenix, serving 150 markets as a code-share partner for big guys like America West ( AWA) and US Airways. Last week, the company announced second-quarter earnings that handily topped Wall Street estimates and on Wednesday, it said traffic was up 31% in the first four months of 2003.

Savvy investors already have caught on to the Mesa story, doubling the stock since it hit $3 on March 13, when it was depressed by war fears. But even after the move, long-term buyers could see additional upside as the company continues to move away from unprofitable turboprops and into the regional jets that its larger partners prefer.

Vertical Stabilizer

"The stock has certainly had a nice run, but there's a lot of opportunity left at this company," said Anthony Cristello, airline analyst at BB&T Capital Markets. (BB&T hasn't done banking for Mesa.) "As long as they grow their ability to continue financing aircraft, there's a material opportunity for long-term growth with US Air."

Cristello isn't alone -- six of the nine analysts covering the company have it rated at buy or better and none with a sell rating. In comparison, only four of the 14 analysts covering Southwest have it at buy or better, with two analysts calling it a sell.

There's reason for optimism. With Mesa trading between $6 and $7 a share, its price-to-earnings multiple is about 7.5 times 2004 earnings. That's less than Southwest, currently trading at 29.2 times 2004 earnings, and also JetBlue, which goes for 22 times 2004 earnings.

Investors seeking to avoid the labor showdowns recently seen at AMR ( AMR) can sleep easy buying Mesa. Last quarter, the company signed a 4 1/2-year contract with pilots and extended its deal with flight attendants, making labor negotiations a relative nonissue for the next few years.

Drag Coefficients

But investing in airlines, even ones with apparent upside, is always risky, and it's important to consider Mesa's potential pitfalls.

Mesa was founded in 1982 and previously served the Southwest region mostly, with propeller planes, ferrying customers in and out of underserved markets. But as code-sharing's popularity surged, especially over the last few years, the company has been adding more and more regional jets, chasing business from larger carriers. Currently, Mesa plans to jump from the 70 regional jets it had at the end of 2002 to nearly 170 by the end of 2005.

But expanding capacity and buying more planes during the worst downturn in the history of commercial aviation is a daunting task, especially when it comes to finding financing. (Standard and Poor's and Moody's both have downgraded airline credit ratings in recent months.) More than fuel costs, labor negotiations or any other factor, Mesa's ability to raise cash to buy planes will determine its success -- and is the biggest risk investors must stomach.

"They certainly are one of the lower-cost regional airlines and their ability to get jets will drive their growth," said Cristello. "They're partners with US Air, who are clearly willing to give them growth as long as they can provide jets."

Blue Birds Over

Indeed, US Airways, which just emerged from bankruptcy protection a month ago, is at the heart of Mesa's growth story. Mesa derives 50% of its revenue from and currently flies 40 planes in conjunction with US Air and has plans to add 12 more in 2003. Recently, the company signed a letter of intent to provide another 50 planes to US Air and is currently in discussions with management over how to proceed with the planned expansion.

Because a letter of intent is not a binding contract, the major issue is how and when Mesa must deliver that many planes. And while Cristello believes that Mesa's ability to finance these jets will improve as the airline industry recovers, some analysts caution that management could be overreaching if it has to add 50 planes all at once.

" The carrier reports that it has interim financing lined up for most of its regional jet deliveries in 2003, which helps alleviate near-term growth uncertainty," said Brian Harris, analyst at Citigroup Smith Barney, in a report from last Friday. "But that still leaves about 15 other undelivered regional jets that are not financed."

In Harris' view, there are too many uncertainties out there to value Mesa based on 2004 earnings expectations. He estimates there could be as much as 10 cents per share downside to his 2004 earnings estimates if the company can't finance what it plans to add. But even Harris is cautiously optimistic, telling investors that "with the economy expected to improve, we think the potential upside scenario is more likely than not."


If the financing issue can be managed and the details of the letter of intent with US Air worked out, then going forward, there are some catalysts that could certainly boost Mesa shares.

In addition to greater clarity on its situation with US Air, Mesa also has a bid in with UAL, parent of bankrupt United Airlines, to expand its role as a code-share partner with that carrier. While company CEO Jonathan Ornstein was bound by a confidentiality agreement and couldn't disclose details in a recent conference call, he did add that he felt Mesa's bid had a good shot.

"I think our offer is extremely competitive," said Ornstein. "And based on United's own documents that they filed in the bankruptcy, it would be significantly below their current cost. That's not to say that our competitors will not sharpen their pencils."

In the end, Mesa's story may come down to fleet financing. But for investors with a taste for riskier, speculative stocks, the company could be an interesting small-cap alternative to carriers that are better known. On Thursday, shares in Mesa rose 1.3% to $6.32, while Southwest gained 1% to $16.12 and JetBlue dropped 2.3% to $31.99.

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