SkyWest's Cash Prompts Upgrade

NEW YORK ( TheStreet) -- Shares of SkyWest ( SKYW) jumped Tuesday after Avondale Partners lifted its rating on the stock, giving the St. George, Utah-based company kudos for its cash holdings.

Also citing a bullish view of SkyWest's August deal to acquire ExpressJets Holdings ( XJT), analyst Bob McAdoo lifted his rating on the stock to market outperform and boosted his 12-month price target to $16 from $14. McAdoo had been at market perform on the shares since February 2009.

The stock responded well, closing up 5.3%, or 64 cents, to $12.74. Volume of around 450,000 was slightly ahead of the issue's trailing three-month daily average of 433,000. Based on Monday's close at $12.10, the stock was down nearly 29% year-to-date, but it had bounced about 6% since scraping a 52-week low of $11.38 on July 7 prior to Tuesday's run-up.

McAdoo's upgrade looks mainly motivated by the aforementioned cash. He likes both how much SkyWest has -- around $750 million with the XpressJets' deal still pending completion -- and what the company is doing with it.

"SKYW has been using its cash to create growth in a generally shrinking industry," he told clients in a research note. "Excluding its surplus cash, SKYW's market cap is just over 2 times its earnings."

XpressJets has been a loss maker for the past three years and that isn't expected to change in calendar 2010, but McAdoo sees the deal for SkyWest, currently the biggest regional jet operator, to acquire its next largest rival as a relative bargain with numerous strategic benefits.

In particular, he thinks the combined company "will now own center stage" for regional jet operations for the combined entity resulting from the Continental ( CAL)- United ( UAUA) hook-up that received antitrust clearance late last week.

Bringing Continental into the fold through the XpressJets' deal is big for SkyWest, as its results have been held back for the past two years by major partner Delta Airlines's ( DAL) flight reductions. Of the 452 aircraft in SkyWest's fleet as of June 30, a total of 244 were assigned to Delta, compared to 204 to United and the remaining four to AirTran Holdings ( AAI).

" By being the primary contractor for both Continental and United with binding agreements related to both Continental and United, SKYW will clearly be at the table as the new United/Continenal sorts out its future regional jet fleet and strategy," he wrote, adding definitively: "We believe SkyWest has positioned itself to be the winner as contracts get modified, and potentially expanded, following the United/Continental merger."

As for whether SkyWest is paying too much for XpressJets, McAdoo believes the company has a strong plan in place for when the deal closes, which is expected to take place in the fourth quarter.

He notes that merging ExpressJets' operations into those of SkyWest's Atlantic Southeast Airlines unit should eliminate some overhead costs, including the expense of being a public company, and that SkyWest could also opt to pull the plug on XpressJet's floundering charter business and then find other uses for these aircraft or else potentially return them to Continental.

On top of these moves, McAdoo says the cost of the deal is much better than the headline number of $133 million. After taking into account XpressJets' cash balance of $96 million, offset by the assumption of $33 million in convertible notes and $13 million in fees and expenses related to the transaction, he says SkyWest is only spending around $83 million on a net basis.

That brings the upgrade back to SkyWest's cash hoard. Besides pointing out recent shrewd moves such as providing a secured ten-year term loan of $80 million with an 11% interest rate to United, McAdoo thinks investors might want to consider a different way of valuing the stock.

Rather than relying on just earnings, his method calls for carving out around $500 million of SkyWest's available cash, or roughly $8.82 a share. This leaves the company with around $250 million, which McAdoo views as sufficient to cover day-to-day operations.

McAdoo then applies a 4.2x multiple -- consistent with that of what will eventually by SkyWest's only remaining peer, Pinnacle Airlines ( PNCL) -- to his current estimate for earnings of $1.60 a share in calendar 2011, and arrives at a valuation of $6.72 per share for the business. That brings the per share value of the stock to $15.54, McAdoo estimated.

Finally, the analyst thinks SkyWest may not be done dealing yet. He theorizes that the company could take the roughly $675 million that will be left over after the XpressJets deal is done, and do some more shopping, maybe making a run at fellow regional Comair, which Delta has been looking to sell.

McAdoo also theorized SkyWest could ramp up its buyback program, or go after a private regional jet operator, among other options, before concluding: "In summary, SKYW is not appreciated as a profitable growth story in a shrinking industry."

SkyWest's second-quarter earnings of 33 cents a share fell short of Wall Street's consensus estimate for a profit of 38 cents a share when it reported on August 4. McAdoo's upgrade tilts analyst sentiment on the company in the positive direction for the first time in a while.

He previously was one of the three analysts with the equivalent of a hold rating on the stock among a total of five, according to Thomson Reuters. That status quo was in place for at least two months.

-- Written by Michael Baron in New York.

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