The global airline industry is on a flight path for higher altitude this year, with increasingly confident consumers clamoring for passenger tickets.
But one mid-capitalization regional airline is flying too close to the sun. Those who own shares of SkyWest (SKYW) should sell before they get burned.
In its latest report released last month, the International Air Transport Association estimated that new destinations will rise by 4% this year, with frequencies up as well.
The industry trade group expects 0.9% of the world's gross domestic product to be spent on air transport this year, totaling $769 billion, compared with $732 billion in 2016.
Among all the world's airlines, North American-based carriers are expected to perform best, with a forecast 8.5% net post-tax profit margin this year.
The improving "wealth effect" in the U.S., spawned by falling unemployment, a resurgent housing sector and rising wages, is prompting consumers to open their wallets for travel. These factors have been boosting airline stocks.
But overbought regional operator SkyWest has gotten ahead of itself.
With a market valuation of $1.88 billion, SkyWest provides airfreight and passenger services with about 3,600 total daily departures to destinations in Canada, the Caribbean, Mexico and the U.S. The airline's 702-aircraft fleet flies under code-share arrangements with major airlines such as American Airlines and Delta Air Lines.
Regional airlines took the Great Recession on the chin, with scores of carriers filing for bankruptcy protection. However, the economic recovery has lifted the fortunes of this once-struggling sector.
As mid- and small-cap plays, the regionals offer greater growth potential than their large-cap counterparts, albeit with slightly more risk.
Over the past 12 months, SkyWest's stock has soared by a whopping 143%, driven by greater passenger demand and the addition of fuel-efficient, operationally superior Embraer regional jets. SkyWest began its fleet modernization in 2015, by adding 86 Embraer jets to its fleet, and it plans to add another 18 this year.
Lower operating costs have pushed the airline's gross profit margin to a robust 67.61%, higher than the average of 59.61% for its peers.
But after its huge run-up, SkyWest stock faces headwinds that will probably bring it back to Earth.
A chronic pilot shortage will put upward pressure on labor costs, the most expensive single operational cost for any airline after fuel. What's more, operational efficiencies the company has generated so far will soon reach their limit, especially as rising oil prices make jet fuel more expensive.
SkyWest owes a lot of its enhanced margins to its new Embraer jets. Based in Brazil, Embraer manufactures aircraft for the regional market that are "green," sleek and easier to maintain.
Regional travel is a niche that major aircraft original equipment manufacturers such as Boeing largely ignore.
However, SkyWest already has wrung the available profitability boosts from its new Embraer models. The advantages should soon taper off, and that will show up on the bottom line.
What's more, many analysts are predicting a broad stock market crash and even a recession early this year, which means that overbought stocks such as SkyWest would fall the farthest and fastest.
It is time for SkyWest investors to disembark and enjoy their huge gains.
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