MESA - Mesa Air Group: Time To Buy The Stock?

2023-03-31 12:31:15 ET

Summary

• Mesa Airlines shows topline stability despite 40% reduction in compensated block hours.
• The road to recovery is long for Mesa Air Group, but there are some tailwinds that will manifest within six months.
• I am cautiously optimistic on the prospect of Mesa Air Group stock as the company has put items in place to regrow profitably.

I haven't always been positive about Mesa Air Group stock (MESA) and that was not a wrong way to view the stock because while regional airlines have an appreciable cost structure and were set to lead the recovery, the recovery of mainline carriers and the subsequent pilot needs which were sourced from the regional airlines did squeeze the airline. However, we also saw the company make some much needed changes which positively impacted the risk profile and that led me to mark Mesa Air Group stock as a speculative buy . In this report, I will analyze the Q1 2023 results.

How Did Mesa Air Group Stock Perform?

In June 2022, I covered Mesa Air Group for the first time and concluded that while the business case for regional airlines is quite appealing in an undisturbed market, shares of Mesa Air Group were not a gem as the market was in fact disturbed by widespread pilot shortages. That call, while almost a no-brainer, was correct as shares have underperformed and even lost some value compared to today's stock price.

So, share price performance has not been great. Shares already were on a downtrend, but it got worse in mid December when the airline announced it would be postponing the fourth quarter and full-year earnings release. The cause of the further drop was that the market feared that Mesa Air Group was in financial distress that would affect its continuity going forward. In fact, Mesa Air Group delayed its earnings release as it was working with United Airlines on an amended capacity purchase agreement while winding down its business with American Airlines, which had become a loss-making agreement for Mesa Air Group. From the point of announcing the postponement until the capacity agreement was finalized, shares shed 27.4% so the way Mesa Air Group handled things definitely was not good for the company's stock price.

I did not provide a sell rating for Mesa Air Group despite not being charmed by the way they handled things, but did note that the pop we initially saw on the announcement of a to-be-finalized agreement with United Airlines (UAL) would fade as the company provided little useful information supporting a reversal and that did happen. The reversal, however, did happen once the agreement was finalized and share prices recovered. So, holding shares was the right call. Overall, the story at Mesa has not been pretty when looking at share price performance over the past two years but we have seen some deflation to the risk profile.

Mesa Air Group: Top Line Stability

I could do a big dive in the quarterly results, but what holds is that year-over-year the revenues have been stable on 7% lower contracted revenue offset by pass-through revenue. That revenue figure reflects the higher pilot payscales implemented which Mesa gets compensates for in some of their capacity contracts. What we're not seeing is the 41% in lower block hours, or in other words, the lower block hours are not having a visible impact. That does not mean it's not there, but for now higher pilot pay and deferred revenue is offsetting a significant part of the decrease in block hours. That also means that as Mesa Air Group improves attrition, it will be able to fly more block hours and organically grow the its topline but with full pilot payscale compensation whereas this is not the case now for the operations they have with American Airlines (AAL) and will be shut down in a few days. That will remove the American Airlines revenues but also the associated losses. So, things should get significantly better from Q2 and onward as the losses are eliminated and the profitable block hours for United Airlines ramping up.

The Risks And Opportunities For Mesa Air Group

I believe Mesa Air Group has a lot of potential as it recovers, but there also are items that investors should be aware of. The good thing is that pilot attrition has reduced to pre-pandemic levels. That means that at some point we should see block hours expansion and those will be profitable block hours while there will be a ramp up swapping unprofitable block hours from American Airlines to profitable ones by May. What should be kept in mind is that there's a transitory period, and while attrition is at pre-pandemic levels, for block hour recovery the headcount should grow. So, there still are some steps to take but a higher pay scale and a more streamlined path towards becoming a mainline pilot from a regional carrier provides significant support to increasing the number of pilots again. So, I really do see that as a positive but it will take time. Utilization is not expected to be at an utilization level of 10 hours for another 12 months and another 18 months to improve to 11.5 hours. Both of which are conservative estimates.

So, things will get better but a full recovery will take quite a long time. What investors also should be aware of is that United now has a 10% stake in Mesa, so in order for improvement in results to be reflected in the earnings per share those earnings should be at least 10% better but I would not expect that to be a major issue in Q2 and onward as the loss making contract with American Airlines will no longer affect the P&L.

Conclusion: Mesa Air Group Stock Is A Cautiously Optimistic Buy

As a regional airline, Mesa is shielded from the air fare environment and more concentrated on the capacity requirement and right now the company simply does not have enough capacity to deliver. What we see at Mesa is that the next 18 months will be a ramp up in the block hours, so the recovery will be long as there is a lag between getting people in the flight schools and actually improving utilization but the trajectory, although uncertain, is certainly there and there are some short-term tailwinds in terms of American Airlines related losses being eliminated and deferred revenues being recognized.

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