Keeping the debt low: REX now owns almost all of its planes outright. Photo: Andrew Taylor
It is hard to avoid the drama that is currently enveloping our national carrier. Every day we seem to read a new headline about Qantas' latest cost-cutting exercise, or pleas for government assistance. So you may be surprised to learn about one Australian airline that is still profitable, and hasn't asked for a single bailout!
Regional Express (ASX: REX), or Rex, is Australia's largest independent regional airline, and rose from the ashes of the Ansett bankruptcy. Rex operates a small fleet of just over 50 planes and focuses on regional markets that are poorly served (or often not served at all) by its larger competitors.
In the first half of fiscal 2014 Rex made a profit before tax of $5 million. Over the same period Qantas reported an underlying pre-tax loss of $252 million and Virgin Australia made a pre-tax loss of $49.7 million. In other words, this tiny regional airline was not only profitable, it made over $300 million more profit in the first half than Qantas and Virgin Australia combined!
Shoot the Wright Brothers down!
The aeroplane was a revolutionary invention that transformed the way we think about global transportation. Yet despite this, airlines themselves have generally been atrocious investments... for many reasons. It is a capital intensive business, with fixed assets that can be redeployed almost anywhere, and consumers generally see an airline ticket as a commodity, so are more than willing to shop around.
The result is fierce price-based competition to keep these expensive assets utilised whenever there is a downturn. To cap it off, one of the airline's biggest costs, aviation fuel, fluctuates wildly in price and is almost entirely beyond management's control!
But perhaps more important than all these structural reasons is that the airline industry always seems to attract a plethora of irrational players. Magnates are drawn to the glamour and prestige of owning an airline, and so the economics of the investment become an afterthought. National airlines often aren't allowed go bankrupt, no matter how poor their returns, because of the concerns over national security (not to mention national pride!), while others are owned by the governments themselves, with priorities other than running them for a profit.
Warren Buffett has summed up the situation for most airlines pretty well "...a durable competitive advantage has proven elusive ever since the days of the Wright Brothers. Indeed, if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down."
The Regional Express secret
By focussing on under-served markets, Rex benefits from reduced competition on its routes. In many markets Rex even enjoys a monopoly position – something that the big guys could only dream of!
Rex is also very rational in the manner in which it deploys its capital and is not afraid to shrink to maintain its bottom line. If a particular route is no longer profitable (despite the company's best efforts) then it will simply stop calling there. This may sound like an obvious approach, but let's contrast it with that of our beloved national carrier. Qantas has firmly committed to maintaining a 65% market share of the domestic aviation market, regardless of the cost.
The final factor that puts Regional Express ahead of the pack is the strength of its balance sheet. Most airlines are carrying huge debts in an effort to leverage up their meagre returns. Rex on the other hand has over $260 million in assets (including $25 million in cash) but only $24 million of debt. Rex now owns almost all of its planes outright and so can do with them as it sees fit – idling capacity or divesting entirely when necessary. This robust financial position means that the airline is able to withstand the current turbulence and gives Rex the fortitude to continue making rational and shareholder-centric decisions.
Airlines are a tough business to be in. There are numerous structural reasons for their poor track record when it comes to investor returns. There are also just as many reasons that have more do with the flaws of human nature. But despite the challenging operating environment that the industry is facing, Regional Express has been able to not just weather the storm, but remain profitable.
The management of Regional Express have been patiently playing the long game, maintaining a strong balance sheet, and pivoting when things don't turn out their way. Qantas and the other big players could learn a thing or two from the discipline of this nimble competitor. When it comes to airlines, big is not always beautiful!
Regional Express is a quality company, but it is also just the best of a bad bunch. Rex has the potential to become seriously undervalued if one of the big airlines files for bankruptcy so it is definitely one for the watchlist.
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Matt Joass is a Motley Fool analyst. He owns shares of Regional Express. You can follow The Motley Fool on Twitter @TheMotleyFoolAu. The Motley Fool's purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.