For the last eight consecutive trading days and the second consecutive week the Russell 2000 small cap index has roared higher. Last Friday the Russell 2000 rose another .4% to close at 632. The index hasn't been at this level since January 20^th, a full month ago. And with both European and Asian markets rising during Monday's trading session, I expect we'll see similar gains from U.S. small-cap stocks today. The iShares Russell 2000 ETF (NYSE: IWM) has followed suit, rising eight straight days to finish the week at $63.06. This close marks the ETF's first close above $63 since January 20^th.   

 ***I wrote in Friday's issue of Small Cap Investor Daily that I'll be taking a closer look at individual stocks again. You sent in some interesting requests over the weekend so let's move on and take a look in the mailbag. First up is Small Cap Investor Pro subscriber Patricio.  

"Dear Ian, as a Small Cap Investor Pro subscriber I follow regularly your analysis and points of view on the Small Cap Market Indices and companies. I would really appreciate your thoughts on Republic Airways Inc. (NASDAQ: RJET), the largest regional carrier in the USA. The stock has been hammered over the past few weeks, but has recovered lately. It has a dominant market share and what I consider an attractive P/E ratio. Thank you in advance." 

As Patricio noted, Republic Airways is a regional airline and the company has a market cap of $184 million. The company owns Chautauqua Airlines, Frontier Airlines, Lynx Aviation, Midwest Airlines, Republic Airlines and Shuttle America. 

Now I'll be straightforward with you, I don't like investing for the long-term in airline stocks, with one exception: Southwest Airlines (NYSE: LUV). This best-of-breed large cap stock has demonstrated an ability to buck the broader industry trend and link years of profitable quarters together. It was not immune to the recession however, and cracks in its fuel hedging strategy and a generally tough economy led to a loss in the first quarter of 2009. But that was the exception. Southwest Airlines is still the clear industry winner and the standard that all other airlines are measured against. Shareholders have taken note and spoken with their wallets. Southwest's stock is rich, currently trading with a PE of 93. This valuation implies investors think it will be the next Google (Nasdaq: GOOG)!    

But let's get back to Republic Airways and the reasons I dislike the airline industry. What's to like? The industry is highly competitive, profits are largely dependent on the price of fuel (meaning complex hedging strategies are a necessity), and customers are hard to satisfy. And let's not forget, the U.S. is coming out of a recession with almost 10% unemployment. Consumers aren't exactly jumping at the chance to fly across the country. 

However, Patricio has found a company that has all of this bad news priced into the stock. And I like his strategy. In fact, investing in beaten down companies trading at a deep discount can be highly profitable, albeit risky. And this is a company that seems to be priced for the worst case scenario with shares trading at $5.34.  

Take a look at the three year chart below and you'll see what I mean. If you look back even further, you'll notice that Republic Airways shares climbed steadily from $9 in October of 1994 to $21 in March of 2008, right before the stock market crash. This stock has absolutely cratered since then, and despite some promising breakouts, has fallen back to the ground.  

 

Now, I don't want to appear upbeat on this company's growth prospects, I'm not. And before buying shares for the long-haul I would recommend spending more time analyzing Republic Airways ability to grow. This means looking closely at current flying routes, plans for route changes, and the company's prospects for adding popular hubs. These are typically the most important factors that determine the success of regional carriers. And difficulty landing both popular routes and busy hubs is why regional airlines are in such a tough industry.

But my distaste of the industry doesn't mean investors can't make money in these stocks. Republic Airways' stock looks undervalued right here. I think there could be upside based on oversold conditions. But I would consider this to be more of a short-term investment executed to catch a recovery in the stock price, rather than a long-term investment.   

Republic Airways has a market cap of $184 million, but it has an enterprise value of $2.3 billion. Where does the discrepancy come from? Debt, lots of it. At of the end of the last quarter the company had $2.07 billion in long-term debt, and another $840 million in current liabilities. That's a heavy burden. And even though the company routinely turns a positive net profit, it hasn't recorded positive cash flow since 2006. 

Growth is a problem for this company too. After reasonably solid earnings growth of 12% in 2007 and 14% in 2008, earnings plummeted in 2009 by 56% (including analyst estimates for the fourth quarter). And projections for 2010 are for a further 42% decrease in earnings. However, despite lower earnings estimates for 2010, consensus analyst estimates do project 25% revenue growth so there may be a light at the end of the tunnel for Republic Airways. That is of course if it can make it out of the black hole it's currently in.   

While the Standard and Poor 500 has risen 44% over the last 52-weeks, Republic Airways has seen shares of its stock go down by 23%. In addition to all the aforementioned reasons, the stock has suffered because the company keeps missing consensus analyst earnings estimates. Last quarter they missed by 70%, leading analysts to decrease estimates for 2010 from $1.35 to a more moderate $0.75.  

But here's the thing: analysts aren't very good at estimating how profitable an airline is going to be, especially Republic Airways. At the moment, earnings estimates are all over the place and range from negative $0.54 to positive $1.72 in 2010. Any sort of positive surprise out of the company should send shares sharply higher.  

With a current P/E of 4.8 this company's stock is dirt cheap, just as Patricio noted. It's forward P/E is also low, only 7.1. And its price-to-earnings-growth (PEG) ratio sits at .56. This valuation measure divides the current stock price by the expected earnings growth rate over the next five-years. It gives another measure of the relative trade-off between a stock's price, company earnings, and expected growth rate. A PEG of one indicates a fairly valued stock. With a PEG of .56 and a PE of 4.8, Republic Airways looks to be trading at a discount.   

The bottom line here is that Republic Airways is cheap, really cheap. Its stock has fallen apart because of industry pressures and a tough economy. But if any positive developments occur, the stock could move higher. I think speculative investors who are comfortable using a bottom-feeder strategy and picking up shares in hopes of a dead cat bounce could profit from Republic Airways. But I wouldn't buy shares and forget about them for the next five years – remember that this is a short-term investment.  

Also, if you do invest, be sure to check out the company's prospects for adding routes and hubs. I haven't done a thorough analysis here and these are the factors that will determine if the company will actually grow in the future or not. I'll keep an eye on Republic Airways and will provide you with updates in a future issue. 

What do you think of this stock? Let me know. And keep sending me tickers of companies you like and I'll review them in a future issue. My address is: editorial@smallcapinvestor.com