JetBlue: Target Capital Structure Achieved

| About: JetBlue Airways (JBLU)

Summary

JetBlue has been quietly deleveraging its balance sheet over the past two years, largely from buying its new aircraft in cash.

JetBlue will reach its target 30-40% adjusted debt-to-capitalization ratio by the end of 2016.

Once JetBlue meets its target capital structure, future cash flows will be available to fund a substantial shareholder capital return program.

JetBlue (NASDAQ:JBLU) has used the excess cash flow from the windfall in profits brought on by the crash in oil prices to pay for its new airline orders in 2015 and 2016 in cash. JetBlue generated cash flow from operations of $1.6 billion in 2015 and $1 billion in the first half of 2016. As of June 30, 2016, JetBlue had $1.5 billion in cash and short-term investments on its balance sheet.

During JetBlue's second quarter 2016 conference call, JetBlue CFO Mark D. Powers explained that the strong results of the past two years have enabled JetBlue to delever its balance sheet enough to reach its target capital structure:

Our balance sheet has been considerably strengthened over the past two years, driving quarterly interest expense savings over that time period of over $10 million. At the close of the second quarter 2016, our adjusted debt to capitalization ratio was 41% compared to 64% at the end of the second quarter 2014. We expect the year-end ratio will be below 40%. Our balance sheet affords us the flexibility to consider ways to accelerate profitable growth including acquisitions over incremental aircrafts.

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Given the strength of our cash balance and cash from operations, we anticipate we'll continue to pay cash for our remaining six non-leased A321 - 2016 deliveries from Airbus. For 2017 and 2018, we believe we will pay for deliveries with the combination of cash and debt with a goal of managing our adjusted debt-to-capital ratio between 30% and 40%.

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In the near term, we are focused on paying cash for aircraft, offsetting share dilution, addressing our upcoming EETC maturities later this year, and other opportunities similar to the aircraft lease buyouts we executed in 2015. We plan on providing you an update about our ability to start a capital return program at our Investor Day later this year.

Source: Q2 2016 Conference Call Transcript

The significance of these comments is enormous as this is the first time JetBlue has ever achieved its target capital structure. JetBlue had been forced to issue equity to fund its growth over its 15-year history, growing from operating a fleet of 24 planes at its 2002 IPO to 219 planes today while shares outstanding grew from 40.95 million at its April 2002 IPO to 342.6 million shares today.

Those 15 years of growth coincided with some of the worst events for the airline industry: 9/11/2001, mid-2000s high fuel prices, the Great Recession, and a return to $100/barrel oil prices. Given JetBlue's high cost of capital and shareholder dilution, despite JetBlue's growth, shareholders from the early 2000s have seen no real return.

Since 2009, however, JetBlue has demonstrated an ability to grow operations without diluting shareholders. JetBlue's share count has remained steady - between 330 and 350 million weighted average shares outstanding from December 31, 2009 through today, during which JetBlue has grown its operating fleet from 142 to 219 planes (2009 10-K).

After JetBlue arrives within its target adjusted debt-to-capital ratio of 30-40%, to remain within its target range, JetBlue will have to stop its recent practice of paying for aircraft in all-cash starting in 2017. JetBlue will need to finance at least 30% of its aircraft purchases to stay within its target adjusted debt-to-capital range. Financing 30% of its aircraft purchases will leave JetBlue with excess cash flow that can be used for a substantial capital return program for shareholders.

JetBlue's second quarter 2016 10-Q gives us some insight on its flight equipment commitments and its order book. As of June 30, 2016, its order book had flight equipment commitments of $402 million for the remainder of 2016, $807 million in 2017, $675 million in 2018, $1.0 billion in 2019, $1.4 billion in 2020. These yearly flight equipment commitments exclude the incremental order for 30 more A321 aircraft JetBlue made in July 2016. The timing of those A321 deliveries are detailed below:

Click to enlarge

Source: JetBlue Q2 2016 10-Q

Let's assume JetBlue's incremental orders will be purchased at 70% of Airbus' 2016 list prices ($80 million for A321s and $88M for A321neos). That would increase JetBlue's aircraft capital expenditures to approximately $1.2 billion in 2017, $1.0 billion in 2018, $1.5 billion in 2019, and $1.7 billion in 2020.

Financing 30% of these purchases and using the proceeds of the debt issuance to buy back shares would be a substantial capital return program for JetBlue's approximately $6 billion market capitalization.

In the Q&A portion of JetBlue's second quarter 2016 conference call, Analyst Rajeev Lalwani of Morgan Stanley asked about what the debt to capital target meant for shareholder capital returns. Mark D. Powers responded that JetBlue's November Investor Day would provide more detail. Shareholders will receive an update in November about how JetBlue views its capital structure and what type of capital return program it wants to execute.

In September 2015, JetBlue's board of directors authorized a $250M share buyback program valid for three years, set to begin in 2016. As of June 30, 2016, however, JetBlue had yet to repurchase any shares under this buyback. I believe the unsuccessful bid for Virgin America held back JetBlue from repurchasing shares to date in 2016.

On JetBlue's Investor Day, I believe JetBlue's management will ask its Board of Directors for an increase in its existing share buyback program. With an aircraft capital expenditure budget of at least $1 billion per year over the next five years, financing these expenditures at 30% (instead of continuing to pay all cash) will enable JetBlue to support at least $300 million per year in share buybacks.

A buyback of approximately 5% of outstanding shares per year, mid single-digit capacity growth and a healthy balance sheet (less than 40% adjusted debt-to-capital) should be viewed very positively by shareholders, particularly those holding since 2002.

Disclosure: I am/we are long JBLU.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.