Behind The Idea: JetBlue Airways Stock Could Triple By 2025, Thanks To 6 Key Margin Expansion Catalysts

Dec. 13, 2019 9:00 AM ETJetBlue Airways Corporation (JBLU)29 Comments5 Likes
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Summary

  • JetBlue Airways stock trades for around 10 times trailing earnings, reflecting investors' doubts about the company's profit growth potential.
  • However, four key profit improvement initiatives that could collectively boost JetBlue's pre-tax margin by 5 percentage points will come on line by 2021.
  • As a result, EPS could rise from less than $2 today to between $3 and $4 by 2021, potentially enabling JetBlue stock to double (or more) within two years.
  • Additional margin-accretive initiatives will ramp up in the early 2020s. The replacement of JetBlue's high-cost E190 fleet with the ultra-efficient A220-300 could boost JetBlue's pre-tax margin by 3 percentage points.
  • EPS is likely to rise to at least $4.99 by 2025, and potentially as high as $7.29. Based on peer valuations, even the low end of that range could support a $60 stock price.

This article was selected to be shared with PRO+ subscribers, who also got 7 days' exclusive access to Adam Levine-Weinberg, CFA’s original Top Idea on JetBlue Airways (NASDAQ:JBLU). Find out more about PRO+ here.

Seeking Alpha: Can you briefly summarize your bullish thesis for readers who may not have seen it yet?

Adam Levine-Weinberg, CFA: Several years ago, JetBlue Airways had one of the highest profit margins of any U.S. airline. Since then, it has experienced quite a bit of margin deterioration, both on an absolute basis and relative to the industry. Adjusted pre-tax margin peaked in the 17-18% range in 2015 and 2016 but has fallen to just 9.4% over the past 12 months. As a result, JetBlue stock trades for about 10 times trailing earnings: a valuation consistent with investors expecting close to zero future earnings growth.

Investors don't seem to be digging into the "whys" behind JetBlue's margin deterioration, particularly on a relative basis. JetBlue has announced six significant margin-accretive initiatives at a series of investor day events since 2014. However, due to flukes in the timing of implementation, it has captured very little of the margin expansion opportunity so far. Now, JetBlue has four significant initiatives set to pay off over the next two years: the addition of ultra-fuel-efficient A321neos to the fleet, putting 12 extra seats on each of its 130 Airbus A320s, structural cost reductions, and the launch of basic economy pricing.

Together, these four margin catalysts could boost JetBlue's pre-tax margin by about 5 percentage points over the next two years, driving EPS from less than $2 in 2019 to between $3 and $4 in 2021. Further growth and additional margin catalysts that will ramp up in the following years could bring JetBlue's pre-tax margin back to mid-teens levels (14-17%) by 2025, which would help EPS rise to at least the $5 mark, and possibly beyond $7. At a minimum, that should allow JetBlue stock to triple to $60, with potential upside as far as $95 if the company hits the high end of that margin range and wins a higher multiple from investors.

SA: Can you discuss how the airline industry has changed in the past decade or two, as some investors may be inclined to declare it uninvestable based on an outdated viewpoint?

AW: Prior to 2008, the U.S. airline industry was highly fragmented. To make matters worse, nearly all of the large airlines were hub-and-spoke carriers. The hub-and-spoke model is a volume game, and so the biggest airlines felt compelled to grow at all costs. They also had high legacy costs, as the industry was regulated prior to 1978 in a way that encouraged bloated expense structures. The result was a dreadful record of profitability and frequent bankruptcies.

The consolidation of the U.S. airline industry has led to a far more rational supply-demand balance. The top four carriers hold about 80% of the market (depending on how you measure). JetBlue is in the next tier with Alaska Air Group (ALK): together with the top four, they control about 90% of the market. While all of these airlines want to grow, none of them have a strategic imperative to grow at the expense of profitability. As a result, when costs increase (due to rising oil prices, for example) or demand slows, most airlines reduce their growth to ensure that fares are keeping up with costs. While the U.S. airlines haven't gone through a domestic recession in the past 10 years, they have endured a big surge in oil prices in 2011, several periods of slowing growth, and slowdowns in key international markets. All signs point to their ability to weather a U.S. recession with ease.

SA: Is part of the mispricing because investors simply extrapolate what has (or in this case hasn’t) happened in the past and are missing the turnaround?

AW: I can only imagine that investors (and analysts) are skeptical about JetBlue's margin expansion plans because they have been hearing about these margin initiatives for up to five years in some cases but haven't seen the benefits yet. However, some of the key cost-reduction efforts were delayed due to reasons outside of JetBlue's control (most notably, delivery delays at Airbus (OTCPK:EADSF)). These projects are now moving forward, so investors can look forward to substantial margin expansion over the next two years.

It's important to note that most of JetBlue's margin catalysts (e.g. basic economy pricing, squeezing more seats onto each plane, "upgauging" to larger and more fuel-efficient aircraft) are tried-and-true tactics that most of its competitors have already adopted. Today, JetBlue is producing margins not far from the industry average despite being a few years behind in terms of adopting these strategies to boost revenue and reduce unit costs. As it catches up to (and possibly even surpasses) rivals in terms of implementing these best practices, JetBlue's profitability should return to the upper echelon of the airline industry.

SA: How much (if at all) does the macro outlook factor into your thesis on the upside or downside? How would a downturn in the economy or higher oil prices impact the “new” JBLU in terms of its operating results and valuation?

AW: This is a long-term play. Realistically, nobody knows how the economy may be doing in 2025, so the valuations are based on steady-state macro conditions. Fortunately, as I alluded to earlier, airlines have become far more resilient to macroeconomic shocks over the past decade or so. It helps that oil prices tend to be correlated to GDP growth. In a recession, airlines will likely get relief on the fuel cost line; conversely, if oil prices are rising, it's probably because the economy is strong, which should enable them to raise fares. In recent years, oil price increases have caused temporary margin headwinds from time to time, but within less than a year after oil prices have stopped rising, the airlines' margins have rebounded.

Notably, JetBlue's operating margin was positive in 2008 and a surprisingly strong 8.5% in 2009, so the airline has a solid track record for navigating tough macro environments. Assuming JetBlue's margin expansion drivers work as expected, the airline will be starting from an even more favorable position whenever the next recession hits. As a result, JetBlue's EPS would likely bottom out at a level higher than 2018-2019 levels and should bounce back quickly during the subsequent economic recovery.

The most salient risk that investors need to watch out for is a stagflation scenario: i.e. the possibility of a supply-side shock that drives oil prices significantly higher against the backdrop of a weak economy. Even then, JetBlue's top-tier balance sheet and what should be above-average margins by 2021 will help protect the airline. More-leveraged and lower-margin peers would bear the brunt of any impact.

***

Thanks to Adam for the interview.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

Additional disclosure: Adam Levine-Weinberg, CFA is long JBLU, ALK, DAL, long Jan. 2020 $20 calls on AAL, and long Jan. 2021 $40 calls on LUV.

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