JetBlue: Dark Skies Ahead

Summary

• JetBlue is consistently ranked as one of the best airlines in the US in terms of customer service.
• JetBlue has a lower return on invested capital relative to its peers.
• The company is at a disadvantage in a "price war" scenario due to its higher cost relative to its peers.

Airline stocks have been on a bit of a roll lately with optimism starting to return to the markets. I wanted to do a deep dive and see whether this enthusiasm is warranted. Is there an investment opportunity here or is this a sucker's rally? Today, I am taking a look at JetBlue (NASDAQ:JBLU).

Just a brief background on the company, JetBlue is consistently ranked as one of the best airlines in the US in terms of customer service. In terms of Q1 2020 results, unsurprisingly, revenue was down by 15% due to the impact of the coronavirus pandemic. The full impact of the lockdowns though is not fully captured in these results and will only show for Q2 2020. Like most other airlines, JetBlue took serious steps to mitigate the cash burn from the lack of flights. Cash burn in May was roughly $10 million, down from $18 million in March when the pandemic started.

Like most airlines, JetBlue received a bail-out from the federal government in the form of the CARES Act. The company obtained $936 million with additional possible additional liquidity of $1.14 billion. As payment, the company issued 2.6 million warrants to the government. These warrants will dilute future earnings. According to company management, JetBlue entered the coronavirus pandemic with the "second strongest balance sheet" with a debt to capital ratio of 44%. By May the company had $3.1 billion in Cash which should provide the company with enough of a liquidity cushion.

As mentioned in my previous article, I believe that air travel will gradually return at some point in the future. With the lockdowns easing in different states, domestic travel may be returning soon. However, most international borders remain closed to tourists, including the US, and may remain closed for the foreseeable future. Therefore, I believe most flights in the near-term will be primarily focused on domestic travel. As mentioned by Treasury Secretary Steve Mnuchin "it's a great time to explore America".

Like Southwest (LUV), JetBlue is primarily a domestic carrier and thus gets the majority of its revenue from domestic flights. This means that the company has a chance to be among the first airlines to get their fleet up and running. This is different from the experiences of the majors whose international flights make up a significant portion of their revenue. For example in 2019, international flights made up 28% of Delta's (DAL) revenue ($11.8 billion vs. total revenue of $42.2 billion).

JetBlue route map

In fact, JetBlue has already announced a plan on how to properly conduct social distancing within flights. The company has an entire program called "Safety from the ground up" which encompasses all touchpoints between crew and customers in the travel journey. It starts from before the flight by ensuring contactless boarding as well as temperature checks. Within the flight, certain seats (either middle or aisle) will be blocked off for customers not traveling together in order to promote proper social distancing. Face coverings are required for both customers and crews.

JetBlue is also committed to properly and frequently disinfecting common surfaces and filtering cabin air using hospital-grade HEPA air filters. These steps should ensure that people feel more comfortable flying, however, also have the unwanted side effect of raising costs (more manpower needed for frequent disinfecting) as well as reduced revenue (due to limited capacity per plane).

JetBlue "Safety from the ground up"

JetBlue will survive but is it a good investment

Given that JetBlue is most likely to get out of this pandemic intact, is the company a good investment? Unfortunately, I believe the answer is no. Despite being consistently voted as one of the best airlines in the US, JetBlue has had profitability issues even before the coronavirus pandemic hit.

Using a measurement called Return on Invested Capital ("ROIC") which is a measurement used to evaluate how well the company uses its invested capital, we can evaluate how well JetBlue is run compared to its peers. This measure is appropriate as the airline industry has a lot of capital costs, tying up vast amounts of capital in aircraft, spare parts, and facilities.

Comparing JetBlue with its peers Southwest and Alaska Airlines (ALK) we can see that JetBlue has a much lower return on invested capital. In 2019, JetBlue had a return on invested capital of 9.5% compared to the double digits ROIC of its peers. Looking at the company's operating margins / EBIT margins in comparison to its peers shows the same story as well. JetBlue has had consistently lower operating margins in the last 3 years compared to its peers. This indicates that JetBlue business is more expensive to run than its peers and it has additional costs that are not translating to additional revenue.

Company	2019 ROIC
JetBlue	9.5%
Southwest	17.8%
Delta	16.2%
Alaska Air	12.2%

Click to enlarge

Note: I didn't include United Airlines and American Airlines as these companies do not present their ROIC.

Author's calculations using data from Seeking Alpha

JetBlue is well aware of this issue and such that even before the coronavirus pandemic has been making plans in order to increase profitability. Historically, the company's desire to improve the customer experience has been steadily increasing costs without the necessary improvements in top-line growth. Other drivers of costs have been maintenance-related which the company was able to renegotiate with Airbus (OTCPK:EADSF). At the beginning of 2020, the company announced that it was able to trim-off $314 million worth of non-fuel costs. Unfortunately, the company may not see the fruits of its effort due to the coronavirus pandemic completely upheaving the industry.

JetBlue investor presentation

As detailed in my previous article, I believe the reduced demand and cash burn in the airline industry could lead to a price war among the airlines. Demand has been improving these last few weeks but is still a far cry from "normal times". The headline figures are misleading due to coming off a very low base. Total screenings by the TSA are still down 85% compared to last year. For example, on April 30 the TSA recorded 154,695 passengers screened vs. 119,629 the previous day, a 30% increase. Yet the same day last year the TSA screened 2 million travelers.

Given that airlines are losing millions daily and the commodity nature of the service, airlines could be inclined to lower prices in order to compete for the now limited demand. This sentiment was echoed recently by Southwest's CEO. In a "price war" scenario, the airline with the most efficient operations and cost-structure wins as they have room to lower their prices. As evidenced by the operating margins of the company, JetBlue is at a disadvantage in this situation due to its higher cost relative to its peers.

Even with capacity cuts, the number of available airline seats will still far outnumber customers in the near term, the chief executive officer said in a video message to Southwest employees on Friday. Demand for airline travel is expected to return slowly as the country starts to reopen its businesses.

With a potential price war putting more pressure on already struggling airlines, Southwest is preparing contingency plans in case more radical changes are required for survival, the CEO said

Southwest Air Sees 'Brutal Low-Fare' Pressure in Virus Aftermath - BNN Bloomberg

Valuation

In terms of valuation, I am using the 2019 multiples pre-coronavirus rather than the forward multiples as these would show what the business is like in a stable environment. In 2019, JetBlue had an EPS of $1.91 implying roughly a 7.2x P/E multiple at a stock price of $13.69.

JetBlue always seems to trade at a premium relative to its peers (which have an average of 6.3x). My guess to why that occurs is that JetBlue always tops customer service rankings so the market awards it a premium because of that. While I enjoy flying in JetBlue, that premium is undeserved due to poor financial and operational metrics.

Author's calculations using data from Seeking Alpha

As discussed in my previous article, for the purposes of valuation, I consider the entire airline industry to be "in distress". The airlines are able to operate now but basically needed a bail-out from the federal government to survive. These companies may need to start raising capital if the situation does not improve rapidly.

In situations of distressed asset investing I usually look at the company's book value per share. This is because right now a new entrant can come in and buy all these assets if there is an imminent wave of bankruptcies or downsizing. For JetBlue, I would attach an additional discount of 10-20% due to poor financial and operational metrics. I believe that in times of distress, operational metrics would trump brand recognition. Currently, the book value of JetBlue is $17.02 per share. Applying the discount gives me a share price target of $13.62 - $15.32. At the price of $13.69, JetBlue is already at the lower end of my target range. I would stay away from JetBlue.

Analyst’s 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.

Comments

[Invader from Earth]

I like $JBLU. I will only invest in airlines that announce that they will reconfigure the cabin interiors for the COVID pandemic. Bringing business class two seat aisles all the way back plus partitions. Stop waving the paper HEPA filters to the cameras. You look and sound ridiculous. Yes, the cost of tickets will go up. Move on. Gross a revenue and GAAP profits will still increase. Do the math.

[markcc]

@Irredeemable Deplorable
The problem with your expectation is that the Covid crisis will end. No airline has the money today to do what you are recommending. The loss of seats will guarantee losses for the industry into the future as ticket prices will have to go up so much that many people just won't fly.

[slacker9]

The author is ignoring some valuable information.

JetBlue has three main focus cities where it makes most of its money. JFK, BOS, and FLL. Like all airlines, it is retrenching in the places where it is strongest while it’s competitors are doing the same. JetBlue’s main competitors are currently showing little desire to fight in the JetBlue markets.

LUV is permanently pulling back FLL to focus out west.

In July, JetBlue peak day departures in JFK are at 77 flights. Delta only shows 36 and they were bigger than JetBlue.AAL only 20.

In Boston, JetBlue peak day departures for July are showing 72. Delta at 24 and AAL at 40. Delta was getting close to the same number of departures as JetBlue and now they are 1/3 the number and smaller than AAL.

JetBlue will be able to build back to a full Schedule sooner than the big 3 as the big 3 refocus in their core hubs and pull back where JetBlue is strong.

[Tim Dunn]

nowhere has LUV said they are permanently pulling back from Ft. Lauderdale. The amrket is not there right now; it makes sense for any company that can deploy assets elsewhere to do so.

Airline schedules are very much in flux right now; AAL and DAL are both putting dozens of airplanes back in service for July. Schedules for July are not finalized.

Every airline is and will be competing for the same domestic passenger during the industry's recovery.

JBLU's credit rating is lower than DAL's and just above AAL's. As much as you struggle to admit it, JBLU does not have an advantage. It was unable to demonstrate an earnings advantage over the past 3 years and it won't be any easier for that to change in the near future than it has been in the past.

[slacker9]

“Every airline is and will be competing for the same domestic passenger during the industry's recovery.”

This is where you are wrong. It was true when the big 4 were printing money. All airlines will go where the money is the easiest. They will only compete when they have to., at least until they are profitable again. That is not in BOS, JFK or FLL for the big 3.

[Tim Dunn]

I will let you cling to that hope, even though there is absolutely no evidence it has ever been true in the deregulated era of US aviation (all JBLU has known) or is true now.

[Tim Dunn]

S&P downgraded JBLU's credit rating to B+ which means that JBLU has the 5th lowest credit rating of the biggest US airlines, ahead of only AAL and behind LUV DAL UAL and ALK in that order.

While some people don't quite get it yet, the smaller low cost carriers ALK and JBLU are in a worse financial position to continue to fund operating losses than LUV DAL and UAL.

[venturebandit]

I have read about dark, blue and green skies.
On oil I have read bullish and bearish articles.
I think at the end, everyone needs to make their best judgement. Risk what you are comfortable losing. Dont get caught in the hype. I still feel SAVE, JBLU will be the kings/queens of the sky. Nobody can judge what airline the passenger will fly today. The pre 2020 fundamentals may favor delta but who knows if JBLU is getting all the passengers in this market?

[markcc]

@venturebandit
COVID-19 will reshuffle who is on top. JetBlue is forecasting flying 50% of its schedule in July, while Delta has said nothing about its adjusted levels. American will be at 55%. Southwest is hunkering down on its west coast routes, and expanding its west coast, PHX, LAS, DEN dominance before the other airlines return there. SAVE has the lowest CASM and can add flights at low cost faster than any other airline AND add non-stop flights without hubs. This is bad news for the legacies who depend on premium ticket prices to cover their high costs and connecting flights.

[Tim Dunn]

wait, Mark. You can't use historical data to tell us that SAVE was a low CASM carrier when you just told us that we can't historical data to rank carriers by profitability.
Quite frankly, you have no idea how anyone's cost or revenue performance will work in this environment.

All of the capacity that is being dumped into the market is not creating demand. You have a few airlines including AAL LUV and SAVE that are willing to chase a fraction of original demand.

There simply is no risk of significant share shifts because there is not enough market to chase.

[Skydriverdc6]

Just one guys opinion. Last week another analyst wrote “Smooth skies ahead for JBLU” now 5 days later another guy says dark skies. I think of all the airlines out there JBLU is the most likely to succeed and maybe delta also. The whole market is red this week just chill and wait

[Value Kicker]

@Skydriverdc6 we like our puns

[Res-Int-Gear]

Man I bought a boat load of JBLU yesterday - and damn am i regretting it today.
Im thinking to myself ...........WTF is wrong with me
Then I read this ........and now im thinking.
Any hope in the near term?
Did i get trapped in that mini rally?

[dawgydaddy]

Let’s say you bought at $15.50 and it’s now at $12. If you sell the 2022 $15 calls for $3.60, either they get called away and you make $3.10 per share or they don’t and at least your cost basis is down to $11.40.
Or take the $12 and put it into the 2022 5/10 spread for $2.75. If JBLU stays over 10 you lost $3 per share but make back $9.82 since you can buy about 4.4 spreads per share sold.

Or just wait it out. If they don’t BK, they’ll eventually be worth more than you paid.

[Clairvoyant Investor]

Recessions equal less discretionary spending power which equals finding the best cost option to fly. JetBlue is small enough to grow adapt and reinvent itself to become a more efficient airline that customers will desire. The other airlines have treacherous debt loads and are quite cumbersome with reference to size. JetBlue is a value stock and a growth stock and will triple within 2 years and probably much less than that.

[terry27]

I’m sure this article is for our benefit as investors. My question is based on the chart you showed comparing 3 other airlines ROIC but are the figures you showed are just the total of their domestic flights ? Or Are their annual totals including domestic and overseas flight revenue?
I ask this question because Jet Blue is basically just a domestic air carrier.

[Value Kicker]

Hi @terry27

These are disclosed by the company. So domestic + overseas.

[Tim Dunn]

@terry27
given that AAL DAL and UAL have had higher margins on their domestic than international systems for several years, the ROIC gap is even higher for JBLU compared to the big 3 if you look only at domestic, esp given that international longhaul aircraft are much more costly than domestic aircraft.

[markcc]

ROIC for airlines is not a good metric. Using metrics presumes that the companies you are comparing have substantially similar businesses. Airlines have different structural costs, and JetBlue has the bulk of its flights to/from the more expensive cities like NYC and Boston. Southwest has a larger portion of its operations in lower cost areas, allowing it a better return. What is left out is the fact that last year JetBlue's revenue per seat mile is lower than Delta's cost. As a growth play, they consciously discount to break into and expand markets.

[Tim Dunn]

Of course it is not only completely appropriate but also accurate to compare NI margins not just between airlines but between all companies @markcc
The fact that DAL outperformed JBLU on multiple financial metrics for not just the past year but also the past 3 years is precisely why the author's thesis is correct.

of course, past performance is not a guarantee of future success and that is all the more true now but DAL appears very well positioned to adapt to the new cost/revenue environment compared to other carriers including JBLU.

I hope it doesn't come as a newsflash to you but net income margin is the result of revenues minus costs. The fact that DAL had higher costs and still ended up with higher margins says that they did far better on the revenue side. Now that the pendulum is swinging to low fares across the board, JBLU has to get its costs down even further. may I remind you - which the author did not mention - that JBLU has maintained its low costs by aggressive growth. In a decimated demand environment, that strategy doesn't work. JBLU's unit costs relative to the industry are certain to increase.

And remember also that JBLU's major markets are all in highly competitive markets that will see much larger reduction in demand in the near to mid-term - NYC, BOS and Ft. Lauderdale. Not only is JBLU fighting against deeper cutbacks due to covid but markets like FLL are heavily dependent on the cruise industry. JBLU also does have a significant presence in foreign Caribbean markets which are not likely to recover as quickly as the domestic marketplace.

The author's thesis is correct. JBLU is overpriced relative to known fundamentals.

oh, and I believe that as of the most recent measurement, DAL's credit rating by at least one agency is higher than JBLU's.

[markcc]

@Tim Dunn
Did you actually read my post? You forget that Delta gets its numbers by flying out of cheap airports it saturates to get higher fares, but attracts discounters, while JetBlue competes in the tougher bigger cities.

After your years of posting, you still think high fares are a winning strategy!

Talking about metrics, JetBlue beats Delta in Customer Satisfaction, NPS scores and growth rate. Period.

Airlines are ungrounding planes at a rate faster than Delta, with Southwest projecting a return by the end of the year.

[Tim Dunn]

@markcc
You paint w/ excessively broad brushes - and are inaccurate in the process, just as you were with your original statement.

The margins are what matters. How any airline gets there is up to management to figure out including NPS which doesn't matter one iota if it doesn't translate into improved margins.

After years of trying to argue otherwise, you can't accept that Delta is right up there with LUV in margin performance and well above airlines like JBLU that you have repeatedly positioned as superior companies.

The author is right. JBLU hasn't been an industry leader financially for several years and there is no reason to believe it will improve anytime soon.

[Clairvoyant Investor]

This Airline easily has the most upside when this is all said and done during the recession and afterwards.

[ventureCapital]

I beg to differ on this. They came into this with one of the best balance sheets. Most of the passengers who use Jetblue are pretty loyal. I see them doing just fine.
News of a vaccine will hit the streets hopefully by September...by then all the doom and gloom articles will fade away

[carlomiami]

JetBlue will be fine because more and more people are traveling again and it will be very intense in the next few months

[jade924]

And the only airline that is allowing people 2 years to use their credit. American gave us 6 months Same as spirit. Spirit refused to refund the baggage money. After I redeem my tickets I will never used them again