How Is JetBlue Planning To Improve Its Profitability?

JetBlue (NASDAQ:JBLU) is taking steps to improve its profit margin and return on capital, as its financial results have lagged behind those of its peers in recent months. In the quarter ended September, all network carriers – American, United and Delta – posted profits (excluding special items) of over $1 billion, Southwest posted a profit of $382 million, Alaska reported a profit of $200 million, but JetBlue could manage a profit of just $79 million, up from $71 million that it had posted in the prior year period. ^[1] Even though JetBlue has been expanding its flying capacity aggressively, the carrier hasn’t been able to grow its profits in line with those of its peers.

The network carriers restructured under bankruptcy during the past few years, so their profits are benefiting from lower cost structures. Southwest always maintained its focus on slashing costs, and Alaska took many steps in the last decade to lower its costs. JetBlue, meanwhile, focused on providing a differentiated product and expanding capacity aggressively to grow its profits. We figure this focus on offering a differentiated product prevented the carrier from maximizing its profit. For instance, legroom in JetBlue’s economy class is still greater than that offered by most other U.S. airlines on their narrow body airplanes. Southwest, on the other hand, has squeezed more seats on its airplanes to maximize its profit. JetBlue also does not charge its customers for the first checked bag. Such policies have allowed JetBlue to position its offering as differentiated. However, this focus on a differentiated product has prevented JetBlue from maximizing its profits, which in turn has impacted its return on capital. To grow its profits and return on capital – something investors want – JetBlue has announced that it will take several steps in the next 2-3 years. In this article, we analyze the steps that JetBlue is planning to take to grow its revenue.

We currently have a stock price estimate of $12.20 for JetBlue, around 10% below its current market price.

See our complete analysis of JetBlue here

JetBlue Plans To Charge Passengers For First Checked Bag

JetBlue plans to grow its revenue by focusing on ancillary revenue sources like baggage fees and by packing more seats on its planes. The carrier currently does not charge fliers for the first checked bag. JetBlue has long said that this policy attracts more passengers. Southwest is the other major carrier that does not charge fliers for the first check-in bag. But while these two airlines have maintained this policy, other U.S. airlines have generated significant incremental revenues by hiking their baggage fees. For instance, Alaska Air Group hiked its baggage fees in October last year and the carrier expected to generate incremental revenue of about $50 million per year from this move. ^[2] An important point to note here is that this incremental ancillary revenue does not come at any additional cost, so it goes straight into lifting margins and profit.

Beginning 2015, JetBlue will categorize its fares into three classes – the lowest of which will have baggage fees for the first checked bag. The carrier has not said how much that fee will be, but for the higher fare classes JetBlue will stick to allowing at least one free check-in bag. So, like many other U.S. airlines, JetBlue is seeking to add growth to its top line by leveraging baggage fees.

JetBlue Will Install More Seats To Accelerate Growth

The carrier will also install more seats on its planes to further add growth to its top line. Currently, the average fleet-wide seat pitch (which is the distance from any point on one seat to the exact same point on the seat in front) in JetBlue’s airplane fleet is 34.7 inches. This is among the most legroom offered by U.S. airlines on their narrow body mainline airplanes. For instance, seat-pitch of Alaska’s narrow body airplanes is 31.9 inches, of United’s narrow body airplanes is 31.8 inches, of Delta’s narrow body airplanes is 31.3 inches and of Spirit’s narrow body airplanes is 28.3 inches. This greater legroom has been one of the key elements of JetBlue’s differentiated product. But now, to maximize profit, beginning in 2016 the carrier will increase the number of seats on its Airbus A320s from 150 to 165. This will lower the average fleet-wide seat pitch in JetBlue’s airplane fleet to 33.1 inches, but generate additional revenue of about $100 million per year. ^[3] So, while fliers will have to adjust to less legroom, JetBlue in return will be able to grow its revenue, margin and return on capital. And we figure, at 33.1 inches, JetBlue’s economy class seat pitch will still be among the higher ones in the industry.

Separately, capacity gains from these additional seats has allowed JetBlue to defer deliveries of 18 of its Airbus airplanes that were initially scheduled for delivery from 2016 to 2018. JetBlue will now take delivery of these airplanes from 2022 to 2023. ^[3] This effectively means that JetBlue will be able to expand its capacity as initially planned with fewer airplane purchases. This is a more capital efficient way to expand capacity that will also boost return on capital.

Other initiatives related to JetBlue’s Even More offering, which at an additional charge provides extra legroom seats, early boarding and expedited security check, are expected to add another $150 million to JetBlue’s top line by 2018. ^[3]

In all, from the point of view of profit maximization, these policy decisions are good moves that will help improve JetBlue’s return on capital for investors, but passengers will likely have to adjust. And, we will have to wait and see if these moves dent passengers’ perception of JetBlue’s differentiated product. Earlier this year in May, J. D. Power awarded JetBlue the top position among low-cost carriers in customer satisfaction for a tenth year in a row. J. D. Power ranks airlines through customer feedback, and it will be interesting to see if JetBlue can maintain its top position even after these moves that will reduce legroom and introduce baggage fees. From a return on capital perspective, though, these moves will help JetBlue catch up with other airlines that have significantly grown their returns on capital over the past few years.

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1. JetBlue’s 2014 Q3 earnings form 8-K, October 23 2014, www.jetblue.com [↩]
2. Alaska Air Group’s investor update presentation for 8-K, July 11 2013, www.alaskaworld.com [↩]
3. JetBlue 2014 Analyst Day, November 19 2014, www.jetblue.com [↩] [↩] [↩]