How Will An Oil Price Recovery Impact JetBlue’s Stock Price?

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Over the last year, the stocks of all major US airlines have reached new highs due to the sharp decline in global crude oil prices. Since jet fuel costs constitute nearly one-third of an airline’s total operating expenses, the 50% drop in oil prices has accelerated the earnings of a majority of the airlines. One of the top gainers from this fall was JetBlue Airways. The airline’s net income more than doubled in 2014 and its stock rose by approximately 80% in the last eleven months. Our current price estimate for JetBlue stands at $22 per share, assuming a gradual recovery of oil prices over the next two to three years. However, in this article, we will discuss how different oil price recovery scenarios can significantly impact the airline’s current valuation.

See our complete analysis for JetBlue Airways here

Base Case: Gradual Oil Price Recovery

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Since July of last year, crude oil prices have plunged from over $110 per barrel to $45 per barrel in January of this year on weak global demand, led by slow growth in the Chinese economy, and surplus oil production due to the rising tight oil production in the US.  In addition, the Organization of Petroleum Exporting Countries’ (OPEC) decision to maintain its current production rates has further aggravated the demand-supply mismatch. While the decline has weighed heavily on oil producing companies in the US, it has been extremely profitable for most of the US airlines, particularly JetBlue. In 2014, the New York-based airline’s fuel expenses as a percentage of passenger revenue declined from 38.2% in 2013 to 35.8% in 2014.

Even though the crude oil prices declined drastically in the second half of 2014, the full year prices averaged at around $100 per barrel. Over the last few weeks, crude oil prices have increased to $60 per barrel, showing signs of recovery due to the large cutbacks on production by major oil companies. Keeping this in mind, we forecast oil prices (Brent) to average around $75 per barrel this year and gradually increase to $85 per barrel over the next two years, before rising back to the $100 per barrel mark by the end of our forecast period. Thus, in our base case scenario, we estimate JetBlue’s US fuel costs as a percentage of revenue to fall to over 26% in 2015 and thereafter increase to 33% by the end of our forecast period. Accordingly, the airline’s EBITDA margin is expected to rise sharply from 20% in 2014 to 28% by end of this fiscal year and before reverting to 21%, closer to the 2014 level, in the outer years of our forecast period.

See our Base Case Scenario for JetBlue here

V-shaped Oil Price Recovery (-31%)

If we look at a more optimistic oil price scenario, where we assume that demand for crude oil will improve significantly due to increased economic activity in China and, in parallel, tight oil production in the US will decline, there could be a possibility of a sharper, V-shaped recovery in oil prices. Moreover, if the OPEC decides to change its current stance and cut its production, we estimate crude oil prices to reach over $120 per barrel by the end of our forecast period. In that case, we estimate JetBlue’s fuel costs to rise sharply to almost 37% by 2016 and further rise to almost 42% by the end of our forecast period. Consequently, we forecast the airline’s EBITDA margin to drop severely from an all-time high of 28% in 2015 to close to 13% over our forecast period. Hence, our price estimate for the airline would fall to $15 per share, a downside of more than 31% to our price estimate in the base case scenario.

See our analysis for V-shaped Oil Price Recovery for JetBlue here

Sustained Decline in Oil Prices (+30%)

Contrary to our V-shaped recovery scenario, if demand for oil does not improve either because of a continued slowdown in the Chinese economy, or due to the use of alternative fuels owing to technological advancements, oil prices will take longer than expected to recover. Additionally, if the OPEC continues to operate at its current production levels, or alternatively plans to increase its production rates to eliminate competition and to increase its market share, the global oil market will experience depressed oil prices for a prolonged period. Under this scenario, we forecast JetBlue’s fuel costs to drop to 22.5% of its revenue in 2016, and thereafter rise to 25% by the end of our forecast period. Since this sustained decline in fuel costs will boost the airline’s bottom line growth, we expect its consolidated EBITDA margin to shoot up from 20% in 2014 to close to 29% in the outer years of our forecast period. Taking this into account, we arrive at a price estimate of $29 per share for JetBlue’s stock, an upside of 30% to our current price estimate for the airline.

See our analysis for Sustained Decline in Oil Prices for JetBlue here

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