JetBlue‘s (NASDAQ:JBLU) top line rose by nearly 5% annually to $1.3 billion in the second quarter on higher passenger traffic driven by capacity expansion. However, the low-cost carrier’s second quarter profits dipped by 31% from last year to $36 million due to a sharp rise in its aircraft maintenance and repair costs. 
Additionally, unlike other major carriers including United (NYSE:UAL), Delta (NYSE:DAL), US Airways (NYSE:LCC) and Alaska (NYSE:ALK) that saw their second quarter profits rise on lower jet fuel costs; JetBlue’s fuel costs rose in the second quarter as gains from lower jet fuel spot prices were more than offset by higher fuel consumption from the carrier, driven by its capacity expansion.
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We currently have a stock price estimate of $7.50 for JetBlue, around 15% ahead of its current market price. We are in the process of incorporating second quarter earnings and shall update our analysis shortly.
Capacity Expansion Drives Top Line Growth
During the second quarter, JetBlue continued its strategy of raising flying capacity to drive growth in passenger traffic and top line. The carrier raised its flying capacity by 8% annually, which lifted its passenger traffic by around 7% from last year, in the second quarter.  However, gains from higher passenger traffic were partially offset by lower unit revenues – amount collected from each passenger for a seat per mile of flight – resulting in part from the carrier’s aggressive capacity expansion amid a moderate economic growth environment. This decline in JetBlue’s unit revenues tempered the 7%-8% growth in its flying capacity and passenger traffic to 5% growth in its top line.
Maintenance Cost Pressures Weigh On Margins
Additionally, JetBlue’s second quarter operating margins declined to 7.6% in the second quarter from 10.2% in the year ago quarter. This fall in the carrier’s margins was driven by a 30% y-o-y increase in its aircraft maintenance and repair costs.  JetBlue, which operates one of the youngest fleet among major U.S. airlines, is seeing its maintenance costs rise sharply as with age its aircraft are requiring heavier and more frequent checks and repairs. These costs constitute around a tenth of JetBlue’s total operating expenses.
Looking ahead, the carrier expressed confidence that margin pressure from maintenance costs will ease in the second half of the year, which will benefit profits. JetBlue further indicated that despite recent pressure on its unit revenues from possibly overly aggressive capacity expansion, it will continue to raise its flying capacity in the second half to drive top line growth. The carrier anticipates to raise its flying capacity between 3.5% and 5.5% per year in the third quarter.  Incorporation of three new Airbus A320 aircraft in the carrier’s fleet will help in this capacity expansion.
Separately, Southwest‘s (NYSE:LUV) revenues grew marginally in the second quarter on higher passenger traffic driven by capacity expansion. Like JetBlue, Southwest too raised its flying capacity, albeit at a slower rate of 3% y-o-y in the second quarter. This lifted its passenger traffic by also around 3% annually. 
A sharp decline in jet fuel spot prices during the second quarter also lowered Southwest’s second quarter fuel costs by nearly 6% annually. However, gains from lower fuel costs were more than offset by a sharp rise in AirTran integration costs and moderate growth in other operating costs like salaries and maintenance/repair heads. This reduced Southwest’s second quarter profits to $224 million, from $228 million in the year ago period. 
Southwest further confirmed that AirTran’s integration with Southwest was proceeding on track and will be complete by the end of 2014. In all, AirTran’s merger and integration is expected to cost around $550 million, out of which $363 million has been incurred up till now.  However, these costs are expected to be more than offset by synergies arising out of this transaction.Notes: