Why Have We Revised JetBlue’s Price Estimate To $25 Per Share?

JetBlue’s (NYSE:JBLU) stock price has been on an upward trajectory since September of last year. The rate of ascension in the stock price gathered pace in late November 2016, rising roughly 20%. This momentum in JetBlue’s stock price can be understood by the airline’s resilience in key metrics and Warren Buffet’s investment in the airline sector at the time. Furthermore, the stock price was helped by the diminishing yield pressure on the U.S. carriers in the domestic markets. Talking more about the recent fourth quarter 2016 results, revenues were up slightly at 3% y-o-y to $1.6 billion, while the company limited its capacity growth to 4.5% in Q4’16 to arrest the fall in unit revenues. With a decent set of 4Q’16 results, JetBlue saw an initial rally of almost 4.5% in its stock price, trading at $22.73 per share during the day. However, the rally was short-lived, as the market was quick to reverse its optimism, when the low-cost carrier announced an expected drop of 8%-9% in its unit revenue in the month of January due to unexpectedly harsh winter conditions. As a result, the carrier ended the day at $21.10 per share, 3.2% lower than the previous trading day. Consequently, since September’16 to date, JetBlue’s stock price has increased 20%.

In line with the company’s most recent earnings and the path it has laid down for future earnings growth, we have revised our price estimate for JetBlue to $25 per share. Below we present some of the key reasons supporting the upward revision of the company’s valuation:

Capacity Growth

JetBlue has historically grown its capacity at a rate higher than most of its peers. The first quarter of 2016 saw the carrier’s capacity up as much as 14.1% y-o-y, while the second quarter saw it up as much as 11.1%. Even as the headwinds related to unit revenues became sticky, and most other carriers started trimming their capacity, JetBlue continued to expand it, albeit at a slower pace. Consequently, the third and fourth quarter of 2016 saw a growth of 4%-6% in terms of average seat miles. It believed the headwinds in unit revenues to be systemic, and decided to wait it out, rather than cutting capacity. Despite all time high capacity growth, JetBlue continued to improve its occupancy rate, unlike most other airlines. The improvement in occupancy rate signifies the fact that the company didn’t have superfluous capacity in the system.

The fact that the company saw the decline in unit revenues subside, even with relatively higher capacity growth, showcases that the downward trend in unit revenues was indeed systemic. Going forward, the company has decided to follow the trend of relative moderation in capacity growth, which is still far more than its peers, at an average of 6.5% y-o-y growth.

Promoting Efficiency

JetBlue has successfully managed to keep a lid on its operating costs in the last few years. Although its costs were higher than peers in the period between 2011-2016, they were almost half in the last two years. This is likely attributable to the fact that JetBlue has managed to stay a low cost carrier. Its expenditure on wages has also grown organically, as it didn’t have to sign any new contracts with pilots. Furthermore, its sales and marketing expense, along with maintenance, has grown conservatively over the years.

The company has been able to cap its expenditure on heads other than fuel quite successfully in 2016. While Q1’16 saw a decline of -3.6% y-o-y in unit costs, Q2’16 was lower at -1.0% y-o-y. However, the third and fourth quarters were relatively higher, likely due to the impact of higher wages and maintenance expenses incurred during the quarters. However, the full year costs were in the guided range of the company. Going forward, the company expects its non-fuel costs to increase in a similar range due to the impact of higher wages and other expenses.

In terms of fuel costs, the company has succeeded in capping the full year fuel cost to $1.41 per gallon of consumption, almost 25% y-o-y lower.

Ancillary Revenues and Restyling

The company earns approximately 8% of its revenues in the form of ancillary fees and cargo fees. Ancillary revenue is revenue from non-ticket sources, such as baggage fees and on-board food and services. JetBlue earns approximately $25 per customer in the form of non-ticket revenues. The growth in ancillary revenues is expected to continue at a CAGR of 6% per annum through 2017.

The provision of amenities such as television at every seat has led to the immense popularity of JetBlue. To keep up the momentum, JetBlue has taken up the task of restyling its cabins in the A320 flights. Moreover, to reduce costs, it also plans to add 12 more seats to each of these planes. The understanding is that this will spread the unit costs over more seats, while increasing the capacity. Consequently, the airline expects $100 million incremental earnings, starting in 2017, from its cabin restyling program.

Have more questions about JetBlue Corporation (NYSE:JBLU)? See the links below:

• How Has JetBlue Performed In Comparison To Its Peers?
• How Will The Mint Program Contribute Towards JetBlue’s Long Term Growth?
• The Increasing Significance Of Ancillary Services In The Aviation Industry
• What Are The Initiatives Undertaken By JetBlue To Ensure Sustained Growth?
• JetBlue’s Operations In Boston And Its Struggle To Maintain Dominance
• Millennials And Their Increasing Contribution Toward Air Travel
• How Has The State Of Air Travel In The U.S. Changed Over The Years?

Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such lean communication sparks thinking, and encourages readers to comment and ask questions on the comment section, or email content@trefis.com

2) Figures mentioned are approximate values to help our readers remember the key concepts more intuitively. For precise figures, please refer to our complete analysis for JetBlue Corporation

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