Saturday, September 25, 2010

' Bluer Skies Ahead

JetBlue shares have been flying low, despite the airline industry's gains this year. That will change as more investors notice the carrier's unappreciated virtues.

JETBLUE AIRWAYS became one of its industry's biggest success stories a decade ago by offering domestic leisure fliers cheap fares, new planes and amenities such as leather seats, ample legroom, individual TVs and satellite radio.

Like upstarts elsewhere, New York-based JetBlue (ticker: JBLU) expanded too rapidly, took on too much debt and was battered by competition and the 2008-2009 travel recession. In the five years through 2009, it had a cumulative loss. Its shares, which peaked at 31 in 2003, now trade below 6 and are largely ignored by Wall Street.

The carrier has lured travelers by offering leather seats, more legroom, individual TVs and satellite radio.

But the airline is winning back some investors, who have noticed its rising profits, moderating expansion strategy, growing appeal to business travelers and widening alliances with foreign airlines, stemming from its dominant positions at two international gateways, Boston's Logan airport and New York's JFK. JetBlue also has a sizable presence in Florida and California.

JetBlue has the U.S. industry's youngest planes, with an average age of four years, a relatively low cost structure, a strong reputation for service and motivated non-union workers (despite the well-publicized incident this summer involving a disgruntled flight attendant, who quit, grabbed a beer and then slid down an emergency slide).

"THE COMPANY IS IN THE MIDST of a profits turnaround," says Michael Linenberg, Deutsche Bank's airline analyst. JetBlue is expected to earn about 45 cents a share this year, 60 cents in 2011 and possibly close to $1 in 2012. Linenberg carries a price target of 8, while a more bullish Glenn Engel of Bank of America/Merrill Lynch sees the stock doubling to $12. Tangible book value is almost $4.50 a share. JetBlue's market value is $2 billion.

In a client note, Engel wrote that JetBlue's profits could be powered by "growing international feeder traffic, increased market share in Boston and competitive retreats by legacy carriers in Latin America." JetBlue has partnerships with such airlines as El Al and Aer Lingus, as well as a strong link with Germany's Lufthansa, its largest shareholder. It even has a marketing agreement with rival American Airlines, a unit of AMR (AMR).

JetBlue executives couldn't be reached for comment.

The carrier's recent shift to the mainstream Sabre reservation system will make it easier to attract business travelers, many of whom like its comfortable Airbus A320 jets. JetBlue's coach seats have 34 inches between rows, versus 31 to 32 inches on most big carriers. Fliers can get "Even More Legroom" seats, 38 inches apart, for as little as $10 above the average one-way fare, now a reasonable $139. However, JetBlue is unlikely to become a business favorite because of its limited roster of U.S. destinations, relatively few flights on some popular routes and focus on JFK, which is poison for many business travelers. They prefer New York's La Guardia, which is closer to Manhattan.

JetBlue shares haven't gained much altitude this year, compared with those of some bigger rivals, but that's likely to change.

Linenberg says that JetBlue's stock has been overshadowed by airlines "more leveraged to the global economic recovery." It's up 4% in 2010, while UAL (UAUA), United Airlines's parent, is up 73% and US Airways (LCC) has soared 82%. UAL is to merge around Oct. 1 with Continental Airlines (CAL), which has risen 31% this year.

Linenberg adds that the factors that hurt major carriers during the downturn, notably exposure to business fliers and international routes, are helping them as corporate travel picks up and as overseas travelers again fill planes' lucrative business-class sections. JetBlue, in contrast, still depends heavily on leisure travelers, and its route system is entirely domestic, save for some Caribbean and Latin American destinations.

JetBlue has a higher price/earnings ratio than Delta (DAL), USAir and UAL, based on projected 2011 profits. JetBlue trades for 10 times projected 2011 profits, against a P/E around four for many majors. The big U.S. carriers have more financial and operational leverage than JetBlue and thus attract more hot-money investors.

The Bottom Line
JetBlue shares have trailed those of some rivals this year. But bulls on the stock see it rising at least 33% in a year.

Domestic airline capacity fell about 10% from 2008 through this year, as carriers retired older planes and redeployed others to more profitable overseas routes. This will benefit JetBlue, which can fill that void with its expanding fleet, now 153 planes. For an airline, JetBlue has a good balance sheet, but it's still leveraged with more than $1 billion of cash against $3 billion of debt. It has committed to spend $4.5 billion through 2018 on 113 new aircraft, although it wants to fund capital expenditures with retained profits, rather than borrowings.

"If there has been a core change in the domestic airline industry where capacity is significantly reduced and the pricing structure has improved, this is one of the best ways to play it, and for a long time," says Ross Margolies, head of Stelliam Capital, a New York investment firm and JetBlue holder. In fact, JetBlue may be that rare airline that maintains altitude for years to come.

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