Description

JetBlue is compelling long investment with 33% upside to my base case target price of $25.  The stock is currently trading sub 8x on 2020 consensus of $2.39, which is below managements 2020 EPS guide of $2.50-3.00.  There is also a super bull case scenario where JBLU is put into play by either ALK, LUV or UAL which results in an all out bidding war.  In this case, I could see value up to $45 / share.  I see limited downside to $16 based upon JBLU’s net asset value. 

Industry Thoughts and Current Situation

I am not going to bore you with a bunch of bull about how the airline industry has changed and how Warren Buffet owns 10% stakes in a bunch of airlines.  Fact is, while a lot has changed, the industry still sucks.  So this isn’t a pitch about how you should buy airlines because its some oligopoly or because management teams have stopped going serially bankrupt.  The airline industry still trades at single digit PE’s for a very good reason.  I don’t see that changing and is not part of my thesis at all.  In fact, the space continues to de-rate vs. the broader market because airlines collectively refuse to exercise any semblance of capacity discipline.  Earnings ended up ok in 2019 because the absence of the MAX withheld a bunch of domestic capacity.  This is coming back eventually and its going to look ugly.  In the meantime, airlines are growing capacity far in excess of demand, and their unit costs are growing much faster than their unit revenues.  So this isn’t a good recipe for earnings growth and poses a serious risk to 2020 numbers depending on how the Max is brought back. 

My two cents on how airline stocks trade

Airline stocks generally trade on unit revenue momentum (RASM) and earnings revisions.  Typically when management teams can grow earnings and unit revenues, the stocks tend to re-rate higher.  Here are a couple examples:  Allegiant Airlines began 2019 with consensus EPS at $12 and its looking more like $14.50 now. The stock is up 74% YTD on a +21% EPS improvement.  On the other hand, American Airlines came into 2019 with consensus EPS at $5.75 and it looking to end up around $5.01.  Stock is down around 11% YTD reflecting this earning revision and carries the lowest PE multiple in the space at 5.4x 2020.

What’s the opportunity in JBLU?

Jetblue has a credibility problem and simply put nobody believes them anymore.  During 2019 they have missed quarterly RASM nearly every quarter (1^st, 3^rd and 4^th).  And there is a always an excuse… Easter shift between 1^st and 2^nd quarter, some jewish holiday fell on the wrong day of the week, bad weather in NYC, protests in Puerto Rico about the corrupt governor, hurricanes in Caribbean, tourists dying in Dominican, cheap walk up fares in Boston, etc. The list goes on and on.   I mean it looks bad – can’t sugar coat this at all.  They seem inept at looking at their own data and giving a 2-3 months guide on unit revenues which is kinda shocking.  Notwithstanding all the issues on RASM, 2019 EPS is going to end up marginally higher than were consensus was at beginning of the year.   The real damage here has been on the multiple and how far fetched the 2020 guide is. 

So back on October 2, 2018, JBLU hosted an investor day where they put out a 2020 EPS guide of $2.50-3.00.  Recall 2018 EPS was $1.55 so you have an idea for baseline EPS.

Here is the link to presentation:

http://blueir.investproductions.com/~/media/Files/J/Jetblue-IR-V2/reports-and-presentations/2018-investor-day-slides.pdf

I am not going to re-hash everything in the presentation, but I will call your attention to the various buckets of EPS:

+30-40c  from Network

+35-55c from Product Offering

+10-15c from Fleet

+30-40c from Cost

>7c from Capital Allocation

So Network and Product offering adds up 65-95 cents.  Now lot of this sounds more revenue related which immediately should be discounted given management’s credibility.  But when you dig into the network side, it is comprised of things like “focused growth” “network maturation” “network re-allocation” etc.  And we do know that JBLU has actually taken down their growth plans over the last several years.  So the tendency to empire build has not been a problem with them vs. others in industry.  On the product offering side, I am willing to give them a little more deference as their recently launched fare options 2.0 provides for a real basic economy ticket, which is a de facto fare increase.  So if I had to swag something reasonable, I would give them zero on network initiatives and the low end of 35c from products (customer segmentation).  So only 35c in credit out of the range of 65-95c.

The next, and most interesting piece to me is on the cost side.  Which adds up to 40-55c.  I think this is in the bag, and nearly all driven by the “Structural Cost Program” with a A320 cabin restyle as a runner up.  JBLU on their 2Q19 earnings presentation says that 2020 Savings of $257mm has been achieved of the stated range of $250-300million.  Specifically, Tech Ops savings of $100-125mm nearly fully achieved, with a key milestone noted, “Signed long-term V2500 engine agreement, covering just over 50% of existing A320 fleet”.  I think this is very big deal that is not being properly appreciated by the market.  To put some further context around how much JetBlue was being gouged for engine and heavy frame overhauls, simply look at the maintenance line on income statement divided by # of aircraft shells.  In 2018, this was around $2.5 million per plane for JBLU.  Doing similar back of envelope math for Alaska you get $1.3 million of maintenance / plane (but that includes regional shells so not apples to apples).  For Southwest its about $1.5 million / plane.  For Spirit Airlines its $1.1 million per plane.  Not sure Spirit number is comparable because some of the heavy stuff could be embedded in the lease payments and/or their average fleet age is 5 years while JBLU’s is double at 10 years.  I also don’t know if there are major differences between airlines in how they expense heavy/engine maintenance vs. capitalizing it so take this with a grain of salt.  My point is that JBLU has been paying too much and the CFO’s “Structural Cost Program” is his attempt to better align their maintenance costs to market. 

A minor negative on the cost side of the equation is the delays on getting the requisite number of 321neo’s from Airbus for 2020.  So, I would ding them for about 5c cents on this.  Putting this together, I think 50c from costs is doable. 

Finally, for the last three years or so, JBLU has repurchased about $380mm of stock per year.  At current stock price that is about 20mm shares, or about 7% outstanding.  Assuming run rate earnings of $2.50 /share, a 7% reduction in shares adds about 17 cents to EPS.  So keep numbers round, lets us 15c from buybacks.

Adding this all together, we get 35c from customer segmentation + 50c from costs + 15c from buybacks vs. a baseline of $1.55 EPS.  That translates to 2.55 in EPS.  Using Alaska’s 2020 PE multiple of 9.8x, get me a target price of $25.  Obviously I am not much higher than consensus of $2.39 so the majority of my return is coming from a multiple re-rating due to management hitting their $2.50-3.00 along with my cautious optimism for their ability to begin to lap their revenue stumbles with their own far option initiatives.  JBLU closed the year at $18.72, so that’s about +33% upside to my target. 

 My two cents on the Max

Disclaimer – I am neither an aircraft engineer nor do I claim to have any proprietary knowledge about the Max situation.  I do have some opinions that are informed by my experience as a commercially certificated airplane and helicopter pilot.  I am not type rated in the 737 or any turbine plane. 

·        The 737 Max is not a good plane vis-à-vis the Airbus Neo, especially when comparing the larger gauge versions (A321neo).  It is what I would call putting lipstick on a pig design.  Before the crashes, I think it was fair to say the Max was going to have like 40-45% of the narrow-body market while the Neo was going to get 55-60% share.  When the Max eventually comes back it will be a tainted aircraft and these pro forma market shares will prove to be too optimistic for Boeing

·        I don’t think either of the Max’s would have crashed had those planes been flown by US trained / qualified flight crews.  Sure a poorly designed MCAS contributed to the crashes, but well trained pilots will disconnect a computer that tries to kill him.  When I was checked out fly in a Cirrus SR22, a commonly trained malfunction is autopilot run-a-way trim – that’s when the autopilot tries to kill you.  The first thing you do is disconnect autopilot and take manual control.  If the auto pilot won’t disconnect you can then manually pull the electrical breakers.  Had these pilots disconnected MCAS and just flew a reasonable pitch / power setting, there would have been no crash. 

·        Just because the Max may need MCAS to pass certification doesn’t make it an unsafe plane.  A Cirrus SR22 needs a parachute because its can’t pass spin training without one.   I would personally not hesitate to fly as a passenger on Max with a well trained US flight crew. 

·        The Max has been grounded since 3/10/19 and I think it comes back into service late second quarter 2020.  That being said, further delays beyond this, or god forbid another crash shortly after re-certification, would pose an existential risk to Southwest Airlines.  Southwest Airlines has bet its entire future as an airline on a single fleet type from a single airplane manufacturer. 

 Super Bull Case on JBLU

Southwest is in a tough spot.  They are 100% beholden to Boeing for an aircraft type that is inferior to the competition.  This is an airline with an enviable track record of performance and a consumer brand that is well liked by customers.  Southwest has 752 737 type planes, an enterprise value of nearly $29 billion and $4.0bn of cash.  JBLU currently has a fleet of 254 planes (130 A320, 64 A321, and 60 E190s).  JBLU also has an orderbook for 84 A321neos and 70 A220s (previously known as the C-series).  And JBLU’s market cap currently stands at $5.4 billion.  To put this in perspective, the combined cash sitting on the balance sheets at Southwest and JBLU is nearly the current market cap of JBLU. 

If I was is Southwest’s position I would need to give serious thought to adding a 2^nd or even 3^rd fleet type.  Given how sold out the A320neo family is, and Airbus already facing its own delays in delivering what they have promised, there is no way for Southwest to call someone up and order a couple hundred Airbus.  The only options Southwest has to move the needle is to buy Spirit (136 airbus shells) or JBLU (194 airbus shells).  I think LUV buying SAVE is a tough sell for a couple reasons. Firstly, it eliminates a ULCC (Ultra Low Cost Carrier) that is a high growth disruptor – thus I don’t think it would pass the anti-trust smell test.  JBLU on the other hand is viewed as a more premium carrier relative to Southwest as it operates limited First Class on Mint planes, offers “even more” seat options, TVs in headrests, and carries a RASM premium.  Also, JBLU is East Coast heavy airline and Southwest has a limited presence in the Northeast markets (NY/BOS), so anti-trust issues more limited. 

Secondly, the seating configuration for Spirit (28” pitch) is not consistent with the Southwest model (31-32” pitch), so you would need to redo all the interiors which will take a fair amount of time and money.  On the other hand, JBLU’s restyled A320s will now have 32” pitch and the A321s have 32”/33” depending in the configuration.  So a lot less frictional cost to deal with aligning the equipment back to the Southwest model. 

Finally, a deal with JBLU adds a bunch of Northeast demand with lots of precious real estate across JFK, LGA and BOS.  Spirit isn’t a compelling real estate grab because it just gives you a bunch of Fort Lauderdale supply.  JBLU also gives Southwest the optionality of the A220 and even converting Neos to XLRs as the Boeing NMA seems dead in the water now. 

Personally, I think JBLU offers a compelling way for Southwest to de-risk itself from Boeing long term and thus should be considered.  The price tag isn’t crazy at which I will get into shortly.  One thing to keep in mind however, is that I think if JBLU were to be put into play, it would create an aggressive 3-way bidding way between Alaska, United Airlines and Southwest.  JBLU is the only viable deal that transforms Alaska into a truly national stage competitor against Southwest and the US big 3 (UAL, AAL, and DAL).  It would also further provide Alaska serious Airbus scale to completely de-risk itself from Boeing.  I think United would also try to get in on the bidding because Kirby is irate that UAL gave up their JFK slots/gates.  Kirby thinks this was pure folly.  If you can somehow convince regulators that EWR isn’t part of the NYC (JFK/LGA), then he may have a chance.  I don’t buy this argument as I see EWR as part of the NYC airport environment as UAL dominates EWR.  Delta would obviously strenuously object to UAL buying JBLU.

As we saw with the Virgin America asset that traded north of 15x earnings, sky is the limit when airline M&A turns into a competition.  If you assume $2.50 of core JBLU earnings and another 0.50c to $1 in synergies – call it $3 EPS at 15x gets you to $45.  Seems like crazy talk, but VA IPO’d at $23 and less than 18 months later was taken out at $57. 

What’s my downside on JBLU?

So let’s say JBLU management comes out later this month and walks away from $2.50-3.00 – what’s the downside on the stock?  I think its $16 / share.  Here is a simple net asset value on JBLU.  Take the value of the existing fleet:

130 A320s, 13yr avg. age – figure worth $20mm each = $2,600mm

64 A310, 3 yr avg. age – figure worth $50mm each = $3,200mm

60 E190, 11yr avg. age – figure worth $10mm each = $600mm

Total fleet value = $6,400mm

+ Cash = $994mm

+ Prepaid deposits on order book = $440 million

- Debt (financial + leases) = $2,508

Total NAV  = $5,326

Shares outstanding = 289mm shares out

NAV / share = $18.43

If you exclude the cash, the aircraft only NAV is right around $15. 

Yes, JBLU is currently trading right around NAV now. And this simple calculation doesn’t include any value for all the gates / slots JBLU has in capacity constrained airports like JFK/ LGA.  For example, JBLU’s Terminal 5 at JFK is a crown jewel type asset.  JBLU has 30 gates at JFK with something like 175 daily departures.  This asset alone if arguably worth $1 billion all by itself.  I didn’t bother to include any of this in the NAV because I don’t want to make up numbers.  I see the NAV exercise as defining my downside vs. helping me dream about the upside in JBLU stock. 

If you look back over past 5 years, JBLU stock has tested $16 many times and has held there.  Happened in early 2015.  Then a couple times in summer of 2016.  Then again in fall of 2018, then December 2018.  Then twice in 2019 on the RASM wiffs.   Also as far as airlines go, JBLU carries very modest financial leverage – about 1.0x net debt to EBITDA.  

Catalyst

1.      4q earnings along with a formal update to 2020 guidance later this month

2.      Further delays in the Max re-certification prompting Southwest to consider M&A

3.      Positive earnings revisions to 2020 consensus