JetBlue Airways Corporation
Business Model Diligence
Like most investors, I was pretty shocked to see the news late last week that Warren Buffett's Berkshire Hathaway (BRKB) had just taken a stake in not one, not two, but FOUR different airline stocks!
Why is this shocking, you ask? Well, look at these past quotes from the "Oracle of Omaha" regarding the airline industry:
"Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers. Indeed, if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down"
"The airline industry's demand for capital ever since that first flight has been insatiable. Investors have poured money into a bottomless pit, attracted by growth when they should have been repelled by it."
"the money that had been made since the dawn of aviation by all of this country's airline companies was zero. Absolutely zero"
"I now have an 800 number I call every time I think about buying a stock in an airline. I say, 'Iím Warren and I am an air-aholic.'"
Pretty strong words, right?
What made this doubly interesting is that our Deep Value Spell (subscriber link) is littered with airline stocks. As of 11/25, 6 of these were a part of this 50-stock screen that focuses on high earnings yields and free cash flow yields. Clearly, these stocks are cheap, on a quantitative basis, vs. the rest of the market.
In the spirit of Buffett's big buys, let's take a look at one of these airline stocks for our November Stock of the Month, shall we? With so many to choose from, I took the highest ranked one in the Deep Value Screen. Let's look at JetBlue (JBLU).
JetBlue's Business and Strategy
From a standing start 16 years ago, JetBlue has grown to be the 5th largest carrier in the US, with 900 daily flights to 93 total destinations in the USA, Caribbean, and a few Latin American countries.
JetBlue is the antithesis of another young, growing, and Deep Value carrier, Spirit Airlines (SAVE). While Spirit offers a bare bones, bottom dollar (and very low cost) experience, JetBlue focuses on providing a great customer experience for a cost comparable to one of the major carriers like United or American. JetBlue offers coach features such as best-in-class legroom, in-flight entertainment with DirecTV and SiriusXM, in-seat power connections, free WiFi, and more. Its focus on the experience has been well received. JetBlue has won the JD Power award for airline customer satisfaction for 12 years in a row - almost every year the company has operated! That's impressive, and engenders customer loyalty that its competitors can only dream about (and honestly, don't really try for outside of awards programs).
JetBlue has grown to be the #1 carrier in 3 major U.S. airports: New York's John F. Kennedy (JFK), Boston Logan, and Ft. Lauderdale. This East Coast focus exposes one of JetBlue's opportunities. Let's take a look at those next.
The company has a 3-pronged growth strategy.
1) Expand presence on the West Coast. As we've seen, JetBlue focused its early efforts on the East Coast of the USA. Now, the company is focusing on expanding on the West Coast. It already has a strong hold on Long Beach, but minimal presence at LA's numerous other airports. JetBlue attempted to expand in one big swoop with its failed bid for Virgin America, but organic expansion throughout LA is still management's intention. Similar to its original New York strategy, LA should grow into a base for the company to expand its offerings to West Coast destinations, as well as a springboard for future expansion internationally.
2) Gain share with business and luxury travelers. JetBlue has traditionally been an airline for less price-conscious vacationers or short-trip business travelers. With its move to longer coast-to-coast flights, JetBlue introduced its Mint service in 2013. Mint includes amenities like lie-flat seats, upgraded food menus, dedicated check-in and early boarding, and more. Mint flights have helped JetBlue increase revenue/mile over 20% on its trans-continental flights and represents a nice growth opportunity as the firm executes on its West Coast strategy.
3) International expansion. JetBlue today only has a handful of flights internationally, to the Caribbean and a few Latin American countries. However, the company is looking to build in this area. JetBlue is the first airline to open U.S. to Cuba flights, and is actively supporting a customs facility at Long Beach, which would allow it to begin international flights over the Pacific.
All-in-all, this is a nice set of growth priorities, and represent a top line opportunity in the high single, low double digits for many years. Combined with JetBlue's very strong balance sheet (particularly vs. its peers), that's more than you'll get from the big legacy carriers.
The Valuation Is An Opportunity, Too
Like all the airlines right now, JetBlue is quantitatively cheap. Its earnings yield (EY) is currently 14.6%, with a similar free cash flow yield (FCFY) of 14%, both numbers in the top 7% of the market.
But JetBlue's numbers are even more attractive compared to its peers. It is the highest ranking airline stock in the Deep Value Spell. Compare its valuation yields vs some of the competition:
To put the valuation opportunity alone into perspective, if JBLU was priced at a similar valuation to Spirit, we'd be looking at a stock price closer to $27 - a nearly 29% premium from the current quote around $21!
We're Still Not A Buyer
... of *any* airline stocks!
Look, all of the above is true of JetBlue, and honestly if you held a gun at us and told us we have to buy an airline stock, we'd tell you to put the gun down and then probably consider JetBlue as a first choice. As airline stocks go, the opportunity looks fairly good.
But it is the whole airline industry as a whole that is unattractive. Here is my list of concerns that would keep me up at night with any of these:
Competition. Airlines are a crowded space, with customers shown to value price and availability above all else. As such, price wars have been extremely common throughout history and I don't see any reason that it can't happen again.
Organized Labor. Almost all airlines have a unionized labor force, and JetBlue is no different after its pilots voted to unionize in 2014. Union strikes in this industry have a long history, and just last week pilots at Lufthansa went on strike. Think it won't happen to JetBlue? It is clearly a risk.
Fuel Costs are Volatile and Important. While JetBlue's current GAAP operating margins are over 20%, historically this has been more of a 7-8% operation... and even that is much better than the industry average. Fuel costs have been really low for the past 2 years, and that would have to continue for the stock to truly be cheap. If oil were to rise back into the $60's or even the $80's, JetBlue's profitability would be cut in half.
A Sordid Bankruptcy History. The roster of airlines who have gone to bankruptcy is long and distinguished: Continental, Pan American, Trans World, America West, United, Northwest, Delta, American... and both Frontier and US Airways went broke twice! You're not a real airline until you've gone bankrupt.
I didn't even mention volatile demand, heavy economic sensitivity, high capital expenditures... This is just a tough, tough business to succeed in long-term.
JetBlue looks like one of the nicest houses in a bad neighborhood. While by-the-numbers the stock looks cheap, and the company is one of the few airlines that customers will advocate and stay loyal to (even without a miles card), there are just too many industry risks for us to find any of these "Deep Value" airline stocks to be interesting investments.
But hey, Buffett likes them... so what do we know?
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