jblu equity research
TRANSCRIPT
JetBlue Airways Corporation (JBLU)
NASDAQ | Industrial | Airlines
BUY Price Target $27.00 | Price $16.25
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Historical Price (1/27/15, TTM)
2017E 2018E 2019E
EPS $3.60 $3.96 $4.22
Payout Ratio 5.46% 6.01% 6.39%
Dividend $0.20 $0.24 $0.27
Cash Paid 57 69 79
Yields (%) 0.85% 0.91% 0.91%
Dividend Scenario
Flying High with JetBlue
JBLU shares are currently underpriced compared to its market peers on a P/E,
P/B, EV/SALES, and EV/EBITDA basis. Our fundamental analyses confirm that the
company is undervalued. We issue a BUY recommendation on JBLU with a price
target of $27 per share, which represents a 66% upside from the closing price on
Jan 27, 2015. We base our recommendation on the following catalysts:
Change in Leadership: In February 2015, the current CEO David Barger will be replaced by the current president Robin Hayes. Historically, Barger has served a customer friendly approach to business, as opposed to one focused on JBLU’s investors. Robin Hayes has demonstrated his investor oriented management by leading JBLU’s implementation of changes that will provide greaster returns for its investors. These changes include a new fare system and cabin restructuring. In a recent press release, Hayes made the following statement: “The airline industry has never been more competitive, but I believe we can continue to grow profitably. As we maintain our operational focus on safety and efficiency, we will continue to expand our network in underserved markets and roll out new products that enhance the JetBlue Experience and create value for our shareholders…”
Latin American Dominance: JBLU generates 20.2% of its revenues from LatAm,
representing an important part of its business model moving forward. JBLU
continues to offer new routes in addition to deploying greater capacity to the
region. With a 25% CAGR in LatAm operations over the past 6 years, this strategy
has continued to be an internal form of growth for JBLU. As U.S. relations with
Cuba improve and lucrative opportunities exist in Brazil and Mexico, we believe
that JBLU further capitalize on LatAm growth.
Low Oil Prices: Jet fuel generally accounts for 30-35% of JBLU’s operating
expenses. In recent months, the price of oil plummeted due to excess supply,
primarily because of increased global oil production. Meanwhile, emerging
markets have experienced lagging demand growth for oil as well. Current oil
prices are trading at less than 50% of their June 2014 value. As the price of oil
continues to remain low we are confident that JBLU will improve its margins.
Strong Future Free Cash Flow: As industry experts agree that low oil prices are
likely to continue in the foreseeable future, we expect that JBLU’s short-term
margins will increase. JBLU is deferring aircraft acquisitions scheduled from
2016-2018 and 2022-2023, saving $900 million of CAPEX during our projected
period. Furthermore, the new fare system will generate greater future cash flow
as well.
Rewarding Shareholders: With a forecasted cash balance of $1bn in 2016, JBLU
will have the ability to accelerate its share repurchase plan or declare a dividend
payout. Based on our valuation of JBLU, we believe the company is undervalued
and will repurchase more shares to return value to shareholders. Additionally,
JBLU may face pressure from institutional shareholders to pay dividends as cash
flow increases.
PT
66% Upside
JBLU
VA
LUV
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WJA ALK
JBLU
LUV
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JBLU | Price Target $27.00 Jan 27, 2015
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2012 2013 2014E
Figure 1. Historical Revenue Structure
Passenger Baggage fee Other
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Figure 3. Change in Fleet Structure
A320 A321 E190
Business Description
Revenue
JBLU generates a majority of its revenue from transporting passengers. In 2013,
91.4% of revenue came from airfare, 1.4% from baggage fees and 7.3% from
other sources such as reservation change fees and transportation of cargo.
Through an innovative business model and successful expansion of destination
cities and routes, JBLU’s revenue has exhibited an astonishing CAGR of 18% over
the past decade.
Blue Cities JBLU’s focus cities include JFK, BOS, FLL and MCO. Currently, JBLU has 36.5% of
JFK’s market share and is displaying greater emphasis on international route
expansion from this hub. JBLU has exhibited expansion by opening its T5i
terminal, which is designed to facilitate international departures and arrivals at
JFK. In 2013, JBLU transported nearly 4 million passengers at BOS and continued
to successfully utilize FLL as a strategic hub for expansion into LatAm. JBLU has a
market share of 14.1% at MCO and is currently expanding into other airports
such as DCA, where its flights doubled from 2011-2013. JBLU has rapidly
increased the number of destination cities it offers while increasing revenues
and profitability (Appendix 5-8). While the company only offered 21 destinations
in 2003, today, the company provides 57 destinations in the U.S. and 30
destinations in LatAm. JBLU has experienced a CAGR of 32.8% in LatAm from
2007-2013.
JBLU Experience
According to J.D. Power and Associate’s 2014 surveys, JBLU was ranked first in
customer satisfaction rating for Low Cost Carriers (LCC) and Low Cost Airline
Segments. Customers were especially satisfied with JBLU’s check-in, in-flight,
and flight crew service experience. JBLU customers enjoy 36 channels of free
satellite TV as well as the industry’s fastest inflight Wi-Fi product, Fly-Fi, on
selected flights. The airline is well known for providing an industry leading seat
pitch of 34.7 inches and has unique customer centric policies such as the
Customer Bill of Rights and the no overbooking policy.
Fleet Structure JBLU is currently operating 130 A320s, 13 A321s and 60 E190s. In 2013, JBLU
cancelled an order of 12 E190s and deferred the delivery of 24 E190s scheduled
from 2014-2018 to 2020-2022. JBLU is choosing to replenish its fleet with A321s,
which have better fuelefficiency and greater seat capacity. The new aircraft
delivery plan signals that JBLU is focusing on improving efficiency and capacity
to satisfy its growing customer demand.
Shareholder Structure
JBLU boasts a strong institutional holding of 71.26%. This high level of institutional ownership can be viewed as a sign of confidence from the overall market. JBLU’s remaining outstanding shares are held by the board of directors and other minority stakeholders at 1.46% and 27.28%, respectively (Appendix 27).
Source: Team Estimate
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Figure 4. Industrial vs. GDP Growth
Airline Industry GDP
Source: Trading Economics
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FIgure 2. Historical # of Departures
Domestic International (right)
Source: Team Estimate
Source: JBLU
JBLU | Price Target $27.00 Jan 27, 2015
Industry Overview & Competitive Positioning
U.S. Economy and Airline Industry Overview
A key indicator of success in the airline industry is economic strength. Supported
by a 5.6% unemployment rate, the U.S. has exhibited strong GDP in Q3 and Q4
with 4.2% and 5% annualized growth, respectively. The World Bank expects that
U.S. GDP will grow roughly 3.2-3.6% in 2015, which will result in increased
discretionary income for Americans, benefiting the airline industry. Due to
strength in the economy, we expect GDP growth. However, we remain cognizant
that substantial decreases in oil prices could temporarily disrupt GDP growth
moving into 2015.
Another key indicator of airline industry success is the Consumer Confidence
Index. In 2008 the CCI reached a record low of 25.3. As of the end of 2014, CCI
increased to 92.6, its highest level since January 2007. In the U.S. airline industry,
we discovered a strong -20% correlation between increases in the CCI and
increased travel demand. With the U.S. appearing to have a strong economic
outlook, we expect consumer sentiment to show an uptick, leading to increased
levels of travel.
Recently, airfare has increased in proportion with the Consumer Price Index.
From 2000- 2014, the CPI increased 40% while market fares only increased 16%.
Airfare was maintained between $300 and $360 before 2008 and plummeted
during the financial crisis. Since the crisis, fares have quickly regained their
previous highs and are now increasing in direct correlation with increases in the
CPI. We expect airfare to continuously rise in correlation with the CPI because of
the high load factor that the industry is experiencing. With 1.6% and 2% growth
in the CPI expected for 2015 and 2016 respectively, we expect the airline
industry to increase airfare, margins, and profitability.
Latin America
LatAm provides opportunities for growth and profit. As the number of U.S.
travelers to LatAm has increased, the number of destinations and routes offered
to this area have increased as well (Appendix 24). According to the International
Air Transportation Association, airline industry profits grew 250% in LatAm for
2014 in comparison with a year earlier, and are poised to grow 43% in 2015. We
believe strong economic conditions in the U.S. will increase the number of
travelers to LatAm in the near future. JBLU is dominant in LatAm compared to
other U.S. LCCs and we expect the company to benefit from increased travel.
Oil Price Outlook The WTI crude oil price plunged to $46.23 per barrel as of Jan 27, 2015 from
$106.91 per barrel on June 13, 2014. Jet fuel prices have followed an almost
identical trajectory. Since fuel expenses represent the largest expense account
for the airline industry, the price decrease has helped to improve JBLU’s profit
margin significantly. In line with industry experts, we expect jet fuel costs for
airlines to remain low. According to the International Monetary Fund, the
forecasted average WTI crude oil price will be $56.70 in 2015 and $63.90 per
barrel in 2016. The IMF’s oil price outlook is conservative and we have applied it
to our projection model.
Source: DOT, World Bank
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Figure 5. Fare vs. CPI
Fare CPI
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Figure 7. Historical Prices of WTI and Jet Fuel
WTI Jet Fuel (Right)
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Figure 6. Fare vs. S&D Gap
Fare S&D Gap (right)
Source: DOT, EIA, OPEC
Source: EIA
JBLU | Price Target $27.00 Jan 27, 2015
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Figure 9. Profit Margin
Strong Presence in Northeast America and Latin America
JBLU has the greatest presence of any U.S. LCC in LatAm allowing it to capitalize
on rapid growth. The number of U.S. travelers to Mexico, the Caribbean, and
Central America showed 12.4%, 9.9%, and 9.2% growth, respectively from 2013-
2014. During the same period, U.S. travel to the rest of the world had
approximately a 2% growth rate. In 2008, LatAm destinations only included
Puerto Rico and since then JBLU has rapidly expanded to offer 30 destinations
reaching as low as Lima, Peru. JBLU will continue to expand to LatAm by
launching 3-5 new routes in 2015. Expansion into LatAm will be critical as the
number of U.S. travelers visiting this part of the world is expected to grow.
Pricing Power
Research shows that JBLU has strong pricing power. While JBLU is considered to
be a LCC, for many routes, JBLU’s fares are higher than those of legacy airlines
such as DAL and UAL. For example, on the BOS-MCO route, JBLU’s weighted
average fare price is 23.5% more expensive than fares offered by DAL. As JBLU
maintains a high load factor on these routes along with higher fares, it
demonstrates that customers are willing to pay higher prices for its superior
customer experience (Appendix 26).
Entertainment Service
According to the Airline Passenger Experience Association (APEX), more than 47%
of passengers spend their time in-flight using the airline’s entertainment options
or personal devices. JBLU’s products, including its Wi-Fi and television channels,
are considered to be industry leading and make JBLU a very attractive option for
customers. JBLU will complete Fly-Fi installation on its entire A320/A321 fleet in
the first half of 2015 and will begin installing this service on the E190 fleet
thereafter. Fly-Fi has a 43% take rate which is substantially higher than
competitors such as Go-go and Row44. DIRECTV, JBLU’s inflight TV system
provides 36 channels of live TV. We believe that industry leading in-flight Wi-Fi
speeds along with DIRECTV’s channels will attract more business travelers who
need to stay connected 24/7, as well as young passengers who value JBLU’s
technological capabilities.
Airline Partners – Codeshare and Interline Agreement
Codeshare and interline agreements with larger airlines that operate
internationally benefit JBLU. Through codeshare and interline, JBLU provides
more destinations to its customers and carries the passengers of its larger
partners. JBLU has 38 agreements as of December, 2014. Compared to other
LCCs in the U.S., JBLU has the largest number of airline partners, and only trails
their Canadian rival WestJet by one partner.
Strategies
Sky High Profit Margin
As of the end of 2014, JBLU is the only airline aside from LUV to refrain from
charging fees for its customer’s first checked bag. In 2013, JBLU earned $74
million in revenue from checked bag fees, accounting for only 1.4% of total
Figure 8. Fly-Fi vs. Others
Source: JBLU
Table 1. LatAm Destinations
JBLU LUV SAVE VA Frontier SCA
30 12 26 0 10 16
Source: Company Websites
Table 2. Codeshare and Interline Agreement
JBLU VA WJA LUV SAVE
C/S 10 3 11 0 0
I/L 28 25 29 0 0
Total 38 28 40 0 0
Source: Company Data
Source: Team Estimate
JBLU | Price Target $27.00 Jan 27, 2015
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2009 2010 2011 2012 2013 2014Oct
Figure 12. Brazilian Airline Market
TAM GOL AZUL
revenues. This is considerably lower than checked bag fee revenue of other
airlines. During its 2014 Investor Day, JBLU announced that it will introduce a
new fare system during the first half of 2015 and that the lowest fare will not
include free checked bags. The change in JBLU’s fare system is expected to
increase revenues by $175mm in 2015 and $508mm in 2016, without adding
additional costs (Appendix 11).
Seating the Fleet
During its November 2014 Investor Day, JBLU announced a seat expansion plan
for its A320 aircrafts that will take place in 3Q16. JBLU plans to retrofit A320
aircrafts with refreshed cabins, adding 15 more seats to each plane by decreasing
the average seat pitch. The average seat pitch will be decreased from 34.7 to
33.1 inches, but according to management, JBLU will be able to maintain a high
level of customer satisfaction by replacing the old seats with new seats. Despite
reducing the average seat pitch, JBLU will still maintain its industry leading
position. The change will require additional flight attendants to be onboard, but
the 10% increase in passenger capacity will be more than substantial enough to
compensate for additional expenses. JBLU will utilize the increased number of
seats to further improve its revenues while adhering to its core competencies
surrounding customer satisfaction.
Minting Success
In June 2014, JBLU introduced a new service, Mint on JFK-SFO and JFK-LAX routes.
Mint is a premium service targeted at business flyers that offers the longest lie-
flat bed in domestic business class, as well as the only private suites on these
transcontinental routes. Mint also includes other luxurious amenities such as the
highest level of comfort, the fastest Wi-Fi, and upgraded entertainment systems
on larger screens. According to management, during 2014, Mint significantly
improved transcontinental margins and the company was able to turn losses into
profits on both routes. Mint services are offered at an approximate 35% discount
in comparison to DAL, who provides the industries next best cost alternative. As
Mint services mature, we are confident that JBLU will gradually raise prices and
increase its profit margin. JBLU will increase the number of premium service
routes as the company acquires 63 A321 aircrafts through 2019.
Latin America: Partnership and Growth
Brazil is the largest country in LatAm accounting for more than 30% of the total
population. We expect the number of travelers from Brazil to the U.S. to grow as
the Brazilian economy further develops. Securing Brazilian travelers would
benefit JBLU significantly and we believe LatAm expansion will occur through the
Brazilian based company, Azul Airlines. Although JBLU is currently in an interline
agreement with TAM, Brazil’s market share leader, we believe that a partnership
with Azul Airlines will benefit the company, given its rapidly growing market
share in Brazil. Azul recently introduced its first international routes, all of which
fly to JBLU hubs. In a recent press release, former JBLU CEO and current Azul CEO
David Neeleman discussed a potential partnership with JBLU.
With diplomatic relations rapidly improving between the U.S. and Cuba, JBLU will
likely have the opportunity to expand in the country. Currently, JBLU is one of
Figure 11. Mint Premium Service
Figure 10. Seat Pitch
36% 20%
Source: Brazil’s ANAC, Bloomberg
Source: JBLU
Source: JBLU
JBLU | Price Target $27.00 Jan 27, 2015
few companies flying to Cuba from the U.S., strategically positioning itself well
against other airlines. Opportunities for increased revenues exist, especially due
to the high population of Cuban Americans in the Miami-Fort Lauderdale area
where JBLU has established a strong presence. However, ambiguity exists
surrounding the benefits at this point in time.
Mexico provides growth opportunities for JBLU. With increased Mexican
travelers entering the U.S., JBLU will likely attempt to capitalize on growth
opportunities by adding beyond the proposed Mexico City route. Over the past
two years, the number of travelers from the U.S. to Mexico has demonstrated
7.6% and 11.8% growth, respectively. From 2013 to 2014, the number of
Mexican travelers to the U.S. increased by 20% (Appendix 23).
Investment Summary
JBLU shares are currently underpriced compared to its market peers on a P/E,
P/B, EV/SALES, and EV/EBITDA basis. Our fundamental analyses confirm that the
company is undervalued. We issue a BUY recommendation on JBLU with a price
target of $27 per share, which represents a 66% upside from the closing price on
Jan 27, 2015. We base our recommendation on the following catalysts:
New Management on the Runway
The replacement of the current CEO, David Barger, with Robin Hayes creates
many opportunities for investors. Since the announcement of the CEO change in
September 2014, JBLU has worked to satisfy its investors by making decisions
that will increase efficiency and profitability. These decisions include the
implementation of baggage fees through a new fare system, planned reduction
of future CAPEX, and decreases in seat pitch. Additionally, Robin Hayes recently
said JBLU will expand its target market to include business travelers in addition
to its leisure fliers. The company will be implementing a Sabre owned software
called Prism, which will help JBLU monitor market share and prices when
negotiating corporate deals to generate new business. Hayes believes that
access to this information will be key in staying competitive in the small to
midsize company corporate market.
Propelling Efficiency
JBLU has been plagued by steep increases in its maintenance expenses since
2011, primarily due to unexpected engine overhauls of E-190s. As a result, JBLU
is promoting higher efficiency by amending its fleet acquisition plan. JBLU
cancelled 12 orders of E-190s while deferring the delivery of 24 E-190s which
were scheduled to be delivered from 2014-2018 and 2020-2022. After
unpleasant experiences with its E-190s, JBLU is in talks with the manufacturer to
replace 24 of these aircrafts with E-190-E2s. JBLU is also striving to improve its
Airbus fleet efficiency. In 2013, the company converted eight A320 orders to
A321s and 10 A320neo orders to A321neos. JBLU ordered an additional 15 A321s
for delivery between 2015 and 2017 and 20 A321neo from 2018-2020. A321s
have high levels of fuel efficiency, which will benefit JBLU when oil prices rise in
the long term.
Figure 14. Fuel Efficiency Comparison
Figure 13. Cuban Demographics in U.S.
67.96%8.63%
4.96% 18.44%
FL NY-NJ CA Others
Source: 2010 Census
Source: JBLU
JBLU | Price Target $27.00 Jan 27, 2015
Large Free Cash Flow - Accelerated Share Repurchases or Dividend Payouts
We are confident that JBLU’s free cash flow will significantly increase over the
next five years. New products, services, and changes will contribute to improving
JBLU’s top line while minimally affecting expense accounts. Additionally,
deferred capital expenditures will increase its free cash flow by $900mm during
this period. The oil market outlook is favorable for JBLU and will further
contribute to a strong bottom line.
We estimate JBLU’s cash balance to be $1bn in 2016 inclining Robin Hayes to
accelerate the companies share buyback program. In Appendix 20, we projected
how costly a repurchase scenario would be, followed by a forecasted increase in
EPS. By 2019, JBLU can boost its EPS by 10% if it doubles its current 25mm share
buyback program. Based on our valuation of JBLU, we believe the company is
undervalued and will repurchase more shares to return value to shareholders. In
line with its competitors, JBLU may initiate a dividend payout. WJA and ALK
started paying dividends when their cash and short term investment balances
reached $1bn. Since we project JBLU to experience similar financial flexibility in
2016, the company will experience pressure from institutional shareholders to
pay dividends in 2017.
Valuation
I. DCF Valuation
We used a Discounted Cash Flow (DCF) valuation to derive the intrinsic value per
share of JBLU to be $27. We believe that the DCF method is suitable for valuing
JBLU due to the changes that the company is implementing. These changes will
create a substantial increase in JBLU’s future free cash flow when compared to
its historical free cash flow.
Passenger Revenue (Price × Quantity)
We multiplied the projected average fare (P) by the estimated number of
passengers (Q) to forecast JBLU’s passenger revenue from 2014-2019 based on
the following assumptions:
Departure (’14-’15): We incorporated new routes launched in 2014 and assumed that routes from the year 2013 will continue to operate. We then assumed that routes from 2013 and 2014 will continue to operate in 2015.
Departure (‘16-’19): We analyzed the historical number of departures of each aircraft, and we assumed that JBLU would maintain its 2015 rate from 2016-2019. We then multiplied the number of operating aircrafts, including the planned delivery of new aircrafts, to estimate the number of departures for this period.
Passenger per flight: We assumed that the number of passengers per flight would increase in correlation with an increase in weighted average seat capacity. Multiplying the estimated passengers per flight by the number of projected departures each year resulted in the number of revenue passengers.
Average fare: We assumed that the average fare price would increase in correlation with the expected increase in CPI. Please see Appendix 10 for
further details and explanation.
$3.28 $3.52 $3.85 $3.38 $3.78
$4.29
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Figure 15. Share Repurchase Scenario
No repurchase 25mm shares
Source: Team Estimate
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Figure 17. Fare and Passenger Forecast
Passenger (in millions)
Average Fare
Source: Team Estimate
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Figure 16. Dividend Scenario
Dividend Yields (%)
Source: Team Estimate
JBLU | Price Target $27.00 Jan 27, 2015
Baggage Revenue There is no detailed information regarding prices of the new fare system to be implemented during the first half of 2015. We assumed that the new fare system will reflect the difference in baggage revenue because the greatest difference in the new fare system will be the number of free checked-in bags provided to each class. We projected baggage revenue based on the following assumptions:
Baggage fee per unit: We assumed the industry low checked baggage fees that ALK charges its customers, $25, will be JBLU’s fee per checked bag.
Number of passengers with bags: During the 2014 Investor Day,
management stated that 50% of its customers travel without bags. Based on
this statement, we assumed that 50% of JBLU’s passengers fly with at least
one bag. As a result of our analysis on baggage fees and the number of JBLU
passengers over the past three years, we found that 5% of JBLU passengers
check in two bags.
Baggage revenue projection: Based on our findings, we forecasted a charge
of $25 to 50% of the projected number of passengers, and then included an
extra charge of $25 to the 5% of customers who will be checking a second
bag.
Please see Appendix 11 for further details and explanation.
Fuel Cost
Fuel consumption: We discovered a consistent relationship between fuel
consumption and ASM, especially over the past three years. We assumed
that JBLU will maintain this ratio, and continue to adjust its fuel
consumption in proportion to changes in ASM.
Fuel price: Historically, jet fuel prices have been adjusted in correlation with changes in WTI crude oil prices. We adjusted JBLU’s estimated average fuel cost per gallon based on our projection of crude oil prices from 2015-2019. For the unit price in 2014, we used the weighted average of 1-3Q actual and 4-Q forecast data provided by JBLU.
Please see Appendix 12 for further details and explanation.
Capital Expenditure JBLU’s 2013 annual report provides estimated capital expenditures from 2014-
2018 and years thereafter. We used the airline’s estimate in computing free cash
flow. However, JBLU announced deferred delivery of 18 aircrafts scheduled from
2016-2018 and estimates to save $900mm of CAPEX over this period. We
deducted the airline’s original estimates by $300mm annually from 2016-2018.
Weighted Average Cost of Capital (WACC)
Weighted Average Cost of Capital (WACC) Cost of Debt While the cost of capital leases are not separately stated on JBLU’s financial
statements, the airline still incurred implied interest expenses from leasing
aircrafts. Therefore, in addition to outstanding bonds, capital leases should be
accounted for when calculating the cost of debt. JBLU’s most recent 10-Q stated
that the weighted average interest rate of its long-term debt and capital lease
obligations is 4.8%. We used this rate as the cost of debt.
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Figure 21. CAPEX Forecast (in millions)
Source: JBLU
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Figure 19. Fuel Consumption& Price per Gallon
Fuel consumption
Price per gallon (right)
Source: Team Estimate
$3,000
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2013 2014E 2015E 2016E 2017E
Figure 18. Revenue Forecast (in millions)
Passenger Baggage fee Other
Source: Team Estimate
JBLU | Price Target $27.00 Jan 27, 2015
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Figure 21. EPS Forecast
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Figure 22. Residual Income Forecast
Cost of Equity Risk-free rate. We used the average 10-year U.S. Treasury bond rate in
2014 (2.17%) as our risk-free rate.
Beta. We unlevered the betas of seven competitors and computed the weighted average of the unlevered betas on their market capitalization, which resulted in an average of 1.07. We re-levered the unlevered beta based on JBLU’s capital structure provided by its most recent 10-Q. We used a beta of 1.41 for our WACC calculation.
Market premium. We used the U.S. market risk premium in 2014, (5.78%) as estimated by Professor Aswath Damodaran of New York University.
Terminal Value We used the Gordon Growth method to determine the terminal value. We assumed JBLU’s free cash flow would increase 1.82%, based on the OCED’s U.S. GDP growth forecast rate from 2020-2060.
II. Residual Income Valuation The Residual Income Model (RIM) focuses on residual earnings attributable to shareholders. This model is suitable for JBLU because we anticipate substantial increases in earnings, which can be attributed to a more lucrative business model and significant reductions in jet fuel expenses.
EPS We estimate 2014 EPS to be $0.64 per share (Appendix 16), excluding the sale of LiveTV in March 2014. We are bullish on the airline’s EPS estimate from 2015-2016 as JBLU will benefit from lower oil prices and its planned operational changes. Residual Income We projected residual income by subtracting the required return on book value from the estimated earnings per share. JBLU should generate a minimum return equivalent to the cost of equity with the given book value of equity. Any earnings exceeding the required level of 10.32% will be regarded as residual income paid to shareholders. We expect JBLU’s residual income to rapidly increase in 2015 and 2016 because of a favorable business environment. After 2019, we assumed that residual income would increase at 1.82% in perpetuity (Appendix 16).
Table 3. WACC
WACC
Risk-free rate 2.17%
Beta 1.41
Market risk premium 5.78%
Cost of Equity 10.32%
Cost of debt 4.80%
Tax rate 35%
Cost of debt, after tax
3.12%
Weight of equity 67%
Weight of debt 33%
WACC 7.93%
Source: Team Estimate
Source: Team Estimate
Source: Team Estimate
Source: Team Estimate
JBLU | Price Target $27.00 Jan 27, 2015
$0 $10 $20 $30 $40
EV/Sales
EV/EBITDA
P/B
P/E
Figure 23. Comparable Analysis
25th Percentile 75th Percentile
III. Comparable Company Analysis Comparable companies were chosen from the NYSE Arca Airline Index based on similar market capitalization and business models. Insufficient financial information was available regarding private LCCs. We used TTM data as of January 27, 2015 to derive the following multiples.
Company P/B P/E EV/S EV/EBITDA
JBLU 1.99 15.19 1.11 8.24
Peer Median 4.31 15.77 1.63 9.35
ALK 4.31 15.77 1.63 7.03
SAVE 6.07 27.20 2.74 13.61
LUV 4.58 27.98 1.65 9.35
WJA 2.31 15.26 0.96 5.74
VA 3.65 14.52 1.03 12.60
ALGT 9.45 33.41 3.16 13.81
RJET 1.18 10.22 2.04 7.00
The above table suggests that JBLU is undervalued compared to the median
multiples of its comparable airlines. Our comparable company analysis confirms
that JBLU is valued in the range of $20-$30. Our DCF valuation of $27 per share
falls within the median range of P/B, P/E, EV/SALES and EV/EBITDA.
Financial Analysis
Source: FactSet
Ratio 2012 2013 2014E 2015E 2016E 2017E 2018E 2019E
Profitability
EBIT Margin 7.5% 7.9% 7.6% 22.9% 22.8% 20.7% 19.8% 20.3%
EBITDA Margin 12.7% 13.2% 13.2% 28.4% 28.1% 26.0% 25.1% 25.6%
Profit Margin 2.6% 3.1% 3.0% 12.3% 12.8% 11.7% 11.5% 11.8%
ROA 1.8% 2.3% 2.4% 10.0% 11.3% 10.7% 10.5% 10.5%
ROE 6.8% 7.9% 7.8% 26.5% 24.7% 20.3% 17.9% 16.3%
Liquidity
Current Ratio 0.68 0.56 0.65 0.68 0.97 1.20 1.65 1.90
Cash Ratio 0.11 0.12 0.18 0.26 0.50 0.76 1.17 1.45
Financial Leverage
LT Debt to Asset 0.35 0.29 0.30 0.24 0.18 0.14 0.11 0.09
D/E Ratio 1.51 1.21 1.12 0.83 0.44 0.33 0.19 0.15
Interest coverage 2.14 2.66 2.99 9.59 15.86 17.49 26.84 29.26
Operation Metrics
Revenue passenger (in thousands) 28,956 30,463 32,089 34,102 37,022 40,125 43,281 45,173
Revenue passenger mile 33,563 35,836 37,813 40,647 44,128 47,827 51,589 53,844
ASM (in millions) 40,075 42,824 44,994 48,390 52,534 56,937 61,416 64,100
Yield per passenger mile (cent) 13.56 13.87 13.99 14.00 14.15 14.47 14.77 15.07
PRASM (cent) 10.96 11.35 11.89 11.94 12.15 12.39 12.64 12.90
Operating revenue per ASM (cent) 12.10 12.43 12.71 13.01 13.25 14.09 14.35 14.62
CASM 11.49 11.71 11.81 10.11 10.18 10.65 11.13 11.58
CASM, excluding fuel 6.99 7.27 7.55 7.40 7.48 7.66 7.85 8.04
Departures 264,600 282,133 294,800 306,803 324,939 340,053 355,166 365,745
JBLU | Price Target $27.00 Jan 27, 2015
18
23
28
33
2008 2009 2010 2011 2012 2013
Figure 25. Revenue per aircraft (in millions)
JBLU LUV ALK
SAVE RYAN WJA
10%
15%
20%
25%
30%
4,000
5,000
6,000
7,000
8,000
9,000
10,000
2015E 2016E 2017E 2018E 2019E
Figure 24. Revenue vs. Margin
Revenue EBIT Margin
EBITDA Margin Profit Margin
Profitability | Growth in Earnings
From 2013 to 2015 we expect JBLU’s profitability to increase from 3.1% to 12.3%
as the company takes advantage of low oil prices. With the introduction of a new
baggage fee system and increased aircraft capacity, JBLU’s topline will improve
by an additional 5%. As a result, we estimate a significant increase in EPS to $2.71
per share in 2015.
Liquidity | Robust cash inflow
As a result of higher margins and its $900mm CAPEX reduction plan from 2016-
2018, JBLU will experience greater liquidity. We forecast that JBLU’s EBITDA
margin will spike to 30% in 2015, resulting in a higher cash balance. We believe
that the company’s liquidity will improve even further as we forecast an increase
in free cash flow and reduction of debt. We also anticipate a significant increase
in the interest coverage ratio as JBLU experiences higher cash inflows and curbs
its debt level.
Financial Leverage | DuPont Analysis
Historically, the main driver of JBLU’s ROE has been financial leverage. JBLU has
exhibited returns on equity of 5.3% in 2012 and 7.9% in 2013. While its profit
margin was only 3% in 2013, JBLU was able to maintain its current ROE range
due to its high use of leverage, as the company had an equity multiplier of 331%.
In 2015, we project JBLU to have a ROE of 25%, as the introduction of new
baggage fees and reduced oil expenses significantly improves the profit margin
to 12.3%.
Efficiency | Efficient Aircraft Utilization
Historically, JBLU operates its fleets with a high level of efficiency. As a result of
JBLU’s efficiency the firm has generated greater revenue per aircraft than its
competitors. We expect JBLU’s ASM to grow at an increasing rate after 3Q16 as
the company installs additional seats on its A320s. Along with an increase in ASM,
we estimate that the PRASM will continue to increase as well. We attribute an
increase in PRASM to a strong economic outlook supported by a 5.6%
unemployment rate, high levels of consumer confidence, and increased
consumer discretionary income. Furthermore, CASM will experience a significant
decrease due to the fall in oil prices. However, CASM can be further reduced
below our estimate as the company reformulates its fleet structure to
experience higher fuel efficiency. Ultimately, JBLU’s high level of efficiency will
prove to be highly profitable.
Financial Leverage | Debt/Equity Ratio
In 2014, JBLU’s D/E was 1.12, a significant improvement over its 2012 D/E value
of 1.51. The company has been steadily buying back their debt over the past year
as it is keenly focusing on improving its financial health. With increases in cash
flow JBLU plans to accelerate its debt prepayment.
Source: Team Estimate
Source: Team Estimate
JBLU | Price Target $27.00 Jan 27, 2015
3%
4%
5%
6%
7%
8%
9%
0
100
200
300
400
500
2011 2012 2013 2014E
Figure 26. Maintenance Cost
Maintenance Expense Revenue%
39%
61%
Figure 27. Cancellations by Destination (2010-2014)
JFK/BOS/EWR Others
$-
$20
$40
$60
$80
$100
$120
0%
10%
20%
30%
40%
50%
20
022
003
20
042
005
20
062
007
20
082
009
20
102
011
20
122
013
Figure 28. Fuel Cost per Revenue vs. WTI
Fuel cost / Revenue WTI
Investment Risks
Operational Risk | Increased Maintenance Expenses
Currently the average number of departures for each JBLU aircraft is 1,519 a year.
If technical issues reduce average departures to 1,380 per year, this will lead to
a HOLD recommendation, valuing JBLU at $18 per share. If the number of
average departures decreases to 1,300 this will lead to a SELL recommendation,
valuing JBLU at $12 per share.
Operational Risk | Unplanned Failure of Aircrafts
The breakdown or failure of aircrafts could harm JBLU greatly. JBLU has invested
heavily in CAPEX to mitigate potential malfunctions. If a large number of flights
are cancelled, JBLU will honor their customer centric programs, experiencing
reduced revenues.
Operational Risk | Dependence on New York Metropolitan Market
In 2007, JFK airport was hit by the Valentine’s Day Storm, which halted
operations in the Northeast and cost JBLU $30mm. Another storm of this
magnitude could create significant risks and costs for JBLU.
Operational Risk | Extraordinary Events
In the case of an extraordinary event that leads to destruction of an aircraft, JBLU
will suffer extreme losses. An event of this magnitude would reflect poorly on
JBLU’s brand, decreasing its number of passengers. Operational Risk | Losing
Loyal Customers JBLU is emphasizing its focus on pleasing investors, and faces
the potential of losing loyal customers. Decreased revenues and reduced free
cash flow are consequences of customer loss. If 5.6% of JBLU’s customers leave
for competitors, our valuation would decrease to $17 per share and we would
provide a HOLD recommendation. If the number of JBLU passengers decreases
by 7%, our valuation will decrease to $15 per share and we will provide a SELL
recommendation.
Market Risk | Oil Volatility
If oil prices increase, JBLU’s jet fuel costs will increase as well. If the oil prices
increase significantly within a short period of time, there is a possibility that
JBLU’s intrinsic value will decrease our valuation resulting in a HOLD
recommendation.
Market Risk | Rise in Interest Rates
An increase in interest rates would increase the overall cost of debt for JBLU and
result in a higher interest expense. Currently, interest rates are extremely low as
part of the FOMC’s expansionary monetary policy. We expect rates to remain
low throughout the end of 2015, and to gradually increase afterwards. Due to
increased future cash flow, we are confident that JBLU will not be materially
impacted by an increase in interest rates over the next few years.
Source: Team Estimate
Source: BTS
Source: EIA, JBLU
JBLU | Price Target $27.00 Jan 27, 2015
Market Risk | Perception of Travel Safety
Historically, public perception of travel safety has resulted in adverse results in
airline performance. Both disease outbreaks and terrorism are risks inherent to
the industry that can negatively affect JBLU. As a result of terrorism and
biological threats, JBLU has complied with costly regulations increasing due
diligence, utilization of the No Fly List, metal detectors, and random searches of
its facilities to provide for customer safety.
Regulatory Risk | Failure to Acquire New Routes
A critical aspect of JBLU’s future outlook includes its plans for international route
expansion in the LatAm region. In order to acquire new routes, JBLU must gain
approval from regulatory agencies, both in the U.S. and other nations. If JBLU
fails to establish new expansionary destinations in the future, this will affect the
company’s future outlook negatively.
Regulatory Risk | Flight Limits
The FAA is proposing a rule to set a daily limit on the number of flights out of JFK,
LGA, and EWR to reduce congestion and flight delays. With JBLU’s large presence
in the area, the implementation of these rules could reduce their flights in the
region. With a growing demand for air transportation it is uncertain whether the
regulation will pass, especially with significant pushback to the proposed rules
being made by the Port Authority and Global Gateway Alliance.
Business Risk | Unionization
As of February 2014, there are business related risks and regulations JBLU faces
surrounding the A.L.P.A unionization. JBLU will experience increased costs if
A.L.P.A bargains and negotiates wages and work hours. Additionally, other
unions may approach JBLU employees in an attempt to unionize the workforce.
Table 4. Risk-Free Rate and Price Target
*Current risk-free rate: 1.83% (1/27/2015)
Risk-free rate 3% 4% 5%
Price Target $18.57 $14.51 $11.22
Rating HOLD HOLD SELL
Risk-free rate and price target
Source: Team Estimate