Hailey Davis, Gino Jo, Beto Ramos, Bridget Parsells · JetBlue Airways Corporation is a U.S. based low-cost passenger airline. The company operates primarily on point-to-point routes

Key Statistics

BUY

Recommendation

Sector: Services

Industry: Regional Airlines

Market cap: $6.69B

52 week high: $27.2652 week low: $16.26

Trailing P/E: 10.72Forward P/E: 8.01P/S: 1.01EV/EBITDA: 4.71

Beta: 1.01

ROA: 7%ROE: 21.3%

One Year Price Performance

Investment ThesisCatalysts

Hailey Davis, Gino Jo, Beto Ramos, Bridget Parsells

Equity Research | February 18, 2016 | NYSE: JBLU

Current Price: $21 Intrinsic Value: $29 Target Price: $35 Implied Return: 33%NYSE: JBLU

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JetBlue Airways Corporation is a U.S. based low-cost passenger airline. The company operates primarily on point-to-point routes with its fleet of 13 Airbus A321, 130 Airbus A320, and 60 Embraer E190 aircrafts. JetBlue’s recent price pullback, attractive growth prospects, and strong financial position provide an deep undervaluation of over 30%.

Company Profile

- Continued growth in demand driven by brand recognition with

the “JetBlue experience” - Competitive cost structure

- High value geography - Cabin restyling program

- Pullback fueled by recession fears creates buying opportunity

- Superior business model

- Greater financial stability - Loyalty program

- Sustained low oil prices

Recommendation: BUY

Investment Thesis Breakdown

Brand Recognition with the “JetBlue Experience”

Competitive Costs

The “JetBlue Experience” is a distinctive flying experience that continues to attract new customers. JetBlue is the carrier of choice for travelers who have been underserved by other airlines as it offers a superior flying experience coupled with excellent customer service.

JetBlue continues to innovate in products such as Mint, its premium transcontinental service launched between New York and Los Angeles and between New York and San Fransisco. Mint offers 16 seats with a premium fully lie-flat bed. Within six months of its release, revenues jumped 20%. Due to its popularity, we expect the Mint service to continue to drive demand in the future.

In the first half of 2015, JetBlue rolled out its Fare Families pricing model allowing customers to choose from a number of options, with all fares complementing its core offering of free in-flight entertainment, free brand name snacks and non-alcoholic beverages. This system allows customers to select the products or services they need and value most when they travel, without paying for the things they do not.

Upon arrival, customers are welcomed by dedicated crew members and are able to purchase from a selection of ancillary amenities like Even More Speed, offering them an expedited security experience. Out of all U.S. airlines, JetBlue’s standard fares include the most comfortable seats with the most legroom in the main cabin out of any airline. Additionally, JetBlue offers flyers the option to purchase Even More Space seats with additional legroom.

With legacy carriers such as American, United, and Delta having lowered their cost structures through restructuring during bankruptcy periods, JetBlue took additional measures to obtain its superior cost advantage. JetBlue is inducting the more fuel efficient Airbus A321 into its fleet, which according to JetBlue, are 10-15% more cost efficient than the Airbus A320. Additionally, the firm is installing curved wing extensions called “Sharklets” onto its existing Airbus A320s, providing a further 3-4% improvement in fuel efficiency on long-haul transcontinental routes.

JetBlue utilizes its higher aircraft efficiently to spread its fixed costs over a greater number of flights and available seat miles. During 2014, its aircrafts operated an average 11.8 hours per day. In addition, the average age of its fleet is 7.8 years, which is the youngest of any major U.S. airline. Operating young fleets and incorporating the latest technologies have resulted in aircrafts being more efficient and dependable compared to other fleets.

Equity Research | February 18, 2016 | NYSE: JBLU Analysts: Hailey Davis, Gino Jo, Beto Ramos, Bridget Parsells 2

JetBlue Airlines

Southwest Airlines

Segment Average

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AirTran Airways

Frontier Airlines 659

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J.D. Power 2015 Airline Satisfaction

Recommendation: BUY

Investment Thesis Continued

High Value Geography

Cabin Restyling Program


JetBlue is a predominantly point-to-point system carrier, with the majority of its routes servicing New York, Boston, Fort Lauderdale - Hollywood, Orlando, Long-Beach and San Juan, Puerto Rico. During 2014, over 86% of its customers flew on non-stop itineraries.

The top five fastest growing cities in the United States are Seattle, Los Angeles, Orlando, Las Vegas, and Atlanta. Out of the five, JetBlue operates in four of these cities, ultimately increasing its domestic capacity growth.

JetBlue plans to grow its market share by expanding into the Latin American and Caribbean markets. JetBlue recently announced that it plans to add more routes to Barbados. JetBlue currently operates daily flights to Barbados from New York and Boston, with plans to add additional daily flights to the island by April 2016. Given how successful JetBlue has been with its previous expansions, the new route can be expected to boost revenues going forward.

JetBlue is expected to roll-out its cabin restyling program during the second half of 2016. The firm plans on introducing Airbus’ innovative galley and lavatory model on its all-core A321 in July, freeing up valuable onboard real estate. The A321 typically carries 190 passengers. However, after the restyling of the aircraft, it will be able to carry 200 passengers by the end of 2016. We expect this to increase JetBlue’s load factor capacity as it will increase Available Seat Miles and revenue per passenger miles (see appendices #17).

The new restyling program will also introduce a fully connected in-seat experience that meets the needs of travelers today, furthering its focus on connectivity, comfort, and space. In addition to the best legroom in the industry, JetBlue continues to provide the premier base-fare flying experience.

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Recommendation: BUY

What is the Market Missing?

Competitor Analysis


- Southwest Airlines: A commuter-focused airline with a business model catering to people looking for quick and cheap flight from point to point. Only utilizes one type of aircraft: the Boeing 737.

- Spirit: An extremely low-fare, high-fees airline with a business model catering to the most price sensitive flyers. While Spirit’s fares are cheap, it does not offer baseline accommodations including water, reclining seats, or baggage.

- WestJet: Low-fair Canadian airline focused on delivering superior customer service. Expanding to a hybrid model in order to expand its customer base.

JetBlue’s business model pins it in the higher-end of the midrange aircraft segment. It’s closest competitor, Southwest Airlines, provides similar fares at a lower flying experience. The firm’s flight experience is comparable to the high-end of airlines competing with American Airlines and Delta Airlines, while providing a more affordable base-fare price. As JetBlue continues to expand nationwide, it will capture market share from both the lower and higher end of its competitive segment. See appendices page 16 for a competitor analysis.

- Increase in Available Seat Miles driven by new routes, more seats per aircraft, and higher demand driven by superior accommodations

- Ability to capitalize on its multiple regional expansions and capture a growing portion of market share from its competitors on new routes

- Growing brand recognition based on its superior business model

- Relatively low oil prices for the foreseeable future

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Industry Analysis

Recommendation: BUY


U.S. Domestic Airline Industry

The U.S. domestic airline industry is expected to soar over the next five years as economic conditions continue to improve with consumers and business people taking more trips. Industry revenue is projected to increase at an annualized rate of 4.6% to $197.1 billion over the five years to 2020. Volatile oil prices will remain a threat, but are expected to remain suppressed for the foreseeable future. Furthermore, low-cost airlines are expected to expand revenues in the future, with recent industry consolidation leading to higher competition among conglomerates.

A greater number of business passengers, rising disposable incomes and increases in services offered will support revenue growth over the next five years. As household incomes grow worldwide, demand for domestic trips is forecasted to increase at a faster rate than it did in the past five years, growing by 1.6% per year on average through 2020. The main factors supporting this trend will be lower ticket prices and higher incomes.

The load factor of U.S.-operated aircraft is also increasing. A higher load factor has the potential to increase airline revenue, which can occur in two ways. First, aircraft can operate more efficiently and achieve higher returns by filling empty seats, ensuring that airlines are operating near maximum capacity. Second, airlines use yield-management software to anticipate demand and extract the highest possible price per seat. As seats fill up, prices for the remaining seats increases. Therefore, airlines can increase returns for the increased number of passengers per plane.

The industry's average profit margin is expected to improve slowly over the next five years as additional fees and charges continue to offset oil price volatility. Earnings growth will rely on the return of demand and additional fee services. The anticipated rise in profit is expected to increase the level of future investments for this industry. Additionally, technological developments in aircraft manufacturing will continue to provide faster and more fuel-efficient models that will improve the competitiveness of operators.

Airlines have cut the number of routes in their networks to control costs and focus their operations on more profitable routes. If fuel costs were to increase again, this trend of network reduction will become more prevalent, with a trip across the country likely to involve a stopover at a more centralized hub. The industry will also continue to charge additional fees for baggage and extra services as a means of protecting profit from volatile fuel costs.

Domestic trips by U.S. residents forecast

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Industry Analysis Continued

Recommendation: BUY


Competition among domestic airlines has intensified over the past five years. Providers of cheap air transportation have increased the level of price competition in the industry, raising the focus on quantity over quality. While quality is still an important measure of success for an airline, this type of competition is more prevalent at the higher end of the market. Price competition is the most important tool in attracting customers in times of poor economic conditions, when unemployment is increasing and incomes are falling. During stable economic times, airlines may offer additional services and higher-quality services to avoid having to cut prices.

Costs to purchase aircraft and specialist machinery, hangar and other airfield space, as well as costs to attract skilled labor and to comply with stringent safety requirements are high and a significant barrier to industry entry. Purchasing aircraft may cost millions of dollars, which may be hard to secure, given the competitive nature of the industry. Once a new company enters the industry, barriers to success become even harder. Existing incumbents may already have network alliances, a wide network of industry contacts, a proven safety record and the evidenced ability to deliver projects on time.

Moat

Pricing power is the economic moat of the airline industry, and the only way to obtain this moat is superior operating efficiency and customer satisfaction. The key measure of operating efficiency for airlines is operating expenses per available seat mile, which compared to its competitors, JetBlue has been able to produce seat miles at a cheaper cost and increase its load factor (see appendices #16).

In an increasingly competitive environment, customer satisfaction is becoming a more critical factor in an airline’s ability to control pricing power. JetBlue has a track record of superior customer satisfaction, holding the number one low-cost carrier airline designation for the tenth year in a row. Due do JetBlue’s operating efficiency and customer satisfaction, JetBlue is one of the few airlines that has created a moat in this highly competitive industry.

JetBlue’s price setting position is highlighted by its ability to attract customers away from both ends of the spectrum. The firm’s lower end peer is Southwest who provides similar fare prices while offering lower customer service and a lesser flying experience. On the higher end, JetBlue competes with Delta and United who offer similar accommodations at much higher fares. Additionally, many of the additional frills added by its high-end peers are largely cosmetic, and do not contribute to the flying experience of the customer. By offering a “sweet spot” for flyers, JetBlue’s growing popularity will continue well into the future cementing its competitive position.

Recommendation: BUY

Catalysts

JetBlue’s business model revolves around aggressive cost cutting measures leading to cost advantages. The firm’s focus on value adding services leads to its lean in-flight offerings. Competitors add frills to fares which only increase their cost and do not improve customer value.

JetBlue is thus in an exciting space within its segment providing better service for a similar price compared to its lower-end peers, and a similar flight experience for a much lower price when compared to its higher-end peers. We expect this position to lead to the continued favorable migration of passengers from other airlines to JetBlue. By incentivizing flyers with lower rates and better service, JetBlue will experience continued growth.


Financial leverage among airlines

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Superior Business Model

Greater Financial Stability

JetBlue continues to prioritize its cash use to strengthen its balance sheet. Over the last 12 months, JetBlue reduced net debt by over $560 million, driving a significant improvement in its net debt to EBITDA ratio, which is down from 2.5 times at year end 2014 to 1.1 times at year end 2015.

With respect to CAPEX in its fleet, JetBlue ended the year with 215 aircrafts including 138 320s, 60 E190s, and 25 A321s. JetBlue purchased four A321 aircrafts in the fourth quarter with cash. In 2016 JetBlue expects to take delivery of 10 A321s including three in the first quarter. Given the strength of its cash from operations, the current presumption is that JetBlue will continue to pay cash for all of its 2016 deliveries.

JetBlue has taken advantage of a low interest rate environment, and as rates rise, its fleet will be new, cheap, and paid off. Since the firm is paying off the little debt it currently holds, increases in interest rates will not be material.

Recommendation: BUY

Catalysts Continued


TrueBlue is JetBlue’s customer loyalty program designed to reward and recognize loyal customers. Members earn points based upon the amount paid for JetBlue flights and services from certain commercial partners. Its points do not expire, and the program has no black-out dates or seat restrictions. JetBlue’s loyalty program is superior to its competitors because points do not expire, whereas competitors points expire after 24 months of inactivity.

JetBlue has partnerships with American Expresses, Banco Santander Puerto Rico and MasterCard in Puerto Rico, Banco Popular Dominicano and MasterCard in the Dominican Republic. JetBlue intends to continue to develop the footprint of its co-branded credit cards and pursue other loyalty partnerships in the future. As JetBlue expands its partnerships, it will help increase its revenue passenger mile as customers will want to use JetBlue Airlines because they earn free flights.

Loyalty program

As demonstrated by the graph to the right, gas prices are predicted to stay relativity low in the forceable future. This is beneficial for JetBlue as it will keep its fuel costs low and continue to improve its operational margins. During the second half of 2016, JetBlue will hedge 10% of its expected consumption based on the forward curve as of January 15, 2015.

With an active hedging strategy alongside the low forecasted range of oil prices, JetBlue is poised to further its margin expansion well into the future. The firm’s strong cost advantages will allow it to outperform its peers in the event of higher than expected oil prices as their superior margins will allow for the dampening in fare hikes, continuing the firm’s strategy of price competitiveness.

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Recommendation: BUY

Risks & Mitigants

Geographical Limitations

Price Volatility of Fuel


Results of operations are heavily impacted by the price and availability of fuel. Fuel costs comprise a substantial portion of total operating expenses and are the single largest operating expense. However, not only is JetBlue engaged in the mitigating of oil prices through diversified hedges and swaps, oil is expected to stay low for the foreseeable future.

Interest Rate Exposure

The airline industry has high fixed costs as it is capital intensive, however JetBlue limits its amount of debt by using cash to fund new aircraft purchases, and leasing or selling aircrafts to other companies. In the event of a significant interest rate hike, JetBlue’s exposure will be largely dampened as it is continuously paying off debt as it has significant cash on hand.

Macroeconomic Environnent

The performance of the airline industry is closely tied to the health of the economy. If the economy goes into a recession and per capita disposable income decreases and the unemployment rate increases, less Americans will be able to travel. However, JetBlue is continually working to manage its mix of customers to include business travelers as well as travelers visiting friends and relatives (VFR). VFR travelers trend to be slightly less seasonal and less susceptible to economic downturns than traditional leisure destination travelers.

JetBlue is present in the fastest growing U.S. cities, however its presence is less than that of some competitors. This poses a risk of a potential loss of customers as those flying to locations not serviced by JetBlue could obtain loyalty points and rewards from other airlines.

Robin Hayes - President and CEORobin Hayes is JetBlue’s Chief Executive Officer and is a Member of the Board of Directors. Previously positions include President, Executive Vice President and Chief Commercial Officer. Prior to joining JetBlue, he spent 19 years at British Airways where he served as Executive Vice President for the Americas. Hayes is a graduate in Electrical and Electronic Engineering from the University of Bath.

Recommendation: BUY

Management Team


Mark Powers - CFOMark Powers, Chief Financial Officer, joined JetBlue in 2006. Under Mr. Powers's leadership, JetBlue implemented a strategic aircraft sales program designed to manage capacity and reduce cost. Prior to joining JetBlue, Mr. Powers held a number of positions in both the finance and legal departments of Continental Airlines, Northwest Airlines and GE's jet engine unit.

Joanna Geraghty - EVP, Customer ExperienceJoanna Geraghty joined JetBlue in 2005 and was named Executive Vice President, Customer Experience in May 2014. Ms. Geraghty served as JetBlue’s Executive Vice President, Chief People Officer and Associate General Counsel. Before joining JetBlue, Joanna was a partner at Holland & Knight. She received her B.A. from the College of the Holy Cross, and her J.D. from Syracuse University.

Mike Elliott - EVP, PeopleMike Elliott joined JetBlue as vice president, crew relations. In 2015, he joined the executive leadership team as EVP, People. Prior to joining JetBlue, Mike spent 19 years at Airborne Express/DHL. Leaving operations as regional manager for the Manhattan operation, he moved to customer service and became director, U.S. customer service operations prior to joining the labor relations and human resources team as vice president.

We conducted a sensitivity analysis on the multiple to account for different scenarios that JetBlue could face in 2019, such as pricing pressure or increases in oil. Over the past 6 years, JetBlue’s EV/EBITDA multiple has been well above 6 times. This poses a significant upside as the multiple regresses to a higher historical average.

Recommendation: BUY

Valuation


EV/EBITDA Model

We utilized multiple valuation methods to arrive at a target price for 2019. Our first model is an EV/EBITDA multiple model. JetBlue currently trades at an EV/EBITDA multiple below its six-year historical average. Its six-year historical average EV/ EBITDA multiple is 11 times (see appendices page #18). We have the multiple expanding over our investment horizon due to the increase in Available Seat Miles driven by new routes, more seats per aircraft, and higher demand driven by superior accommodations. At 8 times EBITDA in 2019, JetBlue will have a market cap of roughly $10.7 billion and an equity value per share of $34.76.

A P/E model was also conducted to help obtain a price target for 2019. We modeled for a P/E expansion as JetBlue is currently trading well below its six year historical average of 12.6 (see appendices page #18). During our investment horizon, we expect JetBlue’s P/E to expand to a multiple of 12.31. JetBlue’s P/E multiple will expand over our investment horizon as JetBlue capitalizes on its multiple regional expansions and captures a growing portion of market share from its competitors on new routes.

Recommendation: BUY

P/E Model


A sensitivity analysis was conducted on the multiple in order to account for a variety of scenarios the firm could face through 2019. Over the past 5 years, JetBlue’s P/E multiple has remained within an average range of around 13. Our estimates of EPS coupled with an expected historical multiple provide a comfortable value proposition.

A sensitivity analysis was conducted on our free cash flow to equity model to account for changes in discount rates and terminal values. Even in our bear case scenario, JetBlue is 24% undervalued.

Recommendation: BUY

Free Cash Flow to Equity Model


We utilized a free cash flow to equity model to estimate JetBlue’s present value, deriving a terminal value of $34.76 from our EV/EBITDA model. The model implies the stock is roughly 33% undervalued in our base case scenario. The model has implied assumptions based on our expectations of the firm, its competitors, and the industry landscape:

- Top line growth will continue with the increase of Available Seat Miles driven by new routes, more seats per aircraft, and higher demand driven by superior accommodations.

- Capital expenditures will increase as JetBlue plans on buying 10 additional planes in 2016, however debt will decrease as JetBlue has an abundant amount of cash and will be using its cash to pay down debt and purchase planes.

- Using a 60-month regression, we arrived at a beta of 1.01.

Recommendation: BUY

Appendices


Recommendation: BUY

Appendices Continued


Recommendation: BUY



JetBlue Southwest Airlines Spirit Westjet

Average air fare $167 $160 $120 $200

Load factor 84% 82% 81% 80%

Cost per ASM $7.53 $8.56 $5.88 $13.8

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Profit $4.07 $3.44 $5.12 $1.2

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Recommendation: BUY


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Recommendation: BUY


Documents

Hailey Davis, Gino Jo, Beto Ramos, Bridget Parsells · JetBlue Airways Corporation is a U.S. based low-cost passenger airline. The company operates primarily on point-to-point routes