Summary

• The airline industry has suffered the most challenging period of its history. More challenges have arisen with the Delta variant, which may delay the already slow return of business travel.
• JetBlue has had a steep decline in share price lately as healthcare concerns continued. However, we think the airline’s current profile and route mix have several hidden upsides especially relative to the rest of the industry.
• Low-cost domestic carriers with exposure to short-haul international routes are the best airlines in the business right now, in our view.
• JetBlue meets these criteria and has the most differentiated product, potentially leading to higher than consensus growth in the post-pandemic environment.
• The company management is using margin expansion as the “North Star” in their plan. In terms of aircraft efficiency and new routes, we consider the management to be years ahead of the competition in many cases.

“I always called JetBlue a customer service company that just happens to fly airplanes.”

– David Needleman, JetBlue Founder

Airlines are a quintessential Epicenter industry that was subject to some of the most significant revenue disruptions associated with COVID-19. As vaccines were introduced and pent-up demand for travel replaced some revenue, the industry was thrown a lifeline, and the prices of their shares appreciated dramatically from pandemic lows. Recently this has reversed with the rise of Delta cases. JetBlue, for example, is below its 50-day and 200-day moving averages. We suspect this will change.

Source: IATA July Survey Of Airline CFOs and Heads of Cargo

Attitudes have shifted from favoring Asia leading the air-travel recovery to North America leading it in industry surveys. Despite burgeoning demand for leisure travel, there are still many complex dynamics affecting the behavior of airline management. Most airlines have had to take dilutive action and increase leverage to survive the unprecedented crisis.

Airlines have undoubtedly suffered as the market faces the reality that COVID-19 will likely become endemic and the Delta Variant spreads. So, in this new reality where vaccinations do not vanquish the virus and business travel may be more delayed than expected, JetBlue gains at the relative disadvantage of their larger, more business-dependent rivals. Although it is not a hub and spoke airline, its core’ hubs’ are in Boston, New York and Los Angeles, and these all have high vaccination rates.

Well Equipped For Bankruptcy Dodgeball

JetBlue is concentrated in domestic and short-haul international travel, which is recovering faster than business and long-haul international travel. This is what makes investing in the airline business not for the faint of heart; business and international travel can be over 50% of revenue for legacy carriers. Flying is undoubtedly a necessary service that customers will need, and there is also much pent-up demand for it, particularly on the leisure side. Domestic airline traffic in the US in the run-up to the 4^th of July exceeded 2019 levels, and North America’s recovery has been faster than much of the world’s.

Nonetheless, the strange economics created by state subsidization and a heavily regulated industry dominated by players with hefty legacy costs and a history of bankruptcy make for some interesting outcomes. It is very counterintuitive, for example, that there were more airline bankruptcies in 2018 and 2019 than in 2020. This is probably due to the fact there was over $225 billion in government assistance doled out to the industry. Some airlines get paid by their governments not to restructure.

Source: JetBlue Company Reports

In this strange competitive landscape, JetBlue’s younger age makes a significant difference in terms of labor costs. We truly believe a ‘smell test’ of any company is whether or not they are in alignment with their stated mission. In the case of JetBlue, the product distinction and its customer-centric approach clearly are in line with its timely mission of bringing ‘humanity’ back to travel.

Source: JetBlue

In addition, the company has a credible path to restoring its balance sheet from the extraordinary measures undertaken in the heat of the crisis. It is executing its impressive 2020 cost-cutting plan effectively. Management seems solely focused on sticking out from the majority of airlines that do not make enough to cover their cost of capital. The focus on margin expansion and balance sheet restoration is encouraging from a shareholder’s perspective, but the benefits will take time to accrue fully.

Source: JetBlue Company Reports

Imitation Is The Highest Form Of Flattery

One distinction between airlines that not all our readers may be familiar with is between full-cost carriers (or legacy airlines) and low-cost carriers. The former were in existence before the significant wave of de-regulation and rely on large hub and spoke networks which make them particularly dependent on business and international travel; the exact segments of demand with the most uncertainty. Low-cost carriers like JetBlue rely on point-to-point service and generally operate flights more efficiently (and have lower labor costs).

One of the main trade-offs is in the level of service. Everyone knows that flying Spirit will save you money but will almost certainly be an unpleasant experience. JetBlue is an undisputed brand leader and has what is probably the most differentiated domestic product. While it is technically a low-cost carrier, the magic of the company’s product is that consumers do not feel that way. Many airlines have been making headlines with big announcements like the largest-ever commercial aircraft purchase by United.

Source: JetBlue Company Reports

JetBlue is a newer and nimbler airline that is well ahead of competitors in making changes required of the 21^st century operating environment. Before the pandemic, a typical investor critique of JetBlue was that it lacked the exposure to lucrative business travel customers that its rivals had. While it has made significant strides in correcting this deficiency with its product differentiation and recent alliance with American, this disadvantage is looking more and more like an advantage in a world where COVID-19 is becoming endemic.

“We’re in the middle of a leisure first recovery,” said Scott Laurence, Head of Planning and Revenue for JetBlue. “We’re built for leisure,” he added. This is a pretty astute observation. JetBlue has a concentration in travel locations that have been booming, like Florida, the Caribbean, and Mexico. In fact, the company nearly shifted its HQ to Florida but instead decided to stay in New York.

Southwest and Alaska Airlines are aggressively marketing to try to retain some of the travel boon that has helped keep them afloat. Delta Airlines is adding routes to New York and Boston; JetBlue is already prominent in these two markets. Meanwhile, JetBlue can reap the rewards of its current leisure-heavy model while also offensively adding a cost-efficient long-range, narrow-body trans-Atlantic flights, once they are permitted, at much lower costs than those that currently dominate the hallowed New York-London route.

Risks And Where We Could Be Wrong

The recent run-up and decline show that markets can quickly change when an unpredictable exogenous threat like COVID-19 threatens commerce. As we have tried to impart, investing in the airline industry is fraught with a litany of complicated risks. However, when measuring JetBlue’s prospects and unique product against the competition, it becomes more appealing. The resurgence of the Delta variant is undoubtedly problematic for JetBlue, but less so than for its competitors, given their business models.

We pay very close attention to the risks associated with COVID-19, and we are seeing some signs that the current situation with the Delta variant is improving. We also have seen an uptick in vaccinations in what we describe as “vax panic.” If vaccination levels continue to increase in the United States, this is a positive for domestic travel. The recovery of international travel will likely be far more delayed as vaccine supplies in the necessary quantities remain elusive across much of the globe.

The stock price action has been harrowing in JBLU recently, but we also see signs of exhaustion in this trend at the industry level. Our Head of Research, Tom Lee, observed a rare DeMark ‘13 buy set up in the JETS 2.42%  ETF last seen in May 2020 before a significant run-up in share prices. Our careful analysis of COVID-19 suggests that markets bottom in advance of the peak in cases. We are starting to see signs of reversal in some of the states most affected by the recent outbreak. We would also point out that the levels of previously infected plus the levels of fully vaccinated is very high in the United States and only increasing.

One significant risk is that the typical seasonal drop-off in travel may adversely affect JetBlue more than its competitors. Most major airlines, including JetBlue, had begun pivoting more toward business travel to respond to this, but some of those plans have been delayed. Fortuitously for JetBlue, despite its goals, the fact that 80% of its customers are from leisure insulates it more from the postponement. When business travel returns, early evidence from JetBlue’s alliance with American suggests that the new and improved product will fare very well against competitors.

Source: Bloomberg

In terms of credit rating and default risk as expressed by CDS spreads, JetBlue is in the middle of the pack. We think this makes sense given their size and is mitigated by their clear plan to restore the balance sheet. We believe it is less likely given its business model and routes to go bankrupt than many airlines, but the risk is always a specter in this industry.

JetBlue has also had to be aggressive as many bigger rivals came in and competed on its home turf as they needed to bolster their leisure revenue. There’s always a chance that competitors out-muscle it to the detriment of shareholders. Many airlines’ newer routes aren’t necessarily concentrated in traditionally strong areas, so JetBlue has seen and could see more setbacks here. Still, airlines are chasing where the revenue is in the new market dominated by COVID-19. In many cases, they are going where JetBlue already has a strong presence made even stronger by its customer-focused product. As business travel returns, folks may be more discerning, and JetBlue could be a beneficiary.

Source: Bloomberg

The most considerable risk to shareholders is bankruptcy in an industry with a history rife with it; we would always suggest you watch this dynamic. JetBlue’s plan looks good right now, but there’s always the possibility it fumbles on execution or can’t grow or change fast enough to keep pace with a rapidly evolving industry. Luckily, management seems dedicated to using margin expansion as its guidepost. We believe it has a real chance to outperform the consensus due to its superior customer experience and concentration in thick domestic routes in highly vaccinated areas.

Prior “Signals”