Interesting Jetblue analysis--article

[General Lee]

PART 1.

Motley Fool
JetBlue's Challenges
Friday September 19, 2:59 pm ET
By Whitney Tilson


In the four columns I've written about JetBlue Airways (Nasdaq: JBLU - News) over the past three months, I've expressed tremendous admiration for the airline -- in particular, its cost structure, customer service, and culture -- and concluded in my initial column that JetBlue "has a decent chance to become the Wal-Mart (NYSE: WMT - News) of the airline industry over time."
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That being said, this upstart airline operates in what remains one of the worst industries imaginable and faces significant challenges, factors that I'm not sure investors are considering fully given the nose-bleed valuation they are assigning to the stock (at yesterday's close of $59.13, it trades at 44.5x this year's consensus analysts' estimates of $1.33 and 32.2x next year's estimates of $1.73).

While I did not recommend the stock three months ago at $39.71, I did pay it a great compliment by saying, "If I were forced to buy one stock trading in excess of 35 times this year's estimates, it would be JetBlue." I can no longer say this today, given the substantial run-up in the stock since then and my greater appreciation for the many challenges JetBlue faces. Let's talk about a few of them, keeping in mind that after extolling the company's many virtues for four columns, I'm going to give skeptics a full hearing.

Maintaining the culture
As I noted in JetBlue's Beautiful Cost Structure, the company's success is rooted in two areas: highly productive people and highly productive aircraft. Regarding the former, with the exception of Berkshire Hathaway (NYSE: BRK.A - News), I have never in my studies of thousands of businesses seen such universally motivated, hard-working employees (called crewmembers) as I have at JetBlue -- and this in an industry infamous for having horrific labor-management relations.

I attended a new employee orientation session last week, at which both CEO David Neeleman and President Dave Barger spoke (as they do at nearly every such event), and the enthusiasm in the room was palpable. This benefits the company in so many ways, including lower costs and exceptional customer service. I wish I had the space in this column to tell you the remarkable story of teamwork and commitment that enabled JetBlue to continue flying through the recent blackout, when every other airline in the New York City area shut down.

JetBlue's senior managers, without exception, agree with me that maintaining such a strong culture is the single biggest challenge facing the airline. It can be done -- witness Southwest Airlines (NYSE: LUV - News) over the past three decades -- but my experience is that most companies lose this magic as they grow. The fact that airline unions (rightly) view JetBlue as a tremendous threat only adds to the challenge. One airline CEO told me that "JetBlue is ALPA's (the militant and powerful Air Line Pilots Association) worst nightmare, and they will do anything to unionize JetBlue." (He added that, if JetBlue continues treating its crewmembers well, he thought it could possibly fend off ALPA and the other unions, though it might have to boost pay rates to do so.)

Pay rates
Generally speaking, JetBlue's overall pay scale is somewhat lower than that of major carriers -- it's roughly in line with discount airlines -- but JetBlue attracts and motivates talented crewmembers in a number of ways, including developing a well-deserved reputation for treating crewmembers well and having a great work environment, offering the opportunity for rapid advancement (for example, a First Officer can be promoted to Captain in less than three years), scheduling efficiently (thereby minimizing unpaid downtime), and contributing 15% of profits to a crewmember profit sharing plan.

Key motivators also include stock options and especially the generous employee stock purchase plan -- both of which are linked to JetBlue's soaring share price. My concern is what happens if the stock is flat for many years or, worse yet, tumbles -- both of which could easily happen, given its current levels. While this would not affect many of the factors discussed above that contribute to high morale, crewmember enthusiasm could wane, demands for higher pay could emerge, and odds of unionization could rise -- all of which would substantially erode JetBlue's cost advantage.

Next half on next page:

 

[General Lee]

Maintenance
Airplanes are very expensive to maintain and, unlike many other cost areas, there is little room for one carrier to gain a cost advantage over another, assuming variables such as type and age of aircraft, stage length, etc. are held constant. Yet JetBlue's maintenance costs are dramatically lower than even other low-cost carriers, primarily because its planes are brand new.

As of the end of 2002, the average age of JetBlue's planes was a mere 15.5 months. For comparison, on the same date Continental's (NYSE: CAL - News) 366 mainline jets were seven years old on average -- and this is one of the youngest fleets among the major carriers. So many new planes give JetBlue an enormous cost advantage in its first few years, but this advantage is certain to diminish over time as JetBlue's aircraft and engines reach the age at which they require multi-million dollar overhauls.

As the fleet ages, the question becomes just how much and how quickly this cost advantage will diminish for JetBlue. It's not easily answered. JetBlue estimates that maintenance costs will only rise moderately by 0.2-0.3 cents per available seat per mile (ASM) over the next five years. I tend to believe that estimate, assuming JetBlue maintains its aggressive delivery schedule of new aircraft, though it's disputed by one executive of an airline that operates A320s: "I don't think [their estimate] is consistent with their fleet plan -- I think it's underestimated."

Another executive told me, "The downside of taking so many new aircraft in such a short period of time is that all of these planes and engines will need major overhauls at the same time. Just watch what happens to their stock when they unexpectedly report $20 million in maintenance costs one quarter."

This is indeed a danger, but I'm not convinced that it will play out this way. JetBlue may be able to offset higher maintenance costs with efficiencies in other areas (overall economies of scale, lower landing fees, and reduced financing costs, for example) or the ability to charge higher prices over time due to success building the brand, generating customer loyalty and/or achieving dominance in certain markets -- but investors should keep in mind that these factors are uncertain, while significantly higher maintenance costs are 100% certain.

Finding attractive markets
Like any airline, JetBlue evaluates every possible route that it might fly based on many factors, including current and potential traffic, existing price levels, strength of competitors and their likely reaction to encroachment, etc. I think it's reasonable to assume that as a general rule JetBlue chooses to serve the most attractive routes first, which explains why most flights today are in the heavily traveled New York-Florida and New York-West Coast routes.

But consider what happens as JetBlue grows: It must go further and further down its list of attractive routes, which is likely to pressure growth and margins. As one airline executive commented to me, "If Oakland-Atlanta is the best they could do for a new route, what on earth are they going to do with all of the new planes being delivered in the near future? And Southwest already owns 70 of the top 100 markets."

JetBlue strongly disagrees that there is any shortage of attractive routes to expand into, and cites data showing hundreds of routes with decent levels of traffic, in spite of current high fares. By introducing low fares and exceptional service, JetBlue believes it can stimulate demand as it did in the New York-Buffalo market, which has grown from 500 to 1,400 passengers per day each way since JetBlue started flying that route. If JetBlue can indeed grow the new markets it targets by such a degree, its growth plans will likely pay off -- but that's a big if.

Competitive reaction
While JetBlue has faced significant competition to date, the competitive environment is likely to provide an even stiffer headwind in the future for three reasons. First, as recently as this spring nearly every major airline was facing severe financial distress, yet almost all are in significantly better (though still precarious) shape today because they refinanced debt, raised additional capital and so forth (just look at the stock charts -- the airline sector is one of the top performers this year). While one could argue that healthier competitors might lead to more rational pricing, it can't be good news for JetBlue when its competitors significantly enhance their financial strength.

Second, to continue its torrid growth, JetBlue will increasingly have to start flying routes -- generally into competitors' hubs -- that will trigger violent reactions. One executive at a competing carrier told me, "JetBlue has been successful so far by flying fragmented markets [thereby avoiding all-out retaliation], but this will not be true going forward."

As evidence of this, consider the Long Beach-Atlanta route: When JetBlue launched three flights a day, Delta and AirTran (NYSE: AAI - News) responded by slashing prices and flooding the market with extra flights, which CEO David Neeleman said bordered on "predatory behavior." This was one of the reasons JetBlue pulled back to only one flight a day in this market and instead increased frequency on the Oakland-Atlanta route.

Finally, JetBlue's success is sure to attract new upstart competitors that may have even newer planes and lower maintenance costs. In fact, Richard Branson's Virgin Group, which has successfully built low-cost carriers in Europe and Australia, recently announced that it plans to launch a well-capitalized U.S. airline "definitely within nine months."

Managing hypergrowth and a new type of aircraft
JetBlue's success to date can be attributed in large part to wisely copying much of the model that has made Southwest the shining star of the airline industry for more than three decades: treating employees well, offering only point-to-point service, flying only one type of aircraft, etc. But JetBlue is deviating from this model in two related and important ways: Rather than being content to grow at a 10-15% rate each year, as Southwest has been historically, JetBlue has pursued hypergrowth, leaving little margin for error (last quarter, revenues grew 64% and the company plans to take delivery of 21 new aircraft by the end of next year, growing its fleet 45% from 47 to 68 planes).

To continue high growth, JetBlue recently announced that it has placed firm orders for 100 new Embraer 190 aircraft, with options for 100 more. I've seen mock-ups of this plane, which seats 100 passengers (vs. 156 in the A320), and I'm impressed. However, adding a second type of aircraft adds significant complexity, and committing to so much additional growth is risky. One airline executive told me that he has carefully analyzed point-to-point routes for smaller markets and, even assuming a cost structure as low as JetBlue's, concluded: "There are only a small handful of markets that can support 90- or 100-seat jets, so I have no idea where JetBlue thinks they can put so many planes."

Conclusion
I believe that sensible, prudent investors should spend the bulk of their time thinking about what can go wrong, especially when analyzing a richly valued growth stock like JetBlue, so let's consider the following doomsday scenario, outlined to me by a long-time executive in the industry:

"Everybody seems to believe that JetBlue has reinvented the wheel, but the fact is that they haven't. I worked for [an upstart airline] years ago and our stock rose more than ten times over a few years as we grew quickly and reported high margins, due primarily to the low maintenance costs associated with new aircraft. But then we ran out of new, attractive markets to penetrate, growth slowed, maintenance costs soared and our stock collapsed. I've seen situations like this many times before: As planes and employees get older, things change -- and what's amazing is how rapidly things change in this industry."

Will JetBlue follow the same Icarus-like path of so many of its predecessors? I don't know, but I'm certain that to avoid this fate, JetBlue will have to create a powerful brand that will translate into customer loyalty and a willingness to pay more for JetBlue's product. I don't believe that any airline has truly been able to break away from the commodity-like nature of this industry, but I applaud JetBlue's audacious attempt to do so. And it just might succeed if it can replicate its success in the New York-Florida market, in which JetBlue has the greatest number of flights and highest load factor, despite charging higher prices and flying from a less convenient airport.

Long article, but interesting.

Bye Bye--General Lee

 

[Vladimir Lenin]

sounds to me this guy is saying that as soon as JB gets unionized, profit margins will decrease substantially

anyone from JB want to comment on the state of unionizing?

 

[Flying Freddie]

As long as the culture at jetBlue remains, there will be no need for a third party to represent me. I have been ALPA and Teamsters and would not welcome them. They have let me down everytime.

 

[General Lee]

Flying Freddie,

I hope you are right, but as profits grow, it is only natural for employees to want a bigger piece of the pie. Eventually that may happen. Look at Southwest right now-----the flight attendants want more. The pilots over there got a great contract, but the others will also want more. We shall see how long Needleman's "pump up" parties and speeches last. (NY isn't getting any cheaper)

Bye Bye--General Lee

 

[Redtails]

Mr. Bethune from CAL also stated that this company wouldn't last a year. There are many factors that make this industry so troubling, but to achieve the success that we have during this "down" time is against all belief. So, if you're with this gentleman who pretty much has spelled out many of our fears, then I guess we're doomed! It is incredible that our major hub is in NYC and we're still not unionized. In fact, in our infancy, we had some non-union electrical workers hired to repair terminal 6. When the electrical workers union at the airport found out, they showed up at terminal 6 and instituted a slow-down at check-in by asking frivolous questions. We countered that with a special line for people with questions while our traveling customers continued to be checked in without disruption. I don't see a union here for pilots for years-- about 50% are military and many are former ALPA members who had no-furlough clauses. The FAs and maintainers pretty much feel the same way. As long as the management continues to keep the family here happy, I don't see the relationship that majors have developing here for a while. For the blackout, every crewmember received a mini- Mag light with "Blackout 2003" inscribed on it...

 

[Flying Freddie]

General Lee,

Things started going that way after Herb left. Southwest may have lost the culture at that time. Time as always, will tell.

 

[yaks]

You forget. With your employment contract you couldn't have a union if you wanted one.

 

[canyonblue]

Things started going that way after Herb left.

Herb left?

Then who in the hell is Chairman now?

Dammit I keep missing everything by going on those freakin trips.

 

[colorado418]

You forget. With your employment contract you couldn't have a union if you wanted one.

Are we really going to get into the contract thing again. I thought that was killed in the other thread. If you don't like the employment contract here, don't apply...

 

[SWA/FO]

Herb has left the building...only long enough to run down to the store for smokes and some wild turkey!!!

 

[Beerme]

As long as the culture at jetBlue remains, there will be no need for a third party to represent me. I have been ALPA and Teamsters and would not welcome them. They have let me down everytime.

I have been ALPA, APA, Teamster, and NO union (worst). I'll take ALPA any day. I don't agree with everything ALPA does...You can't make everyone happy all of the time. They're the best game in town. You guys keep drinking that Kool-Aid...you'll get *ucked in the end. Sooner or later, it always happens. Ever stop to think maybe YOU guys have let the pilot profession down? I go to work to bring home a paycheck for my family...not to go to company picnics and pep rallys , cheering about my low wages. Anyone can work for lower pay...it takes balls to hold the line. Time will tell.

 

[lowecur]

<there are only a handful of markets that can support a 90 - to 100 seat jet aircraft>

Whoa, what turnip truck did this myopic airline exec fall off. I think that statement was for direct point to point service only. B6 see's these a/c opening up 500 to 700 new city pairs. The hub and spoke concept may seem outdated, but I can assure you that David Neeleman has every intention of partially including that business model within the overall scheme of things for the 190. I think Jon Ornstein correctly said the hub and spoke concept would be exceptionally profitable for the legacy carriers if they had LLC expenses and work rules. WN and AAI already have proved this.

These will also be the a/c that will go head to head against WN, AAI, ACAI, DL, XJT, NWAC, and F9 on some of their most profitable routes. I would be more than a little nervous if I were the airline exec who didn't own EMB a/c when this competition begins.

As far as a/c maintenance in regards to securing a new fleet. I believe B6 has layered their purchases perfectly. 18 new 190's per year till 2011 will not be a problem.

Don't look for B6 to fall off a cliff anytime soon.

 

[jetblue320]

Flying Freddie,

We shall see how long Needleman's "pump up" parties and speeches last. (NY isn't getting any cheaper)

Bye Bye--General Lee

Not that it matters, but it's Neeleman, not Needleman.

 

[jetblue320]

I have been ALPA, APA, Teamster, and NO union (worst). I'll take ALPA any day. I don't agree with everything ALPA does...You can't make everyone happy all of the time. They're the best game in town. You guys keep drinking that Kool-Aid...you'll get *ucked in the end. Sooner or later, it always happens. Ever stop to think maybe YOU guys have let the pilot profession down? I go to work to bring home a paycheck for my family...not to go to company picnics and pep rallys , cheering about my low wages. Anyone can work for lower pay...it takes balls to hold the line. Time will tell.

Goodie for you and ALPA. Please don't apply at JB and come crying for a job in two years when ALPA sells you out.

 

[JayDub]

First and foremost, let me say I think this article (as can be expected from them) is right on. Absolutely every item he listed is a future concern. In fact, I’ve heard all this before… from our Senior Management Team. That's why we have a Senior Management Team; to also see these obstacles and react to them proactively. This is contrary, it would seem, to the philosophy of most other airlines. To me, these other guys seem to think reacting within three months after a market condition presents itself is timely. Why was Goodwin not trying to negotiate better deals on his leases, gates, etc. during the time Bethune knew he had to replace his fleet with newer airplanes? Totally different philosophies, totally different results.

I have been ALPA, APA, Teamster, and NO union (worst). I'll take ALPA any day. I don't agree with everything ALPA does...You can't make everyone happy all of the time. They're the best game in town. You guys keep drinking that Kool-Aid...you'll get *ucked in the end. Sooner or later, it always happens. Ever stop to think maybe YOU guys have let the pilot profession down? I go to work to bring home a paycheck for my family...not to go to company picnics and pep rallys , cheering about my low wages. Anyone can work for lower pay...it takes balls to hold the line. Time will tell.

1. If you worked under APA, you worked for American Airlines. If you have been around as long as it would be necessary to make the profile you provided truthful (and I think it is), you in all likelihood operated under a "B" scale that Crandall oversaw. Exactly how is that not letting the profession down?

2. You say that you worked while being represented by the I.B.T. (I assume you meant while being a pilot). I have yet to see them included in any conversations about "industry leading" wages for the airline profession (at least as far as pilots are concerned).

If my assumptions are wrong, then we are even. I have never gone to

company picnics and pep rallys , cheering about my low wages.

I, too make a living for my family. It's a dang good one too, if I may say so myself.




Respectfully,

JayDub

 

[Ty Webb]

Well said, JayDub.

I'm tired of these a-holes telling us how they're "protecting the profession" while their colleagues are stacking mulch at Home Depot.

I'm willing to accept less pay than the "legacy" carriers mostly were paying, in exchange for continuous employment and a rapid upgrade.

To each their own, but don't slam your competitors for your own company's problems. This isn;t Communism, Comrade.

 

[General Lee]

Here comes Ty again, trying to fit in. Thanks for your great comments again Ty. What? "don't let these A holes..." Duh!



Jetblue320,

Sorry about the mis-spelling. I am so used to spelling something easy like "Leo" and "Fred Reid" etc. I will get it right next time.

Bye Bye--General Lee

 

[Heavy Set]

Ty,

You need to chill out. Take some prozac. I re-read your post and I still have no clue what you are talking about.... You don't want higher wages? Would you rather the industry average be lower so that you could then finally say you are at the top? General Lee is zealous about getting the Delta furloughees back in their airplanes. Your predictions about "legacy" carriers are a bit premature - if United has not gone out of business yet despite SARS, 9/11 and a rough Chap. 11 filing, why should you expect Delta and the other majors to go under soon? The economy is improving - despite your negativity. Business passengers are slowly returning. Things are getting better...

Time to chill out a bit and reduce your hostile responses....

Wave to the Comair guys in Flint for us!

Cheers

 

[V2+10]

General Lee...

First things first. Over 1000 posts on this board alone! That is truly impressive. It might even be a record. You must be proud. I've gotta ask...when do you find the time to fly?!

Secondly, you really seem to have one great big blue thorn up your a$$. For the most part, many of your posts on this board are somewhat informative...as long as you are not talking about jetBlue that is. You really come across as having some sort of deep rooted vendetta for some reason. I'm not really sure why. Anyway...get over it.

It's obvious that you are very proud of your red, white, and blue (DL), and of course your lime green and white (also DL). You should be, and I would expect no less. DL has many fine folks, that I'm sure includes yourself, that care a great deal about the airline. However please remember that the folks over at B6 also have some very talented and dedicated individuals. They too care a great deal, and I'm sure have tremendous pride in what they do.

Stop throwing arrows. It's not very becoming.

V2