Cloudy skies ahead for jetblue – jetblue airways corporation (nasdaq jblu) seeking alpha electricity projects for class 12


There were two pieces of news in the past month that have made the near term future for JetBlue quite dim, especially when combined with 2017’s subpar operating performance. At first glance, it appears the company did very well in 2017, increasing earnings 51.12% from $759 million to $1,147 million. However, reading through the annual report reveals that the gain was due to the new tax reform laws favoring lower corporate taxes. When looking at the actual operating performance, the company seems to be heading in the wrong direction.

From 2016 to 2017, operating income dropped from $1,312 million to $1,000 million. Perhaps surprisingly, this increase came despite an increase in both operating revenues and "Revenue Passengers" (which represent total number of passengers). So on one hand, it seems that demand for JBLU is growing. Over the past 5 years, the average growth for Revenue Passengers has been 7.093% per year. This falls in line with total top line growth, which has seen an average of 6.59% growth per year over the same time period. However, expenses are increasing faster than this demand; and it’s been the lower average fuel costs of 2017 that allowed revenue to increase faster than demand in the past year. Attached is a picture of the breakdown in operating income so we can get a better sense of what the short term trend of the company’s operating performance has been, what the numbers really mean, and how the recent news pieces might impact operating income moving forward.

As we can see, the two biggest expenses for the airline are "Aircraft fuel and related taxes" and "Salaries, wages and benefits". At first glance, it may appear that 2017 was a more expensive fiscal year in regards to fuel costs, as it was 26.9% higher than 2016. However, looking at fuel costs from 2013 – 2014 shows that previous levels hovered around $1,900. The most important difference in fuel costs over the last 3 years is how they have impacted operating margin. Notice how operating margin in 2015 and 2016 was both above 19%, while operating margin in 2017 was 14.3% despite similar fuel cost levels.

It becomes evident now that Salaries, wages and benefits are outpacing demand growth and that is suppressing margins. Plotting that expense in a graph would show a straight linear increase every year, with the average increase over the past 5 years showing as 13.6% per year.

How important is keeping labor costs down? Consider that one of Warren Buffett’s most successful stock purchases, The Washington Post back in 1973, was able to aggressively grow return on equity, share repurchases, and dividend payments through a relentless cutting of wage expenses; even winning a bitter battle against unionized workers in order to make that happen. This was all documented in The Warren Buffett Way by Robert Hagstrom, for those of you who are interested in an in-depth summary of that story.

Playing devil’s advocate, JBLU states clearly in their 10-k that one of their competitive advantages is their "Differentiated Product and Culture". They stress the importance and focus of customer service and the customer experience throughout each stage of the flying process, from check-in to in-flight to keeping flights as scheduled. The company boasts an impressive 97.3% scheduled flight completion in 2017, achieved through their dedication to avoiding overbooking their flights. It’s possible that increasing, generous wages will assist the company is this goal of differentiated culture, which would increase the brand’s goodwill and hopefully spurn higher demand in the future.

Now that we have better insight on the stock’s operating income components, let’s look at two recent pieces of news that have the potential to impact the developments in the income statement. The first was reported here on Seeking Alpha. Airline fares dropped 6.9% YOY in the month of April, possibly due to increased competition on the discount airline flights space, which is JetBlue’s domain. As mentioned in the Risks Section of the company’s annual report, a substantial movement into the space by one of the major airlines such as American Airlines, Delta, or United. To understand how this drop in airline fares may affect JBLU, it’s helpful to examine the breakdown of operating income once again and this time compare it to top-line revenue. Metric

Take note of how closely the changes in revenue passengers and average fare follow the changes in the company’s revenue. In 2014, there was growth in revenue passengers of 5.3% and growth in the average fare of 2.07%. Now add the two growth figures for a total of 7.37%, which is within a percentage point of the revenue growth of 6.91%. The same applies to 2015 – 2017.

The new YOY decrease in the average fare of 6.9% would likely result in a similar decrease in revenue for 2018 if revenue passengers doesn’t change from its 2017 level. However, remember that the trend line for revenue passengers over the last 5 years has seen an average of around 7% growth per year. It’s probable that can be sustained, thus offsetting a likely decrease in the average fare for 2018 based on recent figures. All other factors ignored, this would mean a flat 2018 revenue change and final result of around $7,015 million. Were "salaries, wages and benefits" to continue its increase of around 13.6% per year, operating income would fall around 13.6% in 2018 in this sort of a scenario.

This chart corresponds with what we saw earlier in JBLU’s fuel cost expenses. However, what I really want to see is how the changes in price are affecting production. Remember basic economics 101, an increase in supply would likely result in a decrease in price, and vice versa.

Supply has seen a recent sharp decrease, which confirms the other news piece I wanted to report on. In an article by CNBC at the end of April, fuel prices were set to surge and earnings projections for American Airlines were trimmed as a result. While this could be offset by an industry-wide increase in the average fare price, it’s often not a 1-for-1 correlation. The fact that many of these airlines are heavily competing on price already could result in a sort of "who’s the first to flinch" contest. This second development could very well also counter-act the reported YOY drop in average fares as the rest of the year goes on. It’s not easy to tell as of right now, but both pieces of news do seem to support a bearish thesis for 2018. The Bottom Line