The Stock to Own in this Out-of-Favor Sector

David Sterman's picture

Friday, January 22, 2010 - 11:28am

by David Sterman

It’s been more than a decade since JetBlue’s (Nasdaq: JBLU) planes first took to the skies. As the company’s business model gained altitude, consumers have continually voted for JetBlue as their favorite carrier. Yet even with its legions of fans on Main Street, supporters on Wall Street are harder to find: shares have steadily fallen, from $30 in 2003 to the mid single digits these days. A massive oil spike, followed by an unprecedented economic downturn, has put the whammy on profits. But those clouds are parting, and the low-cost carrier looks ready to climb back to cruising altitude.

To be sure, airline stocks have already recovered off of their 2009 lows, especially carriers most at risk of bankruptcy, such as UAL (Nasdaq: UAUA), parent of United Airlines, and AMR (NYSE: AMR), parent of American Airlines. But if history is any guide, airline share prices should keep rising as investors see profit margins steadily rebound from a combination of sharp cost cuts and rising traffic. Right now, profit reports highlight the heady cost cuts. In the next several years, rising revenues should expand bottom lines.

Of course, investors remain wary that the economy will truly emerge in fighting shape, which could bring new troubles for the legacy carriers with high debt levels. In this industry, a rebound in profits can quickly lead to unexpected losses when air travel slumps. The charm of JetBlue is its rain-or-shine business model. The carrier has been able to maintain a healthy balance sheet and a lean cost structure, which has enabled JetBlue to report an operating profit every year since 2001. Larger carriers have a habit of losing loads of money whe the economy is not at full bore. So if the economy sinks anew, JetBlue is far better-positioned to weather the storm than its larger brethren.

More than likely, though, the economy is headed for a rebound as unemployment peaks and the process of job creation -- and consumer spending -- starts anew. And JetBlue, with nearly $1 billion to spend, can continue to expand its route network, while some of its larger peers must conserve cash in the face of still-high debt loads.

So what’s the growth plan? For starters, JetBlue has emerged as a key player in the Caribbean vacation market, serving an increasing number of island countries from its Northeast and Florida hubs. As tourism rebounds, the carrier can expand the number of flights serving those destinations. In addition, the company has shed some programs that were initially put in place to win the heart of consumers. These days, you’ll pay much more to make a last-minute flight change, and the company’s website does a much better job of squeezing higher revenues on flights where few open seats remain. The international expansion and pricing changes haven’t yet perked up profits (thanks to the double-hit of an energy spike and an economic crash), but they soon will.

How tough has it been? In the third quarter of 2009, the average paid fare was just $127, -11 % below year-earlier levels. But a drop in fuel costs, and a sharp eye on other operating expenses enabled the carrier to revert from a loss in the third quarter of 2008 to a small profit in the same period a year later -- despite those lower seat prices.

Now, the trick is to boost ticket prices back to pre-recession levels. That has already started in recent months, and thanks to far fewer planes flying across the industry, it now looks as if carriers, including JetBlue, will be able to push prices back up over the course of 2010. If sales and profits start to rise as expected, JetBlue is likely to move back on to the expansion track.

The airline industry is very sensitive to demand. A plane that is 70% full is a money loser, while a plane that is 90% full is a big source of profits. JetBlue saw its load factor fall below 80% for the first time in 2009, yet still managed to eke out a profit. In 2010, analysts expect the load factor to climb back into the low 80s. Analysts also expect per share profits to rebound back to the $0.40-$0.50 range -- impressive considering 2010 is likely to be a tepid year for economic growth and consumer spending. By 2011, JetBlue’s profit picture could prove even brighter.

David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.