Download pdf - JBLU Equity Research

JetBlue Airways Corporation (JBLU)

NASDAQ | Industrial | Airlines

BUY Price Target $27.00 | Price $16.25

$-

$2

$4

$6

$8

$10

$12

0

2,000

4,000

6,000

No

v 1

2

Dec

20

12

Jan

13

Feb

13

Jun

e 1

3

Ap

r 1

4

May

14

Sep

14

Historical Repurchases

Number of Shares Purchased (in thousands)

Average Price

5

10

15

20

25

30

35

0 1 2 3 4 5 6 7 8 9 10

P/E

P/B

P/B, P/E Comparison (1/27/15, TTM)

4

9

14

19

0 1 2 3 4

EV/E

BIT

DA

EV/SALES

EV Multiple Comparison (1/27/15, TTM)

$6

$9

$12

$15

$18

$21

$24

$27

$30

Historical Price (1/27/15, TTM)

2017E 2018E 2019E

EPS $3.60 $3.96 $4.22

Payout Ratio 5.46% 6.01% 6.39%

Dividend $0.20 $0.24 $0.27

Cash Paid 57 69 79

Yields (%) 0.85% 0.91% 0.91%

Dividend Scenario

Flying High with JetBlue

JBLU shares are currently underpriced compared to its market peers on a P/E,

P/B, EV/SALES, and EV/EBITDA basis. Our fundamental analyses confirm that the

company is undervalued. We issue a BUY recommendation on JBLU with a price

target of $27 per share, which represents a 66% upside from the closing price on

Jan 27, 2015. We base our recommendation on the following catalysts:

Change in Leadership: In February 2015, the current CEO David Barger will be replaced by the current president Robin Hayes. Historically, Barger has served a customer friendly approach to business, as opposed to one focused on JBLU’s investors. Robin Hayes has demonstrated his investor oriented management by leading JBLU’s implementation of changes that will provide greaster returns for its investors. These changes include a new fare system and cabin restructuring. In a recent press release, Hayes made the following statement: “The airline industry has never been more competitive, but I believe we can continue to grow profitably. As we maintain our operational focus on safety and efficiency, we will continue to expand our network in underserved markets and roll out new products that enhance the JetBlue Experience and create value for our shareholders…”

Latin American Dominance: JBLU generates 20.2% of its revenues from LatAm,

representing an important part of its business model moving forward. JBLU

continues to offer new routes in addition to deploying greater capacity to the

region. With a 25% CAGR in LatAm operations over the past 6 years, this strategy

has continued to be an internal form of growth for JBLU. As U.S. relations with

Cuba improve and lucrative opportunities exist in Brazil and Mexico, we believe

that JBLU further capitalize on LatAm growth.

Low Oil Prices: Jet fuel generally accounts for 30-35% of JBLU’s operating

expenses. In recent months, the price of oil plummeted due to excess supply,

primarily because of increased global oil production. Meanwhile, emerging

markets have experienced lagging demand growth for oil as well. Current oil

prices are trading at less than 50% of their June 2014 value. As the price of oil

continues to remain low we are confident that JBLU will improve its margins.

Strong Future Free Cash Flow: As industry experts agree that low oil prices are

likely to continue in the foreseeable future, we expect that JBLU’s short-term

margins will increase. JBLU is deferring aircraft acquisitions scheduled from

2016-2018 and 2022-2023, saving $900 million of CAPEX during our projected

period. Furthermore, the new fare system will generate greater future cash flow

as well.

Rewarding Shareholders: With a forecasted cash balance of $1bn in 2016, JBLU

will have the ability to accelerate its share repurchase plan or declare a dividend

payout. Based on our valuation of JBLU, we believe the company is undervalued

and will repurchase more shares to return value to shareholders. Additionally,

JBLU may face pressure from institutional shareholders to pay dividends as cash

flow increases.

PT

66% Upside

JBLU

VA

LUV

SAVE

WJA ALK

JBLU

LUV

ALK

VA

SAVE

ALGT

RJET

ALGT

WJA RJET

JBLU | Price Target $27.00 Jan 27, 2015

4,550 4,971 5,257

71

74 77

361

396 421

3,000

3,500

4,000

4,500

5,000

5,500

6,000

2012 2013 2014E

Figure 1. Historical Revenue Structure

Passenger Baggage fee Other

0

50

100

150

200

250

2012 2013 2014 2015 2016 2017 2018

Figure 3. Change in Fleet Structure

A320 A321 E190

Business Description

Revenue

JBLU generates a majority of its revenue from transporting passengers. In 2013,

91.4% of revenue came from airfare, 1.4% from baggage fees and 7.3% from

other sources such as reservation change fees and transportation of cargo.

Through an innovative business model and successful expansion of destination

cities and routes, JBLU’s revenue has exhibited an astonishing CAGR of 18% over

the past decade.

Blue Cities JBLU’s focus cities include JFK, BOS, FLL and MCO. Currently, JBLU has 36.5% of

JFK’s market share and is displaying greater emphasis on international route

expansion from this hub. JBLU has exhibited expansion by opening its T5i

terminal, which is designed to facilitate international departures and arrivals at

JFK. In 2013, JBLU transported nearly 4 million passengers at BOS and continued

to successfully utilize FLL as a strategic hub for expansion into LatAm. JBLU has a

market share of 14.1% at MCO and is currently expanding into other airports

such as DCA, where its flights doubled from 2011-2013. JBLU has rapidly

increased the number of destination cities it offers while increasing revenues

and profitability (Appendix 5-8). While the company only offered 21 destinations

in 2003, today, the company provides 57 destinations in the U.S. and 30

destinations in LatAm. JBLU has experienced a CAGR of 32.8% in LatAm from

2007-2013.

JBLU Experience

According to J.D. Power and Associate’s 2014 surveys, JBLU was ranked first in

customer satisfaction rating for Low Cost Carriers (LCC) and Low Cost Airline

Segments. Customers were especially satisfied with JBLU’s check-in, in-flight,

and flight crew service experience. JBLU customers enjoy 36 channels of free

satellite TV as well as the industry’s fastest inflight Wi-Fi product, Fly-Fi, on

selected flights. The airline is well known for providing an industry leading seat

pitch of 34.7 inches and has unique customer centric policies such as the

Customer Bill of Rights and the no overbooking policy.

Fleet Structure JBLU is currently operating 130 A320s, 13 A321s and 60 E190s. In 2013, JBLU

cancelled an order of 12 E190s and deferred the delivery of 24 E190s scheduled

from 2014-2018 to 2020-2022. JBLU is choosing to replenish its fleet with A321s,

which have better fuelefficiency and greater seat capacity. The new aircraft

delivery plan signals that JBLU is focusing on improving efficiency and capacity

to satisfy its growing customer demand.

Shareholder Structure

JBLU boasts a strong institutional holding of 71.26%. This high level of institutional ownership can be viewed as a sign of confidence from the overall market. JBLU’s remaining outstanding shares are held by the board of directors and other minority stakeholders at 1.46% and 27.28%, respectively (Appendix 27).

Source: Team Estimate

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

Figure 4. Industrial vs. GDP Growth

Airline Industry GDP

Source: Trading Economics

0

10,000

20,000

30,000

40,000

50,000

0

60,000

120,000

180,000

240,000

300,000

FIgure 2. Historical # of Departures

Domestic International (right)


Source: JBLU


Industry Overview & Competitive Positioning

U.S. Economy and Airline Industry Overview

A key indicator of success in the airline industry is economic strength. Supported

by a 5.6% unemployment rate, the U.S. has exhibited strong GDP in Q3 and Q4

with 4.2% and 5% annualized growth, respectively. The World Bank expects that

U.S. GDP will grow roughly 3.2-3.6% in 2015, which will result in increased

discretionary income for Americans, benefiting the airline industry. Due to

strength in the economy, we expect GDP growth. However, we remain cognizant

that substantial decreases in oil prices could temporarily disrupt GDP growth

moving into 2015.

Another key indicator of airline industry success is the Consumer Confidence

Index. In 2008 the CCI reached a record low of 25.3. As of the end of 2014, CCI

increased to 92.6, its highest level since January 2007. In the U.S. airline industry,

we discovered a strong -20% correlation between increases in the CCI and

increased travel demand. With the U.S. appearing to have a strong economic

outlook, we expect consumer sentiment to show an uptick, leading to increased

levels of travel.

Recently, airfare has increased in proportion with the Consumer Price Index.

From 2000- 2014, the CPI increased 40% while market fares only increased 16%.

Airfare was maintained between $300 and $360 before 2008 and plummeted

during the financial crisis. Since the crisis, fares have quickly regained their

previous highs and are now increasing in direct correlation with increases in the

CPI. We expect airfare to continuously rise in correlation with the CPI because of

the high load factor that the industry is experiencing. With 1.6% and 2% growth

in the CPI expected for 2015 and 2016 respectively, we expect the airline

industry to increase airfare, margins, and profitability.

Latin America

LatAm provides opportunities for growth and profit. As the number of U.S.

travelers to LatAm has increased, the number of destinations and routes offered

to this area have increased as well (Appendix 24). According to the International

Air Transportation Association, airline industry profits grew 250% in LatAm for

2014 in comparison with a year earlier, and are poised to grow 43% in 2015. We

believe strong economic conditions in the U.S. will increase the number of

travelers to LatAm in the near future. JBLU is dominant in LatAm compared to

other U.S. LCCs and we expect the company to benefit from increased travel.

Oil Price Outlook The WTI crude oil price plunged to $46.23 per barrel as of Jan 27, 2015 from

$106.91 per barrel on June 13, 2014. Jet fuel prices have followed an almost

identical trajectory. Since fuel expenses represent the largest expense account

for the airline industry, the price decrease has helped to improve JBLU’s profit

margin significantly. In line with industry experts, we expect jet fuel costs for

airlines to remain low. According to the International Monetary Fund, the

forecasted average WTI crude oil price will be $56.70 in 2015 and $63.90 per

barrel in 2016. The IMF’s oil price outlook is conservative and we have applied it

to our projection model.

Source: DOT, World Bank

150

170

190

210

230

250

300

350

400

450

500

Figure 5. Fare vs. CPI

Fare CPI

0

1

2

3

4

5

0

50

100

150

200

Figure 7. Historical Prices of WTI and Jet Fuel

WTI Jet Fuel (Right)

9

11

13

15

17

200

250

300

350

400

Figure 6. Fare vs. S&D Gap

Fare S&D Gap (right)

Source: DOT, EIA, OPEC

Source: EIA


0%

2%

4%

6%

8%

10%

12%

14%

2014E 2015E 2016E 2017E 2018E 2019E

Figure 9. Profit Margin

Strong Presence in Northeast America and Latin America

JBLU has the greatest presence of any U.S. LCC in LatAm allowing it to capitalize

on rapid growth. The number of U.S. travelers to Mexico, the Caribbean, and

Central America showed 12.4%, 9.9%, and 9.2% growth, respectively from 2013-

2014. During the same period, U.S. travel to the rest of the world had

approximately a 2% growth rate. In 2008, LatAm destinations only included

Puerto Rico and since then JBLU has rapidly expanded to offer 30 destinations

reaching as low as Lima, Peru. JBLU will continue to expand to LatAm by

launching 3-5 new routes in 2015. Expansion into LatAm will be critical as the

number of U.S. travelers visiting this part of the world is expected to grow.

Pricing Power

Research shows that JBLU has strong pricing power. While JBLU is considered to

be a LCC, for many routes, JBLU’s fares are higher than those of legacy airlines

such as DAL and UAL. For example, on the BOS-MCO route, JBLU’s weighted

average fare price is 23.5% more expensive than fares offered by DAL. As JBLU

maintains a high load factor on these routes along with higher fares, it

demonstrates that customers are willing to pay higher prices for its superior

customer experience (Appendix 26).

Entertainment Service

According to the Airline Passenger Experience Association (APEX), more than 47%

of passengers spend their time in-flight using the airline’s entertainment options

or personal devices. JBLU’s products, including its Wi-Fi and television channels,

are considered to be industry leading and make JBLU a very attractive option for

customers. JBLU will complete Fly-Fi installation on its entire A320/A321 fleet in

the first half of 2015 and will begin installing this service on the E190 fleet

thereafter. Fly-Fi has a 43% take rate which is substantially higher than

competitors such as Go-go and Row44. DIRECTV, JBLU’s inflight TV system

provides 36 channels of live TV. We believe that industry leading in-flight Wi-Fi

speeds along with DIRECTV’s channels will attract more business travelers who

need to stay connected 24/7, as well as young passengers who value JBLU’s

technological capabilities.

Airline Partners – Codeshare and Interline Agreement

Codeshare and interline agreements with larger airlines that operate

internationally benefit JBLU. Through codeshare and interline, JBLU provides

more destinations to its customers and carries the passengers of its larger

partners. JBLU has 38 agreements as of December, 2014. Compared to other

LCCs in the U.S., JBLU has the largest number of airline partners, and only trails

their Canadian rival WestJet by one partner.

Strategies

Sky High Profit Margin

As of the end of 2014, JBLU is the only airline aside from LUV to refrain from

charging fees for its customer’s first checked bag. In 2013, JBLU earned $74

million in revenue from checked bag fees, accounting for only 1.4% of total

Figure 8. Fly-Fi vs. Others

Source: JBLU

Table 1. LatAm Destinations

JBLU LUV SAVE VA Frontier SCA

30 12 26 0 10 16

Source: Company Websites

Table 2. Codeshare and Interline Agreement

JBLU VA WJA LUV SAVE

C/S 10 3 11 0 0

I/L 28 25 29 0 0

Total 38 28 40 0 0

Source: Company Data



0%

10%

20%

30%

40%

50%

2009 2010 2011 2012 2013 2014Oct

Figure 12. Brazilian Airline Market

TAM GOL AZUL

revenues. This is considerably lower than checked bag fee revenue of other

airlines. During its 2014 Investor Day, JBLU announced that it will introduce a

new fare system during the first half of 2015 and that the lowest fare will not

include free checked bags. The change in JBLU’s fare system is expected to

increase revenues by $175mm in 2015 and $508mm in 2016, without adding

additional costs (Appendix 11).

Seating the Fleet

During its November 2014 Investor Day, JBLU announced a seat expansion plan

for its A320 aircrafts that will take place in 3Q16. JBLU plans to retrofit A320

aircrafts with refreshed cabins, adding 15 more seats to each plane by decreasing

the average seat pitch. The average seat pitch will be decreased from 34.7 to

33.1 inches, but according to management, JBLU will be able to maintain a high

level of customer satisfaction by replacing the old seats with new seats. Despite

reducing the average seat pitch, JBLU will still maintain its industry leading

position. The change will require additional flight attendants to be onboard, but

the 10% increase in passenger capacity will be more than substantial enough to

compensate for additional expenses. JBLU will utilize the increased number of

seats to further improve its revenues while adhering to its core competencies

surrounding customer satisfaction.

Minting Success

In June 2014, JBLU introduced a new service, Mint on JFK-SFO and JFK-LAX routes.

Mint is a premium service targeted at business flyers that offers the longest lie-

flat bed in domestic business class, as well as the only private suites on these

transcontinental routes. Mint also includes other luxurious amenities such as the

highest level of comfort, the fastest Wi-Fi, and upgraded entertainment systems

on larger screens. According to management, during 2014, Mint significantly

improved transcontinental margins and the company was able to turn losses into

profits on both routes. Mint services are offered at an approximate 35% discount

in comparison to DAL, who provides the industries next best cost alternative. As

Mint services mature, we are confident that JBLU will gradually raise prices and

increase its profit margin. JBLU will increase the number of premium service

routes as the company acquires 63 A321 aircrafts through 2019.

Latin America: Partnership and Growth

Brazil is the largest country in LatAm accounting for more than 30% of the total

population. We expect the number of travelers from Brazil to the U.S. to grow as

the Brazilian economy further develops. Securing Brazilian travelers would

benefit JBLU significantly and we believe LatAm expansion will occur through the

Brazilian based company, Azul Airlines. Although JBLU is currently in an interline

agreement with TAM, Brazil’s market share leader, we believe that a partnership

with Azul Airlines will benefit the company, given its rapidly growing market

share in Brazil. Azul recently introduced its first international routes, all of which

fly to JBLU hubs. In a recent press release, former JBLU CEO and current Azul CEO

David Neeleman discussed a potential partnership with JBLU.

With diplomatic relations rapidly improving between the U.S. and Cuba, JBLU will

likely have the opportunity to expand in the country. Currently, JBLU is one of

Figure 11. Mint Premium Service

Figure 10. Seat Pitch

36% 20%

Source: Brazil’s ANAC, Bloomberg

Source: JBLU

Source: JBLU


few companies flying to Cuba from the U.S., strategically positioning itself well

against other airlines. Opportunities for increased revenues exist, especially due

to the high population of Cuban Americans in the Miami-Fort Lauderdale area

where JBLU has established a strong presence. However, ambiguity exists

surrounding the benefits at this point in time.

Mexico provides growth opportunities for JBLU. With increased Mexican

travelers entering the U.S., JBLU will likely attempt to capitalize on growth

opportunities by adding beyond the proposed Mexico City route. Over the past

two years, the number of travelers from the U.S. to Mexico has demonstrated

7.6% and 11.8% growth, respectively. From 2013 to 2014, the number of

Mexican travelers to the U.S. increased by 20% (Appendix 23).

Investment Summary

JBLU shares are currently underpriced compared to its market peers on a P/E,

P/B, EV/SALES, and EV/EBITDA basis. Our fundamental analyses confirm that the

company is undervalued. We issue a BUY recommendation on JBLU with a price

target of $27 per share, which represents a 66% upside from the closing price on

Jan 27, 2015. We base our recommendation on the following catalysts:

New Management on the Runway

The replacement of the current CEO, David Barger, with Robin Hayes creates

many opportunities for investors. Since the announcement of the CEO change in

September 2014, JBLU has worked to satisfy its investors by making decisions

that will increase efficiency and profitability. These decisions include the

implementation of baggage fees through a new fare system, planned reduction

of future CAPEX, and decreases in seat pitch. Additionally, Robin Hayes recently

said JBLU will expand its target market to include business travelers in addition

to its leisure fliers. The company will be implementing a Sabre owned software

called Prism, which will help JBLU monitor market share and prices when

negotiating corporate deals to generate new business. Hayes believes that

access to this information will be key in staying competitive in the small to

midsize company corporate market.

Propelling Efficiency

JBLU has been plagued by steep increases in its maintenance expenses since

2011, primarily due to unexpected engine overhauls of E-190s. As a result, JBLU

is promoting higher efficiency by amending its fleet acquisition plan. JBLU

cancelled 12 orders of E-190s while deferring the delivery of 24 E-190s which

were scheduled to be delivered from 2014-2018 and 2020-2022. After

unpleasant experiences with its E-190s, JBLU is in talks with the manufacturer to

replace 24 of these aircrafts with E-190-E2s. JBLU is also striving to improve its

Airbus fleet efficiency. In 2013, the company converted eight A320 orders to

A321s and 10 A320neo orders to A321neos. JBLU ordered an additional 15 A321s

for delivery between 2015 and 2017 and 20 A321neo from 2018-2020. A321s

have high levels of fuel efficiency, which will benefit JBLU when oil prices rise in

the long term.

Figure 14. Fuel Efficiency Comparison

Figure 13. Cuban Demographics in U.S.

67.96%8.63%

4.96% 18.44%

FL NY-NJ CA Others

Source: 2010 Census

Source: JBLU


Large Free Cash Flow - Accelerated Share Repurchases or Dividend Payouts

We are confident that JBLU’s free cash flow will significantly increase over the

next five years. New products, services, and changes will contribute to improving

JBLU’s top line while minimally affecting expense accounts. Additionally,

deferred capital expenditures will increase its free cash flow by $900mm during

this period. The oil market outlook is favorable for JBLU and will further

contribute to a strong bottom line.

We estimate JBLU’s cash balance to be $1bn in 2016 inclining Robin Hayes to

accelerate the companies share buyback program. In Appendix 20, we projected

how costly a repurchase scenario would be, followed by a forecasted increase in

EPS. By 2019, JBLU can boost its EPS by 10% if it doubles its current 25mm share

buyback program. Based on our valuation of JBLU, we believe the company is

undervalued and will repurchase more shares to return value to shareholders. In

line with its competitors, JBLU may initiate a dividend payout. WJA and ALK

started paying dividends when their cash and short term investment balances

reached $1bn. Since we project JBLU to experience similar financial flexibility in

2016, the company will experience pressure from institutional shareholders to

pay dividends in 2017.

Valuation

I. DCF Valuation

We used a Discounted Cash Flow (DCF) valuation to derive the intrinsic value per

share of JBLU to be $27. We believe that the DCF method is suitable for valuing

JBLU due to the changes that the company is implementing. These changes will

create a substantial increase in JBLU’s future free cash flow when compared to

its historical free cash flow.

Passenger Revenue (Price × Quantity)

We multiplied the projected average fare (P) by the estimated number of

passengers (Q) to forecast JBLU’s passenger revenue from 2014-2019 based on

the following assumptions:

Departure (’14-’15): We incorporated new routes launched in 2014 and assumed that routes from the year 2013 will continue to operate. We then assumed that routes from 2013 and 2014 will continue to operate in 2015.

Departure (‘16-’19): We analyzed the historical number of departures of each aircraft, and we assumed that JBLU would maintain its 2015 rate from 2016-2019. We then multiplied the number of operating aircrafts, including the planned delivery of new aircrafts, to estimate the number of departures for this period.

Passenger per flight: We assumed that the number of passengers per flight would increase in correlation with an increase in weighted average seat capacity. Multiplying the estimated passengers per flight by the number of projected departures each year resulted in the number of revenue passengers.

Average fare: We assumed that the average fare price would increase in correlation with the expected increase in CPI. Please see Appendix 10 for

further details and explanation.

$3.28 $3.52 $3.85 $3.38 $3.78

$4.29

$-

$1

$2

$3

$4

$5

2017E 2018E 2019E

Figure 15. Share Repurchase Scenario

No repurchase 25mm shares


$155

$160

$165

$170

$175

$180

$185

20,000

25,000

30,000

35,000

40,000

45,000

50,000

Figure 17. Fare and Passenger Forecast

Passenger (in millions)

Average Fare


0.76%

0.80%

0.84%

0.88%

0.92%

0.96%

$-

$0.05

$0.10

$0.15

$0.20

$0.25

$0.30

2017E 2018E 2019E

Figure 16. Dividend Scenario

Dividend Yields (%)



Baggage Revenue There is no detailed information regarding prices of the new fare system to be implemented during the first half of 2015. We assumed that the new fare system will reflect the difference in baggage revenue because the greatest difference in the new fare system will be the number of free checked-in bags provided to each class. We projected baggage revenue based on the following assumptions:

Baggage fee per unit: We assumed the industry low checked baggage fees that ALK charges its customers, $25, will be JBLU’s fee per checked bag.

Number of passengers with bags: During the 2014 Investor Day,

management stated that 50% of its customers travel without bags. Based on

this statement, we assumed that 50% of JBLU’s passengers fly with at least

one bag. As a result of our analysis on baggage fees and the number of JBLU

passengers over the past three years, we found that 5% of JBLU passengers

check in two bags.

Baggage revenue projection: Based on our findings, we forecasted a charge

of $25 to 50% of the projected number of passengers, and then included an

extra charge of $25 to the 5% of customers who will be checking a second

bag.

Please see Appendix 11 for further details and explanation.

Fuel Cost

Fuel consumption: We discovered a consistent relationship between fuel

consumption and ASM, especially over the past three years. We assumed

that JBLU will maintain this ratio, and continue to adjust its fuel

consumption in proportion to changes in ASM.

Fuel price: Historically, jet fuel prices have been adjusted in correlation with changes in WTI crude oil prices. We adjusted JBLU’s estimated average fuel cost per gallon based on our projection of crude oil prices from 2015-2019. For the unit price in 2014, we used the weighted average of 1-3Q actual and 4-Q forecast data provided by JBLU.

Please see Appendix 12 for further details and explanation.

Capital Expenditure JBLU’s 2013 annual report provides estimated capital expenditures from 2014-

2018 and years thereafter. We used the airline’s estimate in computing free cash

flow. However, JBLU announced deferred delivery of 18 aircrafts scheduled from

2016-2018 and estimates to save $900mm of CAPEX over this period. We

deducted the airline’s original estimates by $300mm annually from 2016-2018.

Weighted Average Cost of Capital (WACC)

Weighted Average Cost of Capital (WACC) Cost of Debt While the cost of capital leases are not separately stated on JBLU’s financial

statements, the airline still incurred implied interest expenses from leasing

aircrafts. Therefore, in addition to outstanding bonds, capital leases should be

accounted for when calculating the cost of debt. JBLU’s most recent 10-Q stated

that the weighted average interest rate of its long-term debt and capital lease

obligations is 4.8%. We used this rate as the cost of debt.

0

200

400

600

800

1,000

1,200

2015E 2016E 2017E 2018E 2019E

Figure 21. CAPEX Forecast (in millions)

Source: JBLU

$-

$0.50

$1.00

$1.50

$2.00

$2.50

$3.00

-

200

400

600

800

1,000

2015E 2016E 2017E 2018E 2019E

Figure 19. Fuel Consumption& Price per Gallon

Fuel consumption

Price per gallon (right)


$3,000

$4,000

$5,000

$6,000

$7,000

$8,000

$9,000

2013 2014E 2015E 2016E 2017E

Figure 18. Revenue Forecast (in millions)

Passenger Baggage fee Other



$-

$1

$2

$3

$4

2014E 2015E 2016E 2017E 2018E 2019E

Figure 21. EPS Forecast

$(0.50)

$-

$0.50

$1.00

$1.50

$2.00

$2.50

2014E 2015E 2016E 2017E 2018E 2019E

Figure 22. Residual Income Forecast

Cost of Equity Risk-free rate. We used the average 10-year U.S. Treasury bond rate in

2014 (2.17%) as our risk-free rate.

Beta. We unlevered the betas of seven competitors and computed the weighted average of the unlevered betas on their market capitalization, which resulted in an average of 1.07. We re-levered the unlevered beta based on JBLU’s capital structure provided by its most recent 10-Q. We used a beta of 1.41 for our WACC calculation.

Market premium. We used the U.S. market risk premium in 2014, (5.78%) as estimated by Professor Aswath Damodaran of New York University.

Terminal Value We used the Gordon Growth method to determine the terminal value. We assumed JBLU’s free cash flow would increase 1.82%, based on the OCED’s U.S. GDP growth forecast rate from 2020-2060.

II. Residual Income Valuation The Residual Income Model (RIM) focuses on residual earnings attributable to shareholders. This model is suitable for JBLU because we anticipate substantial increases in earnings, which can be attributed to a more lucrative business model and significant reductions in jet fuel expenses.

EPS We estimate 2014 EPS to be $0.64 per share (Appendix 16), excluding the sale of LiveTV in March 2014. We are bullish on the airline’s EPS estimate from 2015-2016 as JBLU will benefit from lower oil prices and its planned operational changes. Residual Income We projected residual income by subtracting the required return on book value from the estimated earnings per share. JBLU should generate a minimum return equivalent to the cost of equity with the given book value of equity. Any earnings exceeding the required level of 10.32% will be regarded as residual income paid to shareholders. We expect JBLU’s residual income to rapidly increase in 2015 and 2016 because of a favorable business environment. After 2019, we assumed that residual income would increase at 1.82% in perpetuity (Appendix 16).

Table 3. WACC

WACC

Risk-free rate 2.17%

Beta 1.41

Market risk premium 5.78%

Cost of Equity 10.32%

Cost of debt 4.80%

Tax rate 35%

Cost of debt, after tax

3.12%

Weight of equity 67%

Weight of debt 33%

WACC 7.93%






$0 $10 $20 $30 $40

EV/Sales

EV/EBITDA

P/B

P/E

Figure 23. Comparable Analysis

25th Percentile 75th Percentile

III. Comparable Company Analysis Comparable companies were chosen from the NYSE Arca Airline Index based on similar market capitalization and business models. Insufficient financial information was available regarding private LCCs. We used TTM data as of January 27, 2015 to derive the following multiples.

Company P/B P/E EV/S EV/EBITDA

JBLU 1.99 15.19 1.11 8.24

Peer Median 4.31 15.77 1.63 9.35

ALK 4.31 15.77 1.63 7.03

SAVE 6.07 27.20 2.74 13.61

LUV 4.58 27.98 1.65 9.35

WJA 2.31 15.26 0.96 5.74

VA 3.65 14.52 1.03 12.60

ALGT 9.45 33.41 3.16 13.81

RJET 1.18 10.22 2.04 7.00

The above table suggests that JBLU is undervalued compared to the median

multiples of its comparable airlines. Our comparable company analysis confirms

that JBLU is valued in the range of $20-$30. Our DCF valuation of $27 per share

falls within the median range of P/B, P/E, EV/SALES and EV/EBITDA.

Financial Analysis

Source: FactSet

Ratio 2012 2013 2014E 2015E 2016E 2017E 2018E 2019E

Profitability

EBIT Margin 7.5% 7.9% 7.6% 22.9% 22.8% 20.7% 19.8% 20.3%

EBITDA Margin 12.7% 13.2% 13.2% 28.4% 28.1% 26.0% 25.1% 25.6%

Profit Margin 2.6% 3.1% 3.0% 12.3% 12.8% 11.7% 11.5% 11.8%

ROA 1.8% 2.3% 2.4% 10.0% 11.3% 10.7% 10.5% 10.5%

ROE 6.8% 7.9% 7.8% 26.5% 24.7% 20.3% 17.9% 16.3%

Liquidity

Current Ratio 0.68 0.56 0.65 0.68 0.97 1.20 1.65 1.90

Cash Ratio 0.11 0.12 0.18 0.26 0.50 0.76 1.17 1.45

Financial Leverage

LT Debt to Asset 0.35 0.29 0.30 0.24 0.18 0.14 0.11 0.09

D/E Ratio 1.51 1.21 1.12 0.83 0.44 0.33 0.19 0.15

Interest coverage 2.14 2.66 2.99 9.59 15.86 17.49 26.84 29.26

Operation Metrics

Revenue passenger (in thousands) 28,956 30,463 32,089 34,102 37,022 40,125 43,281 45,173

Revenue passenger mile 33,563 35,836 37,813 40,647 44,128 47,827 51,589 53,844

ASM (in millions) 40,075 42,824 44,994 48,390 52,534 56,937 61,416 64,100

Yield per passenger mile (cent) 13.56 13.87 13.99 14.00 14.15 14.47 14.77 15.07

PRASM (cent) 10.96 11.35 11.89 11.94 12.15 12.39 12.64 12.90

Operating revenue per ASM (cent) 12.10 12.43 12.71 13.01 13.25 14.09 14.35 14.62

CASM 11.49 11.71 11.81 10.11 10.18 10.65 11.13 11.58

CASM, excluding fuel 6.99 7.27 7.55 7.40 7.48 7.66 7.85 8.04

Departures 264,600 282,133 294,800 306,803 324,939 340,053 355,166 365,745


18

23

28

33

2008 2009 2010 2011 2012 2013

Figure 25. Revenue per aircraft (in millions)

JBLU LUV ALK

SAVE RYAN WJA

10%

15%

20%

25%

30%

4,000

5,000

6,000

7,000

8,000

9,000

10,000

2015E 2016E 2017E 2018E 2019E

Figure 24. Revenue vs. Margin

Revenue EBIT Margin

EBITDA Margin Profit Margin

Profitability | Growth in Earnings

From 2013 to 2015 we expect JBLU’s profitability to increase from 3.1% to 12.3%

as the company takes advantage of low oil prices. With the introduction of a new

baggage fee system and increased aircraft capacity, JBLU’s topline will improve

by an additional 5%. As a result, we estimate a significant increase in EPS to $2.71

per share in 2015.

Liquidity | Robust cash inflow

As a result of higher margins and its $900mm CAPEX reduction plan from 2016-

2018, JBLU will experience greater liquidity. We forecast that JBLU’s EBITDA

margin will spike to 30% in 2015, resulting in a higher cash balance. We believe

that the company’s liquidity will improve even further as we forecast an increase

in free cash flow and reduction of debt. We also anticipate a significant increase

in the interest coverage ratio as JBLU experiences higher cash inflows and curbs

its debt level.

Financial Leverage | DuPont Analysis

Historically, the main driver of JBLU’s ROE has been financial leverage. JBLU has

exhibited returns on equity of 5.3% in 2012 and 7.9% in 2013. While its profit

margin was only 3% in 2013, JBLU was able to maintain its current ROE range

due to its high use of leverage, as the company had an equity multiplier of 331%.

In 2015, we project JBLU to have a ROE of 25%, as the introduction of new

baggage fees and reduced oil expenses significantly improves the profit margin

to 12.3%.

Efficiency | Efficient Aircraft Utilization

Historically, JBLU operates its fleets with a high level of efficiency. As a result of

JBLU’s efficiency the firm has generated greater revenue per aircraft than its

competitors. We expect JBLU’s ASM to grow at an increasing rate after 3Q16 as

the company installs additional seats on its A320s. Along with an increase in ASM,

we estimate that the PRASM will continue to increase as well. We attribute an

increase in PRASM to a strong economic outlook supported by a 5.6%

unemployment rate, high levels of consumer confidence, and increased

consumer discretionary income. Furthermore, CASM will experience a significant

decrease due to the fall in oil prices. However, CASM can be further reduced

below our estimate as the company reformulates its fleet structure to

experience higher fuel efficiency. Ultimately, JBLU’s high level of efficiency will

prove to be highly profitable.

Financial Leverage | Debt/Equity Ratio

In 2014, JBLU’s D/E was 1.12, a significant improvement over its 2012 D/E value

of 1.51. The company has been steadily buying back their debt over the past year

as it is keenly focusing on improving its financial health. With increases in cash

flow JBLU plans to accelerate its debt prepayment.




3%

4%

5%

6%

7%

8%

9%

0

100

200

300

400

500

2011 2012 2013 2014E

Figure 26. Maintenance Cost

Maintenance Expense Revenue%

39%

61%

Figure 27. Cancellations by Destination (2010-2014)

JFK/BOS/EWR Others

$-

$20

$40

$60

$80

$100

$120

0%

10%

20%

30%

40%

50%

20

022

003

20

042

005

20

062

007

20

082

009

20

102

011

20

122

013

Figure 28. Fuel Cost per Revenue vs. WTI

Fuel cost / Revenue WTI

Investment Risks

Operational Risk | Increased Maintenance Expenses

Currently the average number of departures for each JBLU aircraft is 1,519 a year.

If technical issues reduce average departures to 1,380 per year, this will lead to

a HOLD recommendation, valuing JBLU at $18 per share. If the number of

average departures decreases to 1,300 this will lead to a SELL recommendation,

valuing JBLU at $12 per share.

Operational Risk | Unplanned Failure of Aircrafts

The breakdown or failure of aircrafts could harm JBLU greatly. JBLU has invested

heavily in CAPEX to mitigate potential malfunctions. If a large number of flights

are cancelled, JBLU will honor their customer centric programs, experiencing

reduced revenues.

Operational Risk | Dependence on New York Metropolitan Market

In 2007, JFK airport was hit by the Valentine’s Day Storm, which halted

operations in the Northeast and cost JBLU $30mm. Another storm of this

magnitude could create significant risks and costs for JBLU.

Operational Risk | Extraordinary Events

In the case of an extraordinary event that leads to destruction of an aircraft, JBLU

will suffer extreme losses. An event of this magnitude would reflect poorly on

JBLU’s brand, decreasing its number of passengers. Operational Risk | Losing

Loyal Customers JBLU is emphasizing its focus on pleasing investors, and faces

the potential of losing loyal customers. Decreased revenues and reduced free

cash flow are consequences of customer loss. If 5.6% of JBLU’s customers leave

for competitors, our valuation would decrease to $17 per share and we would

provide a HOLD recommendation. If the number of JBLU passengers decreases

by 7%, our valuation will decrease to $15 per share and we will provide a SELL

recommendation.

Market Risk | Oil Volatility

If oil prices increase, JBLU’s jet fuel costs will increase as well. If the oil prices

increase significantly within a short period of time, there is a possibility that

JBLU’s intrinsic value will decrease our valuation resulting in a HOLD

recommendation.

Market Risk | Rise in Interest Rates

An increase in interest rates would increase the overall cost of debt for JBLU and

result in a higher interest expense. Currently, interest rates are extremely low as

part of the FOMC’s expansionary monetary policy. We expect rates to remain

low throughout the end of 2015, and to gradually increase afterwards. Due to

increased future cash flow, we are confident that JBLU will not be materially

impacted by an increase in interest rates over the next few years.


Source: BTS

Source: EIA, JBLU


Market Risk | Perception of Travel Safety

Historically, public perception of travel safety has resulted in adverse results in

airline performance. Both disease outbreaks and terrorism are risks inherent to

the industry that can negatively affect JBLU. As a result of terrorism and

biological threats, JBLU has complied with costly regulations increasing due

diligence, utilization of the No Fly List, metal detectors, and random searches of

its facilities to provide for customer safety.

Regulatory Risk | Failure to Acquire New Routes

A critical aspect of JBLU’s future outlook includes its plans for international route

expansion in the LatAm region. In order to acquire new routes, JBLU must gain

approval from regulatory agencies, both in the U.S. and other nations. If JBLU

fails to establish new expansionary destinations in the future, this will affect the

company’s future outlook negatively.

Regulatory Risk | Flight Limits

The FAA is proposing a rule to set a daily limit on the number of flights out of JFK,

LGA, and EWR to reduce congestion and flight delays. With JBLU’s large presence

in the area, the implementation of these rules could reduce their flights in the

region. With a growing demand for air transportation it is uncertain whether the

regulation will pass, especially with significant pushback to the proposed rules

being made by the Port Authority and Global Gateway Alliance.

Business Risk | Unionization

As of February 2014, there are business related risks and regulations JBLU faces

surrounding the A.L.P.A unionization. JBLU will experience increased costs if

A.L.P.A bargains and negotiates wages and work hours. Additionally, other

unions may approach JBLU employees in an attempt to unionize the workforce.

Table 4. Risk-Free Rate and Price Target

*Current risk-free rate: 1.83% (1/27/2015)

Risk-free rate 3% 4% 5%

Price Target $18.57 $14.51 $11.22

Rating HOLD HOLD SELL

Risk-free rate and price target
