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Airline Shares' Descent Could Mean Bargains

JetBlue's travails and higher oil sends them lower for another day.
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(JBLU) - Get JetBlue Airways Corporation Report

shares fell 16.6% on Friday, after the low-cost carrier warned fourth-quarter margins would be narrower than previously thought. Many analysts saw the pullback as a buying opportunity.

On Thursday night, JetBlue told investors that fourth-quarter operating margins would come in between 13% and 14%, down from the 19.7% posted in a seasonally strong third quarter and lower than the 16.8% margins it had a year ago. As the economy recovers, competition is increasing as network carriers add back capacity, hurting the industry's overall pricing power.

"We're faced with a challenging revenue environment due to capacity additions resulting in lower average fares, particularly in our western markets," said David Neeleman, JetBlue's chairman and CEO, in a statement. "This, coupled with the ongoing maturation of our newer markets and depressed traffic to southern California earlier this quarter, has caused us to revise our margin guidance."

While JetBlue said it still anticipates a "very solid fourth-quarter performance," analysts were nonplussed, moving to reduce their earnings estimates, valuation multiples and target prices. Some warned that network carriers were adding back capacity too fast. To stay competitive, JetBlue has been cutting ticket prices and sacrificing its own profit margins.

"Increased competition from major carriers is also having an adverse influence on JetBlue's revenue productions, notably


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Song in the Northeast/Florida and American/United from New York to the West Coast," said Michael Linenberg, airline analyst at Merrill Lynch, in a research note.

As evidence, Linenberg cited airfare prices between Fort Lauderdale and the Los Angeles area, a market where JetBlue competes head-to-head with Song, which offers flights for as low as $109 one-way to Los Angeles. While JetBlue flies to nearby Long Beach for $99 one way, such fares are extremely low and JetBlue is reducing its service, flying just one 156-seat A320 a day starting in January. "As these types of fares enter the market, JetBlue's revenue is almost certain to come under pressure," noted Linenberg.

With low-cost names like JetBlue, AirTran and


(LUV) - Get Southwest Airlines Co. Report

planning massive expansions over the next four years, the competition will only intensify in 2004 as network carriers add back flights to keep that expansion in check.

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Early skirmishes have favored the network names. Already, Delta and low-cost rival



can claim victory in their shared hub city of Atlanta, causing JetBlue to pull service from the city, citing the stiff competition.

"The recent pre-announcements at low-cost carriers may suggest further downward earnings revisions are on the horizon for a number of airlines," said William Greene, analyst at Morgan Stanley, in a note. "We have heard from numerous major airline executives that they are finished shrinking their networks."

Because of these fears -- along with news that OPEC would push for higher oil prices in 2004, raising fuel prices, which are the second-largest expense for airlines -- investors have become spooked.

Since early October, airlines have been giving back the gains they put on over the summer, and Friday's action was no different. The Amex airlines were down 2.4%, led lower by JetBlue's fall of $5.19 to $26.19. Other low-cost names were down, too, with AirTran off 91 cents, or 6.8%, to $12.46 and

America West


down $1.57, or 11.4%, to $12.22.

But investors with a tolerance for risk and an interest in JetBlue and other names may want to keep a close eye on the slide. Given JetBlue's long-term growth prospects and the fact the company will remain a cost leader in the industry, Lehman Brothers analyst Gary Chase, who cut the company's price target to $34.50 from $41.50, told investors that a big pullback could represent a buying opportunity.

"We continue to believe in the JetBlue story and feel that investors may get a chance to buy a terrific franchise at reduced prices," said Chase, who is only one of two Wall Street analysts who rate the carrier a buy. "If the shares suffer significant declines, we would be inclined to buy opportunistically."

Analysts who are more bearish on JetBlue issued similar, if slightly less optimistic, comments. Bear Stearns analyst David Strine told investors that JetBlue trades at 26 times his 2005 earnings estimate and would attractive below 25 times 2005 earnings, which is the high end of Southwest's earnings multiple. Morgan Stanley's Greene also said JetBlue would appear more attractive at 25 times 2005 earnings, but both cautioned that JetBlue was still slightly overvalued.

"For airlines, we prefer to pay a P/E multiple less than the long-term growth rate," said Greene. "We're not quite there on 2005 EPS, but investors with a high risk tolerance may want to consider building a position if JetBlue sells off significantly on Friday."

And if other low-cost carriers take significant stumbles over the next few weeks, J.P. Morgan analyst Jamie Baker said those names could be worth looking at as well -- although he admits that shares are still a bit pricey.

"While consistent with our overall preference for the aged and infirmed," said Baker, "a further, more pronounced correction in low-cost carrier shares may cause us to warm to that sector sooner than originally planned, but we're not there yet."