Note to JetBlue: Please Don't Change -- Just Drop Money-Losing Flights

NEW YORK (TheStreet) -- Wall Street wants change at JetBlue (JBLU), and usually Wall Street gets what it wants. In fact, Wall Street is so confident of its influence that some analysts are already recommending JetBlue stock, based on their anticipation that 2015 will be a year of change.

The trouble is that, for consumers, change at JetBlue would probably be unwelcome. The JetBlue concept is to provide premium service at coach prices. That includes more legroom, free snacks, free TV and free checked bags. That word “free” is not at all something Wall Street likes to hear.

Unfortunately, JetBlue shares have been underperformers for the past two years. Over that time, Delta (DAL) is up 306%, Southwest (LUV) is up 211%, Alaska (ALK) is up 153%, United (UAL) is up 142% and JetBlue is up 129%.

JetBlue shares closed Monday at $11.74, up 37% this year. That compares with Southwest, up 52%; American (AAL), up 50%; Delta up 34%; Alaska up 20% and United up 14%.

Last week, Imperial Capital analyst Bob McAdoo raised his one-year target price for JetBlue to $20 from $10, saying “Investor interest is focusing on possible management and strategy changes that could great enhance earnings.”

McAdoo's report came after CEO Dave Barger declared, during the carrier's second quarter earnings call in July, "It is no secret that I have a contract through the February 2015 time frame."

The secret involves what happens after February. 

In the meantime, McAdoo wrote, “In coming quarters, we expect increasing pressure on this management and the board to potentially bring changes to the business as currently configured.”

McAdoo said his list of proposed changes would add as much as $550 million to the base pretax income of $279 million. He recommends adding a first bag fee, which would result in an estimated $150 million to $200 million in annual revenue and adding seats, which could add $250 million to annual pretax income.

Additionally, he recommends cutting unprofitable routes ---primarily trans-continental routes and routes from Boston. “Flights to/from and along the West Coast corridor are generally unprofitable and have been for several years,” McAdoo wrote. “In addition, contrary to the comments in most quarterly earnings reviews, quite a number of the Boston domestic markets, including only those that have been in system for over a year, generate seven-figure losses annually.”

JetBlue’s top 10 money losers include Boston to Dallas, LAX, Phoenix, Washington National, Charlotte, Buffalo and Seattle, which annually lose between $3 million and $7.4 million each. Additionally, trans-con flights from Fort Lauderdale and Dulles to San Francisco, Los Angeles and Long Beach lose between $4.2 million and $6.6 million annually.

By contrast, McAdoo said Florida flights from JFK and Boston produce an estimated $800 million annually in revenue, and make money. The JFK/Florida operation produces margins of 9.5%, he said; the three most profitable flights, in terms of absolute dollars, are JFK to Orlando, Fort Lauderdale and Palm Beach International.

“Jet Blue’s network is one of extremes,” he said, with Caribbean flights and Northeast to Florida very profitable, while West Coast and Boston flying is unprofitable.

As for seating, JetBlue has 150 seats in the A320, its most common aircraft type. Coach seats have a generous pitch -- the space between the seats -- of 34 inches. By contrast, the A320s flown by the US Airways division of American Airlines seat 150 but have a more standard pitch of only 31 inches, according to SeatGuru.

In 2011, JetBlue added a product called “Even More Space,” which provides 38 inches of pitch -- equivalent to first class in many airlines -- for an added fee.

That was a mistake, according to McAdoo. “They ought to go back to their roots,” he said in an interview. “They made good money when they started out. 'Even More Space' is not paying for itself.” In his report, he writes that seats were removed to create “Even More Space” with the hope that extra leg room would attract enough higher-paying passengers, which would more than offset the loss of eliminating seats for up to six passengers. The offset did not occur.

Moreover, an earlier decision pulled six seats from planes in order to eliminate the need for unscheduled fuel stops on trans-continental flights.

In all, JetBlue lost 12 seats on A320s that once carried 162 passengers. Put them back, McAdoo says, except on the few airplanes used for trans-con flights. Don’t worry about the extra cost of adding a flight attendant when a flight has more than 150 passengers. Before cost, the 12 extra seats would add $250 million annually to pretax income, he said.

On the July earnings call, analysts raised questions about adding seats and and bag fees, and JetBlue executives offered vague answers.

Regarding bag fees, Hayes said JetBlue is looking at introducing a new fare structure in the first half of next year. The new structure would "put different bundles of offerings in front of customers,"  he said. 

In Florida markets, Hayes aid, JetBlue benefits from offering a free checked bag, but that is not the case in other markets. He said a new fare structure would enable the carrier "to monetize first bag in markets where you don't get it [free]."

As for adding seats, Hayes noted JetBlue benefits from "maintaining a differentiated product" and that "a big gap has emerged between what we offer and what other airlines offer." He said the airline intends to restructure its fares before it considers a change in seat density.

A JetBlue spokesman declined to comment on whether JetBlue might drop unprofitable routes.

McAdoo isn’t the only analyst who foresees change at JetBlue.

In a report issued Sunday, Stifel Nicolaus analyst Joseph DeNardi wrote that JetBlue shares have been rising, driven by the belief that JetBlue President Robin Hayes will replace Barger in 2015 and that “Mr. Hayes will enact a more shareholder-friendly business plan [including] a first bag fee and higher seat density.

“Sentiment and valuation may be getting ahead of itself at this point, with multiple analysts now including EPS from a first bag fee in 2015 estimates,” DeNardi wrote. After analyzing Hayes’ comments on the July earnings call, DeNardi estimates the chance of a first bag fee in 2015 at 40% and the chance of increased seating density at 15%.

Wolfe Research analyst Hunter Keay was apparently first to recommend JetBlue on the basis of an impending management change. In a July reported, he wrote that JetBlue shares will do well in the long term because "inadequate yields [drive] necessary change." Keay has a target price of $15 a share and an outperform rating.

"This is by no means a trading call," Keay wrote in his July report. "Our thesis is not predicted on 2Q EPS or even second half EPS, but rather change that will likely facilitate material earnings growth and margin expansion in 2015 and beyond."

Keay drew an analogy between JetBlue and Alaska because both are being challenged in their hubs by Delta,  which has been growing in New York and Seattle. “The two domestic-oriented airlines that demonstrably underperformed on June passenger revenue per available seat mile are both under attack by Delta," Keay wrote.

"Delta's competitive incursions last year prompted Alaska to move aggressively on commercial initiatives prior to Alaska's stock doubling," he wrote. "We think Delta's incursions in JetBlue's markets could prompt a similar response, and JetBlue has more low hanging fruit to pull, in our view."

Written by Ted Reed in Charlotte, N.C.
To contact this writer, click here.

Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

TheStreet Ratings team rates JETBLUE AIRWAYS CORP as a Buy with a ratings score of B. TheStreet Ratings Team has this to say about their recommendation:

"We rate JETBLUE AIRWAYS CORP (JBLU) a BUY. This is driven by multiple strengths, which we believe should have a greater impact than any weaknesses, and should give investors a better performance opportunity than most stocks we cover. The company's strengths can be seen in multiple areas, such as its solid stock price performance, impressive record of earnings per share growth, compelling growth in net income, revenue growth and attractive valuation levels. We feel these strengths outweigh the fact that the company shows low profit margins."

Highlights from the analysis by TheStreet Ratings Team goes as follows:

  • Powered by its strong earnings growth of 518.18% and other important driving factors, this stock has surged by 74.72% over the past year, outperforming the rise in the S&P 500 Index during the same period. Turning to the future, naturally, any stock can fall in a major bear market. However, in almost any other environment, the stock should continue to move higher despite the fact that it has already enjoyed nice gains in the past year.
  • JETBLUE AIRWAYS CORP reported significant earnings per share improvement in the most recent quarter compared to the same quarter a year ago. The company has demonstrated a pattern of positive earnings per share growth over the past two years. We feel that this trend should continue. During the past fiscal year, JETBLUE AIRWAYS CORP increased its bottom line by earning $0.51 versus $0.39 in the prior year. This year, the market expects an improvement in earnings ($0.69 versus $0.51).
  • The net income growth from the same quarter one year ago has significantly exceeded that of the S&P 500 and the Airlines industry. The net income increased by 538.9% when compared to the same quarter one year prior, rising from $36.00 million to $230.00 million.
  • The revenue growth significantly trails the industry average of 51.0%. Since the same quarter one year prior, revenues rose by 11.8%. Growth in the company's revenue appears to have helped boost the earnings per share.

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