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Standard & Poor's


04/14/14 10:06:12 AM



This week's Focus Stock of the Week is JetBlue Airways (JBLU $8.76), which carries S&P Capital IQ's highest investment recommendation of 5-STARS, or Strong Buy. We think the company, which recently bought several slots at Reagan National Airport divested by American Airlines Group (AAL $36.56 NR), is likely to accelerate its revenue growth as a result of the purchase. We are also positive on a recent move to divest its LiveTV business, which we think was a drain on company resources and management focus. Finally, we remain positive on prospects for the overall U.S. airline sector, which we think should benefit from restrained industry capacity and robust demand, aided by our view of an improving U.S. economy.

JetBlue is the fifth largest U.S. airline in terms of annual revenue as well as revenue passenger miles. The company seeks to differentiate itself with low fares, premium leather seats that offer more room than the industry average, as well as an in-flight entertainment system that the company believes is superior to other offerings by competitors. Also, starting in June 2014, the company intends to launch a premium transcontinental service called Mint, which offers lie-flat beds on transcontinental flights at a much lower price point than competitive offerings.

In 2013, JetBlue's capacity was deployed 31% to Florida, 28% to Latin America, 28% Transcontinental, 5% central U.S., 5% East Coast, and 3% West Coast. Network growth over the past few years has been focused on Boston, the Caribbean, and Latin America. JetBlue has a low cost culture and its unit costs are among the lowest in the industry, which it achieves with high aircraft utilization, low distribution costs, and a productive workforce. The company operates a fleet of 130 Airbus A320s, 4 A321s, and 60 Embraer 190s with a total average age of 7.1 years. As its fleet ages, JBLU has been selling its older aircraft while still taking delivery of new planes, which we think is helping to keep fleet age and maintenance costs lower than they would have otherwise been.

On January 30, JBLU announced it had acquired 12 slot pairs (a slot pair is the right to both a take-off and a landing at an airport) at Reagan National airport in Washington, D.C. (DCA) from American Airlines Group. JetBlue expects to use these slots to introduce new nonstop service to cities it does not currently serve from Washington, D.C., as well as adding to flights on some existing routes.

In addition to the 12 slot pairs, JetBlue and American have reached an agreement for JBLU to permanently acquire eight other slot pairs at DCA that JetBlue had already been operating on a temporary basis since 2010. We think this deal will allow JBLU to continue to build out a nice business-travel network on the east coast, with a strong presence in New York, Boston, and D.C. We expect a modest acceleration to capacity growth over the next year as a result of this deal, and expect the deal to help yields as the routes are likely to attract a good mix of business travelers.

On March 13, JBLU announced that it would sell its LiveTV subsidiary to Thales Group, a French based aerospace and defense technology firm, for $400 million. Completion of this sale is subject to regulatory approvals and is expected to close in the second quarter. While LiveTV is the leading provider of in-flight entertainment systems for use in passenger aircraft, we do not believe the unit is profitable for JBLU. In addition, we expect the in-flight entertainment space to remain very competitive, and think the unit was a drain on company resources and management attention. In addition to the cash generated from the deal, we are positive on the ability of JBLU to free up resources to devote to growing and investing in its core airline business. As part of the deal, JetBlue will enter into a long term agreement to continue to access LiveTV for use in its flights.

For 2014, we see revenue growth of about 7%, on 6% capacity growth, which is above our forecasted industry average. We also see about 1% higher yields on a better revenue mix and fare increases. We see jet fuel costs rising about in-line with revenue growth, but see margins benefiting from fixed cost leverage and well controlled spending. We see 2014 EPS increasing 38.5% to $0.72, from $0.52 in 2013. In 2015, we see EPS rising to $0.82.

Our 12-month target price of $13 values the shares at an Enterprise Value to EBITDAR (EBITDA plus aircraft rent) multiple of 7X our 2014 EBITDAR estimate, in line with peers. We believe JBLU's recent discount to peers reflects a slowing of its revenue growth rate along with some execution issues related to its operations. We expect improved operational performance along with an accelerating revenue growth rate to lead to a narrowing of the valuation gap.

Risks to our recommendation and target price include the possibility of a sharp rise in oil prices which would drive jet fuel costs higher, increased competition which could lead to price pressures, and a weakening economy which could lead to lower demand for air travel among both leisure and business travelers. From a corporate governance standpoint, we see the presence of affiliated outsiders on the company's compensation committee as a negative, but note that JBLU's compensation structure is in-line with industry practices.

S&P's views on stocks are constantly re-evaluated. Please refer to our most recent publication on this stock to see our current view.


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