For many years, JetBlue Airways (NASDAQ: JBLU ) has operated a mixed fleet of smaller Embraer (NYSE: ERJ ) E-190 aircraft and larger Airbus A320s. For the past several years, JetBlue's A320s have outnumbered its E-190s by a roughly 2:1 margin. That's all about to change.
On Tuesday, JetBlue announced a radical shift in its fleet plan. The carrier is moving to halt the growth of its E-190 fleet at 60 planes -- roughly where it is now -- while doubling down on the A320, and particularly its larger cousin, the A321. This new plan entails deferring 24 E-190 deliveries scheduled for the next five years until 2020 and thereafter, while ordering 35 more Airbus jets.
This announcement is a nice win for Airbus, and an even bigger blow to Embraer, as JetBlue was the launch customer for the E-190, having placed an order for 100 of the type in 2003. More to the point, the new fleet plan should dramatically boost JetBlue's profit margin over the next few years, because the larger Airbus jets are significantly more efficient than E-190s.
A new (but not so new) direction
Under JetBlue's previous fleet plan, the company planned to add 24 Embraer E-190s and 47 A320-series airplanes to its fleet between 2014 and 2018. This would have kept the current 2:1 balance between the larger Airbus jets and the smaller Embraer jets.
By contrast, under the new fleet plan, JetBlue will not add any E-190s to its fleet in the near term, while it will take 66 A320-series jets between 2014 and 2018. Furthermore, of these 66 A320-series orders, 58 are for the larger A321 model. (JetBlue is receiving another four A321s this quarter.)
The rapid growth of the A321 fleet, combined with the stagnation of the E-190 fleet, will decisively shift the balance within JetBlue's fleet toward larger jets. This amplifies a shift first made in 2011, when JetBlue placed its first order for the larger A321 jets, while simultaneously cutting the target size of its E-190 fleet from 100, to 75.
The reason for JetBlue's change of heart is quite simple: the E-190 has a much higher unit cost than the Airbus jets, primarily due to its lower fuel efficiency. This has been exacerbated by the very high cost of maintaining the E-190's engines. The engine maintenance problems only cropped up within the past year. (The lower fuel efficiency was not much of an issue when JetBlue placed its E-190 order in 2003: jet fuel cost less than $1/gallon then!)
The primary offsetting advantage of the E-190 is its smaller size. This allows it to profitably fly routes that may not have enough demand for a 150-seat A320 (let alone an even larger A321). However, most of JetBlue's routes have plenty of passenger traffic, so the company is better off using larger jets with lower unit costs.
The E-190's real mission for JetBlue today is for short-haul flying -- particularly in Boston and San Juan -- and opening new routes. New routes tend to mature over a two- to three-year period, during which time demand builds up. As a result, it's useful to have a smaller plane like the E-190 when starting service.
However, within a few years, it's usually sensible to "upgauge" to the larger A320, with its lower unit costs. Many current E-190 routes could eventually support A320s, which will free up E-190s for new routes, without requiring any expansion of that fleet.
Reversing cost creep and improving the product
JetBlue's stock has underperformed the rest of the industry in recent years, primarily because its costs have slowly, steadily inched higher. JetBlue's fleet restructuring will reverse this cost creep by shifting the fleet toward larger, more cost-efficient aircraft.
JetBlue's standard configuration for the A321 will have 190 seats, and its unit costs will be 10%-15% less than that of the A320. (JetBlue's A320s, in turn, have significantly lower unit costs than its E-190s). Growing with these lower unit-cost aircraft should keep unit cost increases below the rate of inflation, particularly in the second half of the decade.
JetBlue's order for additional A321s may also allow it to expand its premium "Mint" product offering. JetBlue has already announced that, starting in mid-2014, it will operate a dedicated fleet of A321s on its routes from New York to Los Angeles and San Francisco. These will feature a 16-seat premium cabin with lie-flat seats, including four semi-private suites. JetBlue plans to have 11 A321s flying these two lucrative routes in this configuration by 2015.
However, on JetBlue's recent earnings call, CEO Dave Barger raised the possibility that the company could expand its "Mint" service to other routes, such as its transcontinental routes to Boston. With more A321s entering its fleet each year for the rest of the decade, JetBlue will have ample ability to choose between configuring them with 190 seats for high-density markets, or in the Mint configuration for long-haul business markets.
Foolish bottom line
I think JetBlue's new fleet plan will be a real game changer for the company. The company flies to many crowded airports, and on busy routes where it makes sense to fly larger airplanes. By stopping the growth of its high-cost E-190 fleet and doubling down on the much larger A321, JetBlue will be able to reverse its cost creep problems. The company's premium "Mint" service represents an opportunity to boost unit revenue at the same time.
These fleet initiatives will help JetBlue widen its profit margin over the next few years. JetBlue is expected to post a pre-tax margin of just 5% this year, which leaves plenty of room for improvement. (A 10% pre-tax margin is a realistic goal for 2018.) JetBlue's potential for growth and margin improvement makes it a very attractive investment opportunity today.
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