JetBlue Airways Corporation (NASDAQ:JBLU) is perennially near the top of the customer satisfaction rankings for the airline industry. However, many investors are not satisfied. In fact, when word spread that JetBlue CEO Dave Barger may retire when his contract expires next year, several analysts indicated that JetBlue might be better with new management, anyway.
There is a very clear reason why many people in the investment community are frustrated with JetBlue. The company spends money offering premium amenities to keep customers happy, but it hasn't consistently earned a revenue premium to justify those costs. As a result, JetBlue has a much lower profit margin than ultra-low-cost carriers like Spirit Airlines (NASDAQ:SAVE).
However, long-term JetBlue investors will be rewarded for their patience. The company is likely to see significant margin expansion for the next several years as a number of key investments start to pay off. This will show that there is a "third way" in the airline industry between full-service legacy carriers and no-frills discounters.
More seats vs. more legroom
Airline analysts frequently ask JetBlue executives why they haven't followed other airlines by squeezing more seats onto their airplanes. At the extreme, Spirit Airlines packs 178 seats onto its Airbus A320 planes, whereas JetBlue has just 150 seats on its A320s. In fact, in late 2006 and early 2007, JetBlue removed a row of seats from all of its A320s to reach the 150-seat configuration.
However, the 150-seat configuration has two big advantages for JetBlue. First, it allows JetBlue to sell "Even More Space" extra-legroom seats. The "Even More" program is expected to bring in $190 million of revenue this year, up from just $85 million in 2010.
Second, the FAA requires at least one flight attendant for every 50 seats. As a result, JetBlue would need another flight attendant for every A320 flight if it added even one row of seats. This would drive significant incremental costs, even on flights where JetBlue couldn't sell the extra seats.
Time for more frills
Rather than packing in more seats like Spirit Airlines and alienating customers in order to cut costs, JetBlue is opting for more frills. This is probably a wise -- though counterintuitive -- decision. JetBlue has historically had some key premium amenities like more legroom than competitors and free satellite TV/radio. However, until recently, it did not offer Wi-Fi or first class seats.
As a result, while JetBlue had invested in an upscale product, it was missing some elements necessary to attract business travelers, who are most willing to pay a premium for better service. JetBlue is now making the necessary corrections.
First, it is rolling out "Fly Fi" -- an in-flight Wi-Fi service that will provide true broadband speeds. JetBlue now has 40 Airbus aircraft equipped with the technology, and all of its Airbus planes (which serve JetBlue's longer routes) will have Fly Fi installed by year-end. JetBlue's smaller E-190 planes will have Fly Fi by the end of 2015.
Second, over the next 12 months JetBlue will transition its flights from JFK Airport in New York to Los Angeles and San Francisco to new, specially configured aircraft. This dedicated fleet of 11 A321s will be equipped with a premium cabin featuring 16 lie-flat seats.
Right now, JetBlue is selling these lie-flat seats for a starting price of just $599 one-way and the highest price is $999 one-way. By contrast, competitors' lie-flat seats typically start around $3,000 roundtrip and can easily exceed $4,000. In a presentation last week, JetBlue President Robin Hayes stated that JetBlue wants to build excitement with low prices for now, but it will eventually be able to charge more for these premium seats.
Keeping an eye on revenue and costs
For the past two years, JetBlue has fallen short of its goal of growing return on invested capital by one point annually. However, JetBlue is well positioned to catch up and then exceed its target in the next two to three years.
On the revenue side, the fleetwide rollout of Fly Fi by the end of 2015 and the addition of premium seats on the key New York-Los Angeles and New York-San Francisco routes will bring in high-fare traffic. This should drive industry-leading unit revenue growth.
On the cost side, JetBlue is well positioned to reverse the recent trend of unit costs rising faster than inflation. The completion of JetBlue's international arrivals facility in New York this fall will cut costs by eliminating facility rents at JFK's Terminal 4 and avoiding the need for planes to taxi from T4 to JetBlue's T5 following international flights.
Meanwhile, JetBlue will add dozens of A321 aircraft to its fleet in the next few years. The A321 will offer a double-digit improvement in unit costs compared to JetBlue's current fleet average. Lastly, JetBlue will begin retrofitting its A320s with fuel-saving "Sharklet" wingtip devices next year, reducing fuel consumption by up to 3%.
Foolish final thoughts
Many investors look at JetBlue's recent performance and see a string of disappointments. While legacy carriers have restructured and dramatically improved their competitiveness -- and profit margins -- revenue gains have not been able to offset rising costs at JetBlue.
However, I believe JetBlue is nearing a tipping point. The addition of fast Wi-Fi across its fleet and premium lie-flat seats on two key routes will help JetBlue attract more high-fare business travelers. Meanwhile, a variety of cost initiatives should bring JetBlue's unit cost growth below inflation for the next few years. This should prove that there is a viable "middle road" in the airline industry between the legacy carriers and ultra-low-cost carriers like Spirit.
Warren Buffett just bought nearly 9 million shares of this company
Imagine a company that rents a very specific and valuable piece of machinery for $41,000 per hour (that's almost as much as the average American makes in a year!). And Warren Buffett is so confident in this company's can't-live-without-it business model, he just loaded up on 8.8 million shares. An exclusive, brand-new Motley Fool report reveals the company we're calling "OPEC's Worst Nightmare." Just click HERE to uncover the name of this industry-leading stock and join Buffett in his quest for a veritable LANDSLIDE of profits!
Adam Levine-Weinberg owns shares of JetBlue Airways. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.