Why JetBlue May Recover Faster Than United Continental

As the airline industry has recovered in the past few years, JetBlue Airways (NASDAQ: JBLU  ) and United Continental (NYSE: UAL  ) have been left behind. It's not that either company is in grave danger -- both are solidly profitable. However, they have fallen behind best-in-class competitors such as Delta Air Lines (NYSE: DAL  ) and Southwest Airlines (NYSE: LUV  ) .

Earlier this month, airline analyst John Godyn surveyed institutional investors about JetBlue and United's relative prospects. Two-thirds of investors thought United Continental was more likely to engineer a successful turnaround than JetBlue. (Godyn also liked United's turnaround chances better.)

United and JetBlue need to catch up to industry profit leaders like Delta. (Photo: The Motley Fool.)

However, the smart money may be wrong on this question. While United is implementing a $2 billion cost-cutting program called "Project Quality" to boost earnings, JetBlue has a clearer path to matching the financial performance of Delta and Southwest.

Performance gap
U.S. airline industry profits have soared in the past two to three years. However, the gains have largely come from a few companies that moved quickly following the Great Recession to manage costs, reduce fuel consumption, and boost revenue.

Among the big global network carriers, Delta Air Lines has been the clear leader. Among low-cost or hybrid carriers, Southwest has reasserted its dominance. While margins have remained roughly flat at JetBlue and United, Delta and Southwest have pulled way ahead.

UAL Operating Margin (TTM) Chart

Airline Operating Margins (TTM) data by YCharts

The performance gap has continued to widen this year. For example, in Q2, Southwest posted a 16.3% adjusted operating margin, and Delta wasn't far behind with a 15.1% adjusted operating margin. United and JetBlue were laggards, with adjusted operating margins of 10.4% and 9.4%, respectively.

This divergence in profitability has caused a corresponding divergence in stock performance. All four stocks -- along with virtually all other airline stocks -- have performed extremely well in the past two years, but the gains have been much greater for Delta and Southwest.

UAL Chart

Airline 2-Year Price Chart, data by YCharts

Closing the gap: fuel efficiency
United Continental's better-than-expected Q2 performance has reinforced the notion that United has more upside than JetBlue. However, JetBlue has several overlooked advantages.

For example, United's "Project Quality" aims to derive half of its cost savings (or $1 billion) by 2017 from fuel-efficiency improvements. These include adding rows to certain aircraft, replacing older planes with newer, more efficient models, and retrofitting certain aircraft with more advanced winglets that reduce fuel burn.

United is adding rows on planes like this A319 in order to boost fuel-efficiency. (Photo: The Motley Fool.)

However, United is held back by its massive size. United has nearly 700 mainline planes in its fleet, plus more than 550 regional aircraft. By contrast, JetBlue has fewer than 200 planes today, and 85% of its capacity comes from its fleet of 137 Airbus planes. With a much smaller fleet, JetBlue can quickly make fuel efficiency improvements.

Next year, JetBlue will begin retrofitting 110 of its Airbus planes (which account for the vast majority of its capacity) with "Sharklet" winglets. These can reduce fuel burn by as much as 4%.

JetBlue also has 39 Airbus A321 aircraft on order between 2015 and 2017. Most of these will be configured with 190 seats (compared with 100 to 150 seats for most JetBlue planes today) and should consume at least 15% less fuel per seat than JetBlue's fleet average. (Southwest has used a similar "upgauging" strategy to grow its margins recently.)

JetBlue's 190-seat A321s will be much more fuel efficient than A320s like this one. (Photo: JetBlue.)

Starting in 2018, JetBlue will receive a large number of A321neos with upgraded engines that will offer even bigger fuel savings. JetBlue's small size will thus allow it to easily match or beat United's fuel-efficiency improvements over time.

Non-fuel costs
United also plans to find $1 billion of non-fuel cost savings by 2017. Half of this will come from productivity initiatives such as deploying self-service technology. However, JetBlue may have an advantage over United in this field, too.

For example, JetBlue recently began an "automatic check-in" program that will completely eliminate the check-in process for certain customers. This program will be rolled out more broadly next year. The addition of 190 seat A321s will also vastly improve JetBlue's productivity. Pilots will receive the same pay as for an A320, but the planes will have 27% higher seating capacity.

Southwest will begin international flights from Houston next fall. (Photo: The Motley Fool.)

Revenue risks and opportunities
Lastly, JetBlue has some advantages on the revenue side. Going forward, United is likely to face unit revenue pressure in the off-peak seasons on routes to China, because of rapid growth in competitors' capacity. It will also face pressure in Latin America starting late next year, when Southwest Airlines begins international flights from Houston, United's main Latin American gateway.

United's main tools for combating these pressures are relatively small tweaks to the status quo. It's working to improve its revenue management system to boost fares. United is also looking to squeeze more ancillary revenue from its first-class and Economy Plus seats.

JetBlue has bigger opportunities. In June, it introduced a premium cabin with lie-flat seats on flights from New York to Los Angeles, and the service will be extended to New York-to-San Francisco flights in October. These "Mint" seats will command much higher fares than coach tickets -- and may draw some customers away from United's competing "P.S." premium service.

JetBlue's Mint lie-flat seats will command higher fares. (Photo: JetBlue.)

JetBlue also has plans to boost ancillary revenue, and it's starting from a lower base than United Continental, giving it a bigger opportunity. The biggest change that's coming is the introduction of "fare families," which will allow JetBlue to tailor its ancillary offerings by route and by customer to bring in more revenue.

Foolish wrap
United Continental and JetBlue both have a long way to go to catch up to industry leaders such as Delta and Southwest. However, looking out over the next five years, JetBlue has a better chance to catch up to best-in-class competitors than United does.

United's problems stem in part from its size, which makes it harder to quickly revamp its fleet. It is also likely to face atypical increases in competition on routes to China and Latin America, as well as on the lucrative transcontinental routes. JetBlue's opportunities to cut costs by upgauging and boost revenue with its Mint service and fare families give it an edge over United in the race to catch up.

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Read/Post Comments (4) | Recommend This Article (3)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 26, 2014, at 2:30 PM, SkyJet wrote:

    Jet Blue and Alaska are to merge and create a new, successful, low fare carrier.

  • Report this Comment On July 27, 2014, at 3:58 PM, Tyeward wrote:

    Well I think we need to first be very clear about a few things. JetBlue will never match Delta and or The New American. Just not possible. It´s not a mega behemoth like they are. The problem that I see going forward is that JetBlue does not have a fortress hub. It´s good that they focus on O&D mainly out of JFK and BOS, however it should really have a place or hub somewhere that they can really call their own that they control. I would vote PIT and move connecting traffic there and move to gain control of corporate contracts out of the area. In this day and age, you can´t just rely on traffic. You have to move to lock in a source and provide the transportation for that source. That would mean getting aggressive with corporate contracts. Locking up corporate contracts out of a major metro area that you plan to base yourself at for the sake of shifting connecting traffic makes alot of sense and will keep a decent O&D flow in conjunction with that connecting traffic. Gotta think bigger JetBlue. I really hate that you guy´s are being mentioned in the same article as United (which is another story altogether).

  • Report this Comment On July 28, 2014, at 8:56 AM, Inspectigator wrote:

    A cost-cutting initiative named "Project Quality", illustrates how tolerant we have become of management arrogance. Modern managers have turned the profession into the equivalent of running around in a circle slapping vendors, employees, customers, creditors, investors, banks, regulators, suppliers, and anyone else who may be pushed into taking less or giving more. There is very little creative thinking, few innovations, nothing to excite customers or investors about these companies. Cheapening and dumbing-down the product is not innovation.

  • Report this Comment On July 28, 2014, at 10:07 PM, TMFGemHunter wrote:

    @Tyeward: Just to be clear, I wasn't talking about matching Delta or American in revenue or earnings, but rather in profit margin. I don't see any reason why JetBlue shouldn't be able to earn the same margins as those carriers (although there's no way it can match the ULCCs).

    JetBlue already has a pretty strong position in Boston, and I would expect them to continue growing there. JetBlue's business model is based around point-to-point routes, although it obviously does have some connecting traffic. I think there is certainly some sense to growing in a mid-size metro area like Pittsburgh or maybe Kansas City. But it's really tricky.

    These are relatively high cost airports because they overbuilt relative to the amount of traffic they have. They also have much less O&D traffic, which is higher yielding. Connecting itineraries tend to have a race to the bottom in fares, which means that JetBlue isn't really getting compensated for its "premium" amenities. So while opening a hub in the Midwest would allow JetBlue to serve more city-pairs, I'm not sure it could make much money doing so.


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Adam Levine-Weinberg

Adam Levine-Weinberg is a senior Industrials/Consumer Goods specialist with The Motley Fool. He is an avid stock-market watcher and a value investor at heart. He primarily covers airline, auto, retail, and tech stocks. Follow him on Twitter for the latest news and commentary on the airline industry!

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