The Amazing JetBlue

I'm a frequent flier and, over hundreds of flights in past years, had developed little or no loyalty to any airline; they were all pretty much different degrees of lousy (my opinion is apparently widely shared, as airlines accounted for six of the top 10 complaints at eComplaints.com according to an article I read).

But today, I'm almost embarrassed to admit, I'm crazy about JetBlue (Nasdaq: JBLU  ) , the discount airline that started flying out of New York's JFK airport in early 2000.

JetBlue offers more than just phenomenal prices, which always used to be enough to win my business, but not my loyalty. The planes are brand-new, the overhead bins are huge (I hate being forced to check my carry-on bag), the leather seats are reasonably comfortable, 24 channels of live TV help the flights pass quickly (and entertain the kids), and -- this is critical -- the service is fantastic. I hope you're sitting down, but the flight attendants are actually nice!

And if something goes wrong, JetBlue tries to make it up to you. For example, on a recent flight, the pilot reported that a light in the cockpit was malfunctioning, which led to a 45-minute delay. We were all starting to get pretty unhappy until the maintenance guy came on board, told us that the problem was fixed, and said that everyone on the flight would receive a $50 credit on a future flight, which led to widespread clapping. I was actually happy about the delay!

It won't surprise you to hear that JetBlue has been growing like gangbusters and earning huge profits.

Having studied JetBlue carefully and flown it roughly two dozen times, I'm convinced that it is not only the greatest airline I've ever encountered, but one of the finest businesses in the world. Seriously. Not in the sense that its margins or competitive advantages can rival those of, say, Microsoft (Nasdaq: MSFT  ) or Pfizer (NYSE: PFE  ) , but rather that its strategy, execution, culture, customer service, and success relative to its industry are among the most impressive I've ever seen.

Thus, I think every entrepreneur, businessperson, and investor should study JetBlue carefully because it is a fascinating, illuminating case study in ways that I will highlight in this and subsequent columns.

Incidentally, I have never owned the stock, nor am I considering buying it at its current price (it closed yesterday at $39.71, equal to 36.1 times this year's consensus analysts' estimates of $1.10), but I will pay it a great compliment: If I were forced to buy one stock trading in excess of 35 times this year's estimates, it would be JetBlue.

Why? Because I think the company will continue to rapidly steal market share from the dinosaurs in this industry, making it a good bet to grow to five to seven times its current size in the next eight years (based on the number of planes it has on order), which translates into 19%-25% compounded annual growth. If it can maintain anything close to its current margins and P/E multiple (big "ifs"), the stock will be a fabulous investment.

Background
JetBlue was founded by industry veteran David Neeleman (though he's only 43), and is modeled after hugely successful Southwest Airlines (NYSE: LUV  ) , for which Neeleman briefly worked after selling Morris Air to Southwest in 1993 and before going on to create wildly successful WestJet in Canada. Like Southwest, JetBlue has a low cost structure, does not offer first-class seating, flies point-to-point (shunning the hub-and-spoke system used by the major carriers), sticks mostly to secondary airports, and has created a unique culture that translates into superior customer service.

But there are some significant differences as well (all figures as of Q1 '03 unless otherwise noted): JetBlue flies bigger planes (seating 162 vs. 132) and longer routes (1,169 miles vs. 723 miles on average), resulting in higher revenue per flight ($14,089 vs. $5,796) and lower ticket prices (passenger revenue per mile flown was 8.8 cents at JetBlue vs. 12.0 cents at Southwest). Also, JetBlue is not unionized, whereas 85% of Southwest's employees are, which contributes to lower labor costs as a percentage of revenues (26% vs. 38%; the major carriers are well into the 40%-50% range).

Comparison
To see how truly spectacular JetBlue is, let's compare it to Southwest, the industry gold standard that's been profitable for 30 consecutive years, and Delta Air Lines (NYSE: DAL  ) , which is considered one of the better major carriers -- though that's not saying much (combined, the major carriers managed to lose more than $10 billion last year).

==================================================                    JetBlue   Southwest     Delta==================================================Oper. margin (%)       15.9         3.4     -17.0Net margin (%)          8.0         1.8     -14.9Labor cost/rev. (%)    26.2        38.2      51.8Rev. growth            62.8         7.5       1.7  (YOY %)Net income growth      33.5        14.3     -17.2  (YOY %)Cash flow from oper.   31.0       267.0    -165.0  ($M)Net debt/equity ratio   1.1           *      18.7Load factor (%)        81.4        62.6      68.9Aircraft util.         13.0        11.0       9.0  (hrs/day)Oper. revenue yield/ASM (cents)             7.42        7.77      9.50Oper expenses/ASM (cents)             6.25        7.50     11.11Margin/ASM (cents)      1.17        0.27     -1.61Margin/ASM (%)         18.7         3.6     -14.5% booked thru website  71.0        50.0       n/aMay traffic            74.1         3.2      -9.4  (RPM; YOY %)Revenue/RPM (cents)     8.8        12.0      12.8P/E ratio              36.1        49.7       n/a  (2003 estimates)P/E ratio              26.1        30.2       n/a  (2004 estimates)==================================================
Notes: All data is for Q1 '03 except May traffic; Southwest has no net debt ($1,889 in cash and $1,679 in debt); aircraft utilization figures for Southwest and Delta are estimates drawn from newspaper articles; Delta is projected to lose $8.80/share in 2003 and $2.96/share in 2004. YOY: year over year;
ASM: available seat mile, total of all seats available on every airline route, multiplied by the length of the route (a benchmark of an airline's total capacity);
RPM: revenue passenger mile, number of seat-miles for which the airline is actually filling a seat and making money; load factor: RPM/ASM (higher is better).
==================================================

To summarize, JetBlue is charging very low prices (as evidenced by the low passenger revenue/RPM), leading to full planes (high load factor). Combined with exceptionally low costs (operating expenses/ASM) and exceptional utilization (its planes are in the air for 13 hours a day), it is able to make unheard-of margins despite charging so little.

This creates a virtuous cycle whereby more passengers are flocking to JetBlue, which lowers per-passenger costs (operating expenses/ASM fell 8.2% YOY in Q1 '03, despite a 57% increase in average fuel cost per gallon) and allows the airline to charge even lower prices (revenue/RPM fell 11.1% in Q1) and drives even more traffic.

The end result is that, unlike most other airlines, JetBlue is growing rapidly, generating healthy profits and operating cash flow, and maintaining a strong balance sheet.

Do these characteristics remind you of another wildly successful business? Think about Wal-Mart (NYSE: WMT  ) and its amazing history. Starting with one store in 1950 in northwestern Arkansas (Sam Walton's Walton's Five and Dime; the first Wal-Mart opened in 1962), Wal-Mart has grown to be the world's largest company (by revenues) by building a strong culture, providing exceptional service, and offering great value and low prices.

JetBlue doesn't just talk about doing the same things -- it is actually doing so, which is why I believe it has a decent chance to become the Wal-Mart of the airline industry over time.

Conclusion
The most interesting question is: How has JetBlue achieved such remarkable success to date? What is it about the company that has generated such customer loyalty? How has it created a positive culture and outstanding customer service, especially in an industry known for dreadful labor-management relations and pathetic service? What accounts for such low costs? How has its strategy created competitive advantages, and how sustainable are they? Finally, what can go wrong?

I will address these critical questions in future columns.

Whitney Tilson is a longtime guest columnist for The Motley Fool. He did not own shares of the companies mentioned in this article at press time, though positions may change at any time. Under no circumstances does this information represent a recommendation to buy, sell, or hold any security. Mr. Tilson appreciates your feedback on the Fool on the Hill discussion board or at Tilson@Tilsonfunds.com. The Motley Fool is investors writing for investors.


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