Four years ago, JetBlue Airways' (NASDAQ:JBLU) pilots became the first labor group at the carrier to unionize. Since then, management and the union have spent countless hours trying to negotiate a long-term labor contract for the pilot group. Since this is the first formal contract for JetBlue's pilots, the two sides have needed to negotiate every single point from scratch, including pay, benefits, and work rules.

Fortunately, JetBlue and the Air Line Pilots Association have finally reached an agreement in principle for a contract. This deal is set to be formalized as a tentative agreement in the coming weeks and sent to the pilots for ratification. If a majority of the pilots vote in favor, it will remove one of the biggest question marks regarding JetBlue's future cost structure.

At last, a deal

JetBlue's management has repeatedly noted that it would likely take several years to negotiate the company's first pilot contract. Indeed, it took more than four years for Southwest Airlines (NYSE:LUV) and its pilot union to negotiate their most recent contract, and they were merely revising an existing agreement. JetBlue and ALPA had a lot more to negotiate about.

Nevertheless, JetBlue pilots became more and more frustrated with the pace of negotiations over time. Virtually all of their peers at other airlines have received big raises in the past two years. As a result, about 700 pilots picketed at JetBlue's headquarters earlier this year, calling for a speedy end to the negotiations.

A JetBlue Airways plane preparing to land

JetBlue's pilots began to lose patience with the company over the past year. Image source: JetBlue Airways.

On Friday, both JetBlue and ALPA confirmed that the two sides had reached an agreement in principle. However, neither side is disclosing any details about the proposed terms of the deal, as it still needs to be approved by union leaders and then sent to the membership for ratification.

Assessing the cost headwind

JetBlue's management has promised investors that non-fuel unit costs will rise no more than 1% annually from 2018 to 2020, driven by a structural cost program it is implementing. Many investors seem to doubt that the carrier can achieve this target, largely due to the expected increase in its pilot costs.

That said, JetBlue has voluntarily raised its pilot wages several times in the past few years, so it won't have to absorb a massive increase over the next year. Southwest Airlines, which has the highest pay rates of any low-cost carrier, has a top-of-scale wage of $258 per hour: 18% higher than the $219 per hour top-of-scale wage for JetBlue's Airbus pilots. The difference in the Southwest and JetBlue pay scales varies based on experience level, but averages about 20%.

This likely represents the maximum increase that JetBlue would have to absorb. There could also be offsetting productivity improvements included in the contract.

Southwest Airlines' most recent pilot contract raised wages by an average of 15%. Southwest experienced a roughly 4 percentage point non-fuel unit cost headwind over the following year, which included the impact of a new flight attendant contract signed around the same time. Thus, it's reasonable to guess that JetBlue's pilot contract could add 3 or 4 percentage points to its non-fuel unit costs in the first year after ratification.

JetBlue can afford the additional costs

In recent years, rapid unit cost escalation has been a recurring problem for JetBlue, even with a non-union workforce. For example, the carrier's non-fuel unit costs rose 4.8% year over year in 2017. However, while labor costs could jump if the pilot agreement is ratified, various offsetting factors should allow JetBlue to meet its cost targets.

Last month, JetBlue's management projected that adjusted non-fuel unit costs would decline 2% to 4% in the second half of 2018, offsetting a 2% to 4% increase in the first half of the year. This forecast didn't include the impact of a new pilot contract. Nevertheless, this means that there is enough slack in JetBlue's near-term cost outlook to absorb higher pilot costs while keeping total non-fuel unit cost growth at 1% or less.

Looking ahead, JetBlue's A320 cabin renovations will begin in earnest later this year. The carrier will add 12 seats to each of its A320s. The change in seating capacity won't affect JetBlue's pilot costs, so this project will drive an 8% improvement in pilot productivity over the next few years, helping to offset the upcoming wage increases.

A mockup of the interior of a renovated JetBlue A320

JetBlue's A320 cabin reconfigurations will help offset higher pilot wage rates. Image source: JetBlue Airways.

Additionally, JetBlue is set to expand its fleet of 200-seat A321s again starting this quarter. A320 and A321 pilot pay rates are the same, so the growth of this high-density A321 fleet will also boost pilot productivity and help minimize non-fuel unit cost growth. Finally, the bulk of the savings from JetBlue's structural cost program will be realized in 2019 and 2020.

The net result is that JetBlue should be able to keep non-fuel unit cost growth at a very modest level in the second half of 2018 and the first half of 2019, and non-fuel unit costs could be flat or down thereafter. As investors grow more comfortable with JetBlue's cost outlook -- and with the bogeyman of a new pilot contract off the table -- JetBlue Airways stock could take flight again.

Adam Levine-Weinberg owns shares of JetBlue Airways and is long January 2019 $10 calls on JetBlue Airways. The Motley Fool recommends JetBlue Airways. The Motley Fool has a disclosure policy.