It's not exactly news that the COVID-19 pandemic has severely impacted the airline industry. Air travel virtually ground to a halt this spring due to the imposition of stay-at-home orders and other travel restrictions. On several days in mid-April, the TSA screened fewer than 100,000 passengers, compared to more than 2 million on a typical day in 2019. As a result, airlines' revenue virtually evaporated.
While the federal government stepped in to provide assistance, some of that came in the form of loans. On top of that, airlines have had to issue a significant amount of new debt to cover near-term cash burn. That has led to a slew of credit-rating downgrades across the sector.
The most recent downgrade came late last week, as S&P cut its credit rating on JetBlue Airways (NASDAQ:JBLU) to B+: four notches into junk territory. It also maintained its negative outlook on the company, indicating the potential for additional ratings downgrades. Yet this ratings action ignores the fact that JetBlue actually has one of the best balance sheets in the U.S. airline industry.
JetBlue's credit rating gets whacked
In downgrading JetBlue, S&P analysts warned that the company is likely to post deeply negative cash flow this year. They also opined that cost cuts and lower oil prices would not come close to offsetting the revenue headwind from lower demand.
Both of these statements are true, of course. However, the same could be said of any airline. Nevertheless, following the recent downgrade, JetBlue has one of the lowest credit ratings among airlines covered by S&P, trailing even United Airlines (NASDAQ:UAL).
This makes little sense, as JetBlue has a better balance sheet than many rivals with higher credit ratings, including United. At the end of the first quarter, JetBlue had net debt of $2.2 billion, compared to $18.2 billion for United Airlines (which still holds a BB- rating from S&P: one notch better than JetBlue). United is about five times JetBlue's size, but even after adjusting for that difference, it clearly has an inferior balance sheet.
Furthermore, JetBlue will be able to claim income tax refunds totaling hundreds of millions of dollars, helping it offset some of its 2020 losses. By contrast, United has paid less than $100 million of income tax over the past five years, so there will be little or nothing available to be refunded.
Geographic concentration vs. business model
JetBlue's geographic concentration appears to be a big reason why it is so far from investment-grade territory, despite its relatively strong balance sheet. The airline's two biggest focus cities are New York and Boston, and the vast majority of its flights touch at least one point in the Northeast, which has been the hardest-hit region during the COVID-19 pandemic. Routes to and from Florida account for most of the rest of its network.
This regional focus obviously does make JetBlue's business inherently risky compared to airlines with broad route networks. On the flip side, its status as a low-cost leisure airline will be an asset in the near term, as business travel demand is expected to recover more slowly than leisure demand and industry fares are likely to remain low for the foreseeable future. Indeed, JetBlue is already seeing green shoots of returning leisure demand. As a result, it currently plans to operate about half of its normal schedule in July and even more flights in August.
On balance, United Airlines is likely to face tougher business conditions in the near term. While it can shift capacity between its different hubs, ultimately United needs high fares and robust business travel demand to make money. Moreover, its focus on long-haul international routes could be a significant weakness over the next few years.
Other ratings agencies disagree
S&P is unique among the major ratings agencies in having such a dim view of JetBlue Airways. Moody's rates JetBlue at Ba2, in line with its rating for United Airlines and just two notches from investment grade (although it, too, has JetBlue's rating on review for a potential downgrade). Fitch rates JetBlue at the equivalent BB level: two notches from investment grade and one notch ahead of United.
Investors certainly shouldn't view JetBlue as a low-risk investment. Nobody can be certain about either the future course of the pandemic or how people will react to it. In a best-case scenario, demand would continue to recover steadily over the next 12 months, enabling JetBlue to be solidly profitable in 2021. In a worst-case scenario, a second wave of the pandemic could cause demand to crash back toward zero sometime later this year or next year.
That said, by the end of April, JetBlue had over $3 billion of cash and investments on its balance sheet. It has continued to raise capital since then. The airline is well prepared to ride out whatever volatility it may face over the next year or two, and it should emerge with its substantial competitive advantages intact.