With more fees and cramped planes, airlines are frequently maligned for providing an unpleasant experience for passengers. Now, analysts are pressuring JetBlue Airways (NASDAQ:JBLU) to change key policies to increase profits at the expense of the customer experience.
Wall Street vs. David Barger
For most companies, the actions by Wall Street over the past few months would be cause for celebration. Price targets have been raised by several analysts as they turn more bullish on JetBlue.
So why is this a problem for JetBlue? Unlike most analyst upgrades, these ones come on analyst hopes that serious changes will be made at JetBlue. Specifically, analysts have been bullish because they expect that current JetBlue Airways CEO David Barger will depart next year and be replaced by someone with a greater emphasis on shareholder returns.
While Barger certainly has nothing against shareholder returns, he has led JetBlue as a more customer-friendly airline and has even avoided charging a first checked bag fee. But analysts are hoping that JetBlue can increase profits by instituting new, less customer-friendly policies and use the proceeds to do things like buy back shares and initiate a dividend.
JetBlue's policies are fairly unique in the airline industry, but they have been in place for a long time and are a core part of the airline itself. However, these policies are now being threatened by a perfect storm.
For most the deregulated airline industry's history, posting profits has been good enough for investors, but a new wave of airline profitability has raised the bar for airline investment. Resulting from better capacity management, a series of mergers, and increasing travel demand, record profits are now being posted at major carriers and airline shareholders are finally outperforming the market.
This has left airlines with cash flows beyond what are needed to fund operations, leading to the reinstatement of dividends at American Airlines Group (NASDAQ:AAL), which last paid a dividend in 1980, and Delta Air Lines (NYSE:DAL), which had suspended its dividend in 2003 before entering bankruptcy two years later.
Share buybacks have also taken off with a $2 billion buyback under way at Delta Air Lines and $1 billion buybacks recently announced by American Airlines Group and United Continental Holdings (NYSE:UAL).
At the same time, Wall Street is well aware of a major source of these profits: airline fees. Checked bag fees at U.S. carriers brought in an extra $3.35 billion in revenue in 2013 alone. Besides the fees, airlines are creating higher density layouts to be able to sell more seats per flight allowing them to boost revenue while reducing cost per available seat mile.
Now it's no surprise that profit seeking analysts want JetBlue to post similar returns. Over the past five years, JetBlue's stock has underperformed shares of the other major airlines, and JetBlue also is yet to initiate a dividend or stock buyback program.
These analysts see JetBlue's road to big profits, and hence shareholder returns, as being done through the same methods that have made other major carriers as profitable as they are today. Among the things they cite as ways to build shareholder value are increasing seat density and launching a first checked bag fee.
Who will JetBlue follow?
JetBlue has built its brand around being an alternative airline largely for passengers sick of flying other carriers. But JetBlue is now being faced with tough calls from Wall Street to ditch its flyer-friendly strategy for one more focused on profit generation.
So far, JetBlue is trying to have as much of both sides as possible. Next year, the airline is expected to create fare families that will have different features at different levels. Although it has yet to be confirmed by JetBlue itself, some analysts expect a first checked bag fee to be included in the changes.
But JetBlue and its CEO are not willing to turn the airline into another legacy carrier just yet. As the storm of profit-seeking analysts has descended upon JetBlue, Businessweek reports that Barger is firing back, saying, "You want to compare my track record to bankruptcies and layoffs?" in reference to the bankruptcies seen among legacy airlines.
Barger also continues to argue for the benefits of JetBlue's position as neither a budget airline nor a giant carrier, signaling support for the airline's current place in the market.
But if Barger leaves the CEO position next year, the future of JetBlue's policies will be up in the air. In an August article, Businessweek noted that Barger says the board is still in favor of building the JetBlue franchise. However, if more pressure is brought to bear by Wall Street, some members of the board may seek to implement more of the analysts' suggestions.
Of course there is also always the possibility of an activist investor moving in or even a full takeover of the airline. The argument that JetBlue could post much greater profits with a few policy changes would be enticing for activist investors. Additionally, JetBlue would be a reasonable size for a takeover and has been the subject of takeover rumors for years.
Going forward with JetBlue
Analysts may be annoying to JetBlue's management, but not because of negative opinions on the stock. In fact, analysts are upgrading the stock, but it comes with the catch that they expect the airline to change much of how it operates.
It's true that JetBlue's stock has underperformed shares of major carriers over the past five years, but it's unclear what taking on legacy carrier policies would do to future ticket sales. Over the next several months, JetBlue management and shareholders will have to decide what's more important: the potential for greater profits from implementing legacy carrier style policies or the customer-friendly brand image that separates JetBlue from its larger rivals.
Alexander MacLennan owns shares of AMERICAN AIRLINES GROUP INC and Delta Air Lines. Alexander MacLennan has the following options: long January 2015 $22 calls on Delta Air Lines, long January 2015 $25 calls on Delta Air Lines, long January 2015 $30 calls on Delta Air Lines, long January 2015 $17 calls on AMERICAN AIRLINES GROUP INC, long January 2015 $32 calls on AMERICAN AIRLINES GROUP INC, and long January 2015 $40 calls on AMERICAN AIRLINES GROUP INC. 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.