In deciding whether to buy a stock, it's important to look at its valuation, especially compared with those of its peers. Here, I'll examine the valuation of JetBlue Airways (NASDAQ: JBLU) on a few key metrics and determine whether the stock is currently undervalued, fairly valued, or overvalued.
One of the first factors to gauge airline valuations is a price-to-earnings ratio which shows how much you have to pay for each dollar of earnings. Here's how JetBlue's P/E ratio compares with that of its closest rivals:
|Airline||P/E Ratio||P/E Ratio Excluding Special Items|
|Spirit Airlines (NASDAQ: SAVE)||24.5||22.9|
|Alaska Air Group (NYSE: ALK)||14.2||14.4|
|American Airlines Group (NASDAQ: AAL)||12.5||8.4|
|United Continental Holdings (NYSE: UAL)||22.1||11.9|
|Delta Air Lines (NYSE: DAL)||55.5||12.4|
|Southwest Airlines (NYSE: LUV)||26.1||20.4|
The first thing many investors notice when looking at this table is the often significant difference between the P/E ratio and the P/E ratio excluding special items. Airlines can incur special items for a wide variety of reasons including fuel hedge gains/losses, foreign exchange gains/losses, and debt extinguishment costs among the examples. In JetBlue's case, almost all of its special items came from the sale of its LiveTV subsidiary in June 2014 and the after-tax gain of $169 million realized from the sale.
Special items are common in the airline industry and were especially pronounced in the 2014 results due to the drop in jet fuel prices causing many airlines to take special items losses on mark-to-market adjustments to the value of fuel hedges. Even though special items are common in the industry, airline valuations are still better analyzed after excluding them because special items vary in direction by quarter and year. Also, they are largely based around things airlines are trying to hedge or come from activities not tied to the airline's ongoing health and profitability. Once special items are excluded, JetBlue is shown to trade at a higher valuation than any of its competitors in the table.
But before dismissing JetBlue as overvalued, it's worth considering another key valuation metric.
The forward price-to-earnings metric uses analyst estimates for future earnings and is used for developing a valuation based on where a company is headed. Since future earnings will influence price changes more than past earnings will, this metric may be even more important than trailing price-to-earnings.
The following estimates are developed using analyst estimates.
|Airline||P/E Estimate, 2015||P/E Estimate, 2016|
|Alaska Air Group||10.3||9.9|
|American Airlines Group||5.0||5.4|
|United Continental Holdings||5.9||6.0|
|Delta Air Lines||8.7||7.5|
On a forward P/E basis, JetBlue has a higher valuation than the major carriers but is pretty much in line with Southwest and the smaller growing airlines. This set up is not entirely surprising. Spirit Airlines likely trades at a higher valuation because it gives Wall Street a new strategy in the historically poor-performing airline industry and Spirit's ultra-discount nature may by what these investors are looking for. On the other hand, the major legacy carriers still carry with them the negative perceptions stemming from past bankruptcies and poor historical performance.
One thing that is noticeable here is that analysts expect growth in earnings at all seven airlines with the FY 2015 P/E ratio being lower than the trailing P/E ratio, whether or not special items are excluded, in all seven cases. But what is especially notable from the table below is that JetBlue is expected to grow earnings faster than any of its listed competitors.
|Airline||2014 EPS ex. Special Items||2015 est. EPS||EPS Growth Estimate|
|Alaska Air Group||$4.35||$6.14||41.1%|
|American Airlines Group||$5.70||$9.77||71.4%|
|United Continental Holdings||$5.06||$10.60||109%|
|Delta Air Lines||$3.40||$4.83||42.1%|
So although JetBlue's trailing-price-to-earnings ratio excluding special items is the highest of the group, the airline has both a competitive forward-price-to-earnings ratio and the highest earnings growth estimate of the group.
While earnings tend to grab the headlines and should not be ignored, analyzing key profitability ratios is also important in determining a company's ability to generate profits for its shareholders. The table below shows how JetBlue stacks up against competitors in four critical areas.
|Airline||Operating Margin||Net Profit Margin||Return on Assets (ROA)||Return on Equity (ROE)|
|Alaska Air Group||17.92%||11.27%||10.07%||29.11%|
|American Airlines Group||9.96%||6.76%||6.70%||N/A (negative equity)|
|United Continental Holdings||6.10%||2.91%||3.05%||42.08%|
|Delta Air Lines||4.80%||1.63%||1.24%||6.44%|
With these ratios, higher numbers are preferable for investors and tend to garner higher valuations. ROA and ROE are important since they show how well a company is using its assets and equity while possibly giving indications as to how much returns can be made as equity and assets grow.
In the airline industry, it's also important to look at margins since they can be compressed by any number of unforeseen factors including economic downturns resulting in fewer tickets being sold or increased competition resulting in lower fares, so higher margins are a decent sign of safety in the event of an industry downturn
The profitability ratios given show JetBlue to be most closely aligned with Southwest Airlines on all four metrics except net profit margin. Spirit Airlines and Alaska Air Group beat JetBlue by a wide margin on all four metrics signaling that these two airlines are finding better success in generating returns on what they have and turning sales into profits. On the other hand, the major legacy carrier group lags well behind in nearly all areas showing these companies still have work to do to earn valuations on par with their newer competitors.
Based on these numbers, investors should expect to purchase JetBlue shares at a similar valuation as Southwest Airlines shares, at a higher valuation than American, Delta, or United shares, and a discount to Spirit Airlines and Alaska Air Group shares.
Industry valuation multiples can expand and contract over time but it's important to look at historical valuations to gauge whether a company has extended well beyond its historical range and if the reasons for this are justified. The table below shows the five year historical price-to-earnings ratio averages for JetBlue and its competitors.
|Airline||5 Year P/E Ratio Average||Current P/E Ratio Excluding Special Items|
|Spirit Airlines||N/A (initial public offering in 2011)||22.9|
|Alaska Air Group||10.6||14.4|
|American Airlines Group||N/A (emerged from bankruptcy in 2013)||8.4|
|United Continental Holdings||24.0||11.9|
|Delta Air Lines||32.0||12.4|
Compared to its five year average, JetBlue is trading above the range. On this metric alone, JetBlue appears overvalued; however, this could be resolved if JetBlue can grow earnings making its share price justified with a lower price-to-earnings multiple.
Is it a buy?
One of the challenges of investing is reconciling all available information since not all of it points to the same conclusion. The following table shows how JetBlue performed across the discussed categories of valuation measurement.
|Airline||Price-to-Earnings Ex. Special Items||Forward Price-to-Earnings & Earnings Growth||Profitability Ratios||Historical Valuations|
|JetBlue Airways||Overvalued||Undervalued||Fairly Valued||Overvalued|
Based on its current position, JetBlue shares appear overvalued on metrics looking backward and fairly valued or undervalued on metrics looking forward. This means that JetBlue is in a position where it will need to grow into its valuation. For those who expect JetBlue to be able to execute on its plans, the airline appears undervalued compared to competitors. However, those who are skeptical of JetBlue's ability to execute should consider shares overvalued based on the metrics described above.
The bottom line
JetBlue's valuation metrics are a conflict between rearward looking metrics and forward looking ones setting up a situation where whether an investors thinks JetBlue is overvalued or undervalued should come from their confidence in JetBlue's ability to execute its plans and deliver the earnings growth forecasted by analysts.
I am personally of the opinion that JetBlue can meet its targets based on the airline's past record, current management, and new ancillary revenue streams coming on line this year. For investors that agree with this assessment, JetBlue is well worth looking at for an investment portfolio. On the other hand, investors that disagree may be better off looking at JetBlue's rivals with lower price-to-earnings valuations.