JetBlue Airways (JBLU -6.06%) and Virgin America (VA) occupy similar niches in the U.S. airline industry. They both present themselves as low-cost carriers that offer better service than even the business-oriented network airlines.
The two carriers have also delivered some of the best unit revenue results in the U.S. airline industry this year. Nevertheless, investors appear to be underrating their future prospects. JetBlue and Virgin America are both likely to produce strong earnings growth in 2016, outpacing analysts' estimates and potentially reinvigorating their stocks.
JetBlue's profit growth initiatives gaining steam
In late 2014, JetBlue announced a series of profit-improvement initiatives that it estimated would add at least $450 million to its annual operating profit in the long run. The biggest portion of that benefit will likely arrive in 2016.
Most importantly, JetBlue rolled out its new "Fare Options" scheme in the middle of 2015. This change is expected to boost revenue, primarily by charging more for tickets that include a checked bag. JetBlue recently estimated that the Fare Options rollout will boost operating income by at least $80 million in 2015. That will likely rise to more than $200 million in 2016, providing a big incremental benefit.
Second, the ongoing expansion of JetBlue's Mint premium service will bring in more high-fare passengers. Third, the new co-branded credit card that JetBlue will introduce in the first half of 2016 is likely to produce more revenue with no meaningful increase in costs. Some of the other initiatives that JetBlue outlined last year could also bring smaller benefits in 2016.
JetBlue also faces a very tame cost environment. Nonfuel unit cost increases are likely to remain modest, helped by the company's steady expansion. Meanwhile, fuel costs are on pace to decline again in 2016. As I argued in October, the net impact could be 20%-30% growth in JetBlue's earnings per share.
Virgin America also has tons of upside
Virgin America is also on pace for significant EPS growth in 2016. First, the company is ramping up its capacity growth to an estimated 13%-15% next year. This should produce double-digit revenue growth.
Second, Virgin America's unit costs are likely to fall significantly. In July, CFO Peter Hunt estimated that the company's nonfuel unit costs before profit-sharing would decline 1%-2% in 2016. Furthermore, Virgin America should see an even bigger fuel cost tailwind than JetBlue next year because it was locked into large hedging losses in the first half of 2015.
Third, Virgin America recently rolled out some new technological capabilities that have boosted its ability to generate ancillary revenue. As it fine-tunes its pricing algorithms, ancillary revenue per passenger should rise in 2016.
The favorable cost environment and strong ancillary revenue trends should allow Virgin America to improve its profit margin next year in addition to growing revenue at a double-digit clip. As a result, it too could easily post 20%-30% EPS growth in 2016.
Both stocks are fairly cheap
Despite their prospects for strong earnings growth, JetBlue and Virgin America both have very modest valuations. Based on JetBlue's Tuesday closing price of $25.54, it trades for about 13 times its projected 2015 EPS. That's below the market average, even though JetBlue is on pace for strong earnings growth next year and has ample long-term growth opportunities as well.
Virgin America stock is even cheaper. Its Tuesday closing price of $37.61 puts it at just eight times projected 2015 EPS. To some extent, Virgin America has a low earnings multiple because it has been paying very little income tax up until now, but will start accruing taxes at a normal rate in the next year or two.
Adjusting for that quirk, Virgin America's valuation is similar to that of JetBlue -- which still makes it quite cheap. Furthermore, Virgin America's federal net operating losses of $633 million as of the end of 2014 and accelerated depreciation on the planes it has been purchasing ensure that the company won't pay any cash taxes until late in the decade.
If Virgin America and JetBlue can successfully execute their growth and profit improvement initiatives in the next year or two, their share prices could move significantly higher.