On Tuesday, JetBlue Airways (NASDAQ:JBLU) reported strong earnings growth for the first quarter of 2016. Earnings per share reached $0.59: up from just $0.40 a year earlier, and well ahead of the average analyst estimate of $0.53.
Investors were less pleased about the company's outlook -- and particularly its estimate that unit revenue will decline about 12.5% year over year in April. However, this jarring statistic isn't really representative of JetBlue's revenue trajectory.
Unit revenue deteriorates
In 2015, JetBlue dramatically outperformed the rest of the industry by growing its revenue per available seat mile (RASM) by 0.8%. While its underlying unit revenue trends weakened over the course of the year, even in Q4, RASM declined just 0.2%.
In 2016, JetBlue's unit revenue has taken a turn for the worse. RASM declined 7% in Q1, as weak demand on routes to Latin America and the Caribbean offset stronger results for business markets in the Northeast and JetBlue's transcontinental Mint service.
JetBlue made up for this unit revenue decline with even bigger cost savings. JetBlue's unit costs plummeted 12.6% year over year in Q1, due to a sharp drop in fuel prices and a 3.6% reduction in non-fuel unit costs (excluding profit sharing).
As a result, JetBlue's operating margin widened by 5 percentage points to 21.6%. That was the best operating margin of any airline, beating out even industry stalwart Southwest Airlines (NYSE:LUV), despite Southwest posting a much better unit revenue result.
Headwinds coming in Q2
As noted above, JetBlue expects RASM to fall 12.5% this month, dragged down by shifts in the timing of Easter and Passover relative to last year. That said, the company expects to report a Q2 RASM decline roughly in line with last quarter's 7% decrease. This implies declines in the 4%-5% range for May and June.
JetBlue estimates that non-fuel unit costs will be roughly flat (down 0.5% to up 1.5%) while its projected fuel price is $1.33/gallon, down from $2.13/gallon in Q2 2015. As a result, the company should be able to keep growing its earnings in Q2, but at a slower rate.
In total, JetBlue's guidance implies EPS of about $0.50-$0.55: up from $0.44 last year but worse than what analysts had expected. That means it won't be able to maintain its position as the most profitable airline in the country. Southwest Airlines has the inside track for taking the top spot in terms of operating margin for Q2, due to its strong unit revenue trajectory.
Revenue trends should strengthen going forward
JetBlue's unit revenue trajectory should strengthen in the back half of the year. First, the carrier has tweaked its capacity plans in light of recent demand trends. For example, it has cut some capacity during off-peak periods in the fall.
JetBlue has also reallocated some capacity from weaker markets like Colombia and Puerto Rico to domestic routes during the peak summer period. Recently, unit revenue trends have been much better in the domestic market than on international routes. Indeed, Southwest Airlines' domestic focus is a key driver of its strong unit revenue outperformance this year.
Second, JetBlue's capacity growth will slow in the second half of 2016. Capacity soared 14.1% in Q1 and is expected to rise 9.5%-11.5% year over year in Q2. However, its capacity growth will slow to about 7% in Q3 and even less in Q4. High capacity growth tends to put pressure on unit revenue, so slower growth should lead to better trends.
Third, JetBlue's new co-branded credit card was launched last month. While there will be a bit of a ramp-up period, it is expected to eventually drive at least $60 million of incremental annual operating income. A good chunk of that benefit should start to show up by the second half of 2016.
Finally, JetBlue will further expand its highly successful Mint service this fall. In addition to its New York routes, JetBlue offers Mint service on two daily Boston-San Francisco flights today. By mid-November, Mint will expand to three daily Boston-San Francisco roundtrips and three Boston-Los Angeles roundtrips. JetBlue is also adding more Mint service to the Caribbean.
Better unit revenue trends should help the stock
JetBlue shares are down about 25% since peaking last fall. A big reason for that is the sharp deterioration of its unit revenue trajectory. If the factors mentioned above allow JetBlue to get back to flat unit revenue -- or better still, unit revenue growth -- investors should gain confidence in the sustainability of its high profitability.
JetBlue stock currently trades for less than nine times projected 2016 earnings. That's surprisingly low in light of its massive growth potential. A little boost in investor confidence could therefore drive big stock gains through multiple expansion.