05-Aug-2013 10:30 PM

JetBlue Airways continues to battle cost spikes compounded by weaker demand in 2Q2013

Analysis

Unit cost pressure that has bogged JetBlue down for more than a year continued in 2Q2013 and was compounded by a sluggish economy that helped to decrease the airline's yields and unit revenues. While the carrier has slightly refined some of its capacity growth, cost escalation is continuing into the near future as FY2013 unit costs are now forecast to grow higher than the carrier previously anticipated.

It is not exactly clear when the balance will shift and JetBlue will achieve lower unit costs and bolster its unit revenues. But the carrier is issuing a positive outlook for 3Q2013 as its management believes JetBlue should record a favourable revenue performance for the Jul-2013 and Aug-2013 timeframe.

Summary

JetBlue's unit costs have continued to rise, putting pressure on the airline's profitability.
Lower fares have resulted in decreased yields and unit revenues for JetBlue.
Maintenance costs, particularly engine maintenance, have been a major driver of JetBlue's rising unit costs.
JetBlue is revising its overall unit cost estimates for 2013 upwards due to a revised capacity forecast and engine escalation events.
The airline is refining its capacity targets for lower-demand periods in an effort to improve profitability.
JetBlue is optimistic about the outlook for 3Q2013, with solid demand expected during the US summer high season.

Lower fares hurt yields

JetBlue's average fare during 2Q2013 fell approximately 1.3% to USD157, which drove yields down 2.8% and decreased unit revenues 3.3%. All of those decreases were against a backdrop of a 7.8% rise in capacity and a 7.3% increase in traffic.

JetBlue select financial and operating statistics: 2Q2013 vs 2Q2012 and 1H2013 vs 1H2012

Carrier management in assessing 2Q2013 explained some of the yield and revenue pressure resulted from the timing of Easter and Passover holidays falling in Mar-2013 versus Apr-2012. JetBlue's unit revenues in Apr-2013 fell 9% year-on-year, increased 1% in May-2013 and remained flat in Jun-2013.

Overall JetBlue recorded a 22% drop in operating income during 2Q2013 to USD102 million while profits fell nearly 31% to USD36 million.

JetBlue top-line financial results: 2Q2013 vs 2Q2012 and 1H2013 vs 1H2012

In discussing 2Q2013 earnings JetBlue executives stated that some of the sluggishness it saw in demand during the quarter was similar to sentiments made by other carriers, which in turn drove their yields down year-on-year. Delta recorded flats yields while its US legacy rival United saw its yields drop 4.2%. Southwest also endured yield pressure as it recorded a 2% drop in that metric.

See related reports:

JetBlue faces the unviable situation of rising costs and falling unit revenues

But unlike Delta and Southwest, who managed decent cost performance during 2Q2013 (a 1.5% decline and 1.7% rise in unit costs, respectively. United is still battling cost creep, evidenced by its 7% increase in unit costs during 2Q2013), JetBlue saw its unit costs excluding fuel and profit sharing grow 3.3% year-on-year due largely to the same issues it has been battling during the last year - maintenance. The major culprit driving the carrier's unit costs up nearly 5% during 1H2013 has been engine maintenance on its fleet of smaller 100-seat Embraer jets. During 2011 and 2012 airframe maintenance pressured its overall unit costs. The carrier during the first half of 2013 opted to accelerate some engine restorations on the General Electric CF34 powerplants featured on the Embraer 190s, and has recently concluded a power-by-the-hour agreement with the engine manufacturer that is intended to smooth out future maintenance expense. As a result its year-on-year maintenance costs should decrease during 2H2013.

But despite relief in its maintenance cost line JetBlue is revising its overall unit cost estimates for 2013 upwards to 2.5% to 4.5% from an estimate provided at the end of 1Q2013 of a 1.5% to 3.5% increase. The carrier attributed the increase to a revised capacity forecast for 2H2013 and the engine escalation events during 1H2013.

JetBlue opts to refine capacity in the lower-demand shoulder periods

While JetBlue is assuring that demand and bookings look solid for most of 3Q2013, it has opted to refine its overall 2013 capacity targets back to its original estimate of 5.5% to 7.5% rather than the 6% to 8% planned expansion tabled at the end of 1Q2013.

The carrier is adjusting its capacity mainly in the lower-demand "shoulder" periods in 3Q2013 and 4Q2013 (typically Sep-2013 and Oct-2013). Carrier chief commercial officer Robin Hayes explained the tweaks to JetBlue's capacity are not out of the ordinary. Although he did state in previous years JetBlue has often added capacity in the September timeframe to de-peak the airline and during 2013 he remarked JetBlue is not looking to build out September as aggressively as it has during previous years. A fair amount of the capacity typically introduced during that time has been geared toward the corporate traveller as JetBlue's long-term strategy has been to flatten out the peak and troughs of leisure demand with business travellers and the visiting, friends and relatives segment (VFR).

See related report: JetBlue continues to see benefits and growth opportunities from its hybrid business model

Mr Hayes reiterated the adjustments in capacity are essentially just "really falling back to what we had said about the beginning", and cautioned the slight pull-down shouldn't be interpreted as a pattern that would continue into the shoulder periods during 2014.

A more promising outlook for 3Q2013

Assessing overall demand for 2Q2013 Mr Hayes concluded it was "kind of okay" and a bit sluggish. But as 3Q2013 approached he remarked JetBlue was pleased with demand during the US summer high season, noting the carrier was expanding capacity by 7% in Jul-2013 and Aug-2013. With respect to specific geographic regions he explained that JetBlue's markets in the Caribbean and Latin America were performing particularly well alongside solid performance on its north-south routes from New York to Florida.

He did remark the carrier was seeing some additional capacity on transcontinental routes from Boston (including Alaska in San Diego and Delta in Boston to Los Angeles), "so that's been a little more challenging". But remarked that summer demand in Boston is producing "nice traction".

Overall for Jul-2013 and Aug-2013 Mr Hayes stated JetBlue is "close to mid-single digits" in terms of RASM [revenue per available seat mile] growth".

JetBlue faces queries over when costs will fall and revenue will rise

While the revenue commentary for 3Q2013 is encouraging, the obvious question being fielded by JetBlue is when the switch will flip with respect to unit revenues increasing and unit costs decreasing. In response to the query Mr Hayes remarked JetBlue was building its five-year plan "precisely for that" with the caveat that pilot wage issues could be a factor as wage discussions may occur in 2014.

In the short term, management assures the engine maintenance events that have pressured costs in 1H2013 should not be a cost constraint moving forward. In addition, the larger-gauge Airbus A321s with fuel efficient sharklets due to enter JetBlue's fleet in 4Q2013 will be a "fundamental" unit cost driver, as well as the potential to equip its existing A320 family fleet with sharklets.

JetBlue ended its 13th consecutive quarter of profitability by attempting to allay concerns of analysts and investors that its performance in unit revenues and costs would continue to lag. The carrier still has strong fundamentals and pledges to expand margins in 2H2013, but its capacity growth during the last couple of years has drawn consistent scepticism. Even as the carrier argues it remains in growth mode compared to the mature US legacy airlines, impatient investors largely only concern themselves with the short term - which means its 3Q2013 financials could be watched closely to see if the carrier delivers on its pledges of improved results in the back half of 2013.