What Risks Does JetBlue Face?

By Markets Fool.com

In the past few years, airline stocks have provided exceptionally good returns to investors. That hasn't always been the case. Airlines are considered of the riskiest industries in operation, and often for sound reasons.

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Here I'll look at the biggest risks facing JetBlue Airways (NASDAQ: JBLU) and the airline industry as a whole.

Low-cost carriers
Low-cost carriers, also known as discount airlines or their more extreme cousins ultra-discount airlines, have long been a threat to JetBlue and even established airlines. By having younger workforces, lower compensation, fewer features, or all of the above, low-cost carriers can undercut the fares of JetBlue and other airlines putting pressure on passenger revenue per available seat mile, or PRASM.

While all airlines can be affected by low-cost carrier actions, JetBlue is particularly susceptible to pressure due to the way the airline gets business customers.

JetBlue lacks the groups of large corporate accounts found at major legacy carriers. Instead, the airline's strategy for business customers has been to pursue more small and mid size businesses since these businesses often do not require the full size worldwide networks of major legacy carriers; a key requirement since JetBlue does not have this size of network.

Former CEO David Barger has credited this strategy with being key to building the airline's business customer base, but smaller businesses tend to accumulate less status at airlines than large corporations making them less loyal and more ready to switch airlines. This, combined with the fact that these businesses don't need as large of route networks making low-cost carrier networks more likely to fulfill their needs, makes JetBlue's business clientele more likely to be stolen by low-cost carriers than the business customers at major legacy carriers.

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Partially mitigating the low-cost carrier threat is JetBlue's strong presence at slot restricted Northeast airports. Slot restrictions prevent upstarts from launching operations at these airports. While this can help protect core Northeast operations, it does not protect non-Northeast routes that are necessary to JetBlue's expansion.

Airport concentration
With about half its flights going through New York or Boston, JetBlue carries both an advantage and risks. The advantage comes from being able to serve these in-demand airports at a frequency unheard of for an airline of JetBlue's size. But the downside is that it leaves the airline particularly exposed to events that affect traffic at these two airport areas.

Shutting down a major airport for an extended period of time is unlikely given the pressure that would be put on government officials to reopen it for operations. However, there can be events that generally lower traffic at a specific airport. Major construction projects can cause customers to use alternative airports. This was a real issue for Logan International Airport when Boston's "Big Dig" project was under construction in the early 2000s.

Control Tower at Boston Logan International source: Wikimedia Commons

Expansion at other airports can also reduce demand at existing airports and lower traffic for existing carriers. In the case of New York, JetBlue has operations at New York JFK, New York LaGuardia, and Newark International but expansion at any one of these airports could cause traffic to shift away from another New York airport. If JetBlue is not able to collect additional slots in the expansion, it could lose market share at one airport while seeing traffic drop at other airports it serves.

A similar situation exists in the Boston area where there are other airports that passengers can use to access the Boston area besides Boston Logan International where JetBlue has major operations. Expansion at Manchester, New Hamsphire or Providence, Rhode Island could draw traffic away from JetBlue's Boston Logan operations. And there is precedent for Boston travelers choosing these airports. During the previously mentioned "Big Dig" construction, Manchester and Providence became key alternatives for Boston Logan traffic. Ironically, it drove Boston Logan traffic down so much that it helped convince the Massachusetts Port Authority to allow JetBlue to move into Boston Logan.

While other airlines can also have issues with changes in airport traffic levels, JetBlue's concentration around two major airport areas leaves it particularly exposed to changes in these airports. Although I don't see this area as a solvency risk given JetBlue would still be able to continue operations with less traffic, it does have the potential to negatively impact revenue and earnings.

Growth plan execution
Part of JetBlue's core strategy for revenue growth has been expansion into new markets. Currently, the airline has focused its expansion on Latin America where it already has major Caribbean operations and some destinations in South America.

Right now, the Latin American expansion strategy is my preferred way for JetBlue to expand given its current operations there, but there are risks in this plan nonetheless. If there were to be an economic slump in Latin America, regionwide political instability, or JetBlue's management team is just not able to execute in the market, the airline would face a major problem. Without Latin America and with no current plans for expansion outside the Americas, JetBlue would have to either give up international expansion and try to grow in the slower growing U.S. domestic market, or abruptly change course and take on a new region for growth. The former idea would severely inhibit the airline's growth ambitions while the latter would send JetBlue into a market it may not be prepared to enter.

Aircraft deliveries
Like many of its rivals, JetBlue is also aggressively purchasing new aircraft with 127 aircraft and ten spare engines on order through 2023 at a cost of $6.67 billion. Even though JetBlue has large numbers of aircraft on order, its current average aircraft age is well below that of rivals who are ordering mostly for fleet modenization.

Airline Average Aircraft Age
JetBlue Airways 7.8 years
Southwest Airlines (NYSE: LUV) 11.1 years
American Airlines Group (NASDAQ: AAL) 12.0 years
United Continental Holdings (NYSE: UAL) 13.4 years
Delta Air Lines (NYSE: DAL) 16.9 years

source: Company 10-Ks

Airbus A321 source: JetBlue

JetBlue's plans for these aircraft rely on using them to operate the airline's growth plans and getting them into service will be required in order to earn the revenue to cover the massive order costs. With 203 aircraft in its current fleet, this order would mean adding another 60% to the JetBlue fleet. Some of the oldest aircraft may be retired, but this still leaves a large number of aircraft JetBlue will need to put into operation and begin generating revenue with.

In effect, JetBlue's order book is set up assuming substantial growth over the next eight years. If it fails to materialize, JetBlue could be left with extra planes it would need to either sell, lease to other airlines, or park and incur the costs of aircraft expenses and maintenance.

In a worst-case scenario, these deliveries could pose a solvency risk for the airline if growth slows and reasonable financing terms cannot be secured since the $6.67 billion commitment greatly exceeds JetBlue's $708 million in cash and short term investments. However, the more likely risk scenario is one where JetBlue has to sell some of the new aircraft or parts of its existing fleet to raise cash in the event the airline's growth plan doesn't pan out.

The bottom line
The airline industry has long been a risky place to invest and each airline has a set of risks that apply more greatly to it than the rest of the industry. In the case of JetBlue, the airline faces potential competition from low-cost carriers and the potential for traffic to be diverted in its two key airport areas.

Additionally, JetBlue is heavily reliant on growth at this point and could be in trouble if its Latin American strategy doesn't pan out or if it can't find revenue generating uses for its aircraft on order. All in all, JetBlue carries its own set of risks and investors should be aware of these unique risks before investing.

The article What Risks Does JetBlue Face? originally appeared on Fool.com.

Alexander MacLennan owns shares of American Airlines Group and Delta Air Lines. Alexander MacLennan has the following options: long January 2017 $25 calls on American Airlines Group and long January 2016 $60 calls on American Airlines Group. 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.