Analysts Criticize JetBlue Expansion Plan

As the U.S. airline industry unraveled over the past five years, JetBlue Airways Corp. proved that a carrier with the right mix of low overhead, cheap fares and distinguished service could succeed during a punishing downturn.

The outlook for most big airlines is still pretty grim, with Delta Air Lines Inc. and Northwest Airlines Corp. in bankruptcy, and the rest unlikely to show a profit in 2006. What has changed, though, is that investors now lump JetBlue among the lackluster.

The tarnish on JetBlue's reputation comes just as a few money-losing carriers, such as AMR Corp.'s American Airlines and Continental Airlines Inc., are gaining favor on Wall Street thanks to shrinking costs, increased demand for air travel and rising fares.

Analysts agree that JetBlue's problems stem from an aggressive expansion plan that has run into headwinds, such as high fuel prices, fierce competition and some bad decisions when choosing new markets. Several have placed a "sell" or equivalent rating on the company's stock.

"Since we're not making money, I think there is skepticism that is out there and it is legitimate skepticism," said John Owen, JetBlue's chief financial officer.

While 2006 is expected to be an unprofitable year for six-year-old JetBlue, the discount carrier aims to minimize the red ink by flying more short-haul routes (to save on fuel), serving airports with fewer rivals and raising fares.

CEO David Neeleman said another option on the table is to scale back JetBlue's rapid growth plan, which includes orders for more than 180 new planes worth approximately $7.5 billion.

JetBlue, which recorded its first-ever quarterly loss of $42 million in the October-December period, is expected to report a loss of almost $33 million for the first quarter, according a survey of analysts by Thomson Financial.

The underlying challenges at JetBlue may not be a big deal to customers - its planes were 83 percent full on average in February despite having the worst on-time performance among U.S. airlines - but the story is different on Wall Street.

The company's stock price, which climbed above $30 in March 2003, is now trading near the bottom of its 52-week range of $9.65-$16.85. Shares of JetBlue, which were split three-for-two on Dec. 23, closed at $10.94 Wednesday on the Nasdaq stock market. In contrast, AMR closed at $28.10, near the top of its 52-week range of $9.80 to $29.14.

While other airlines are shrinking their overall flying capacity in the U.S., JetBlue's expansion calls for nearly tripling its fleet by 2011.

In the fourth quarter, JetBlue's seat capacity climbed 25 percent from the year before, and the company has acknowledged that a glut of empty seats to and from the hypercompetitive Florida market has made it difficult to increase fares.

Furthermore, JetBlue's non-fuel-related costs are rising sharply while most of the industry's are only increasing modestly, and in some cases falling. Even before the price of jet fuel marched up to almost $2 a gallon, or roughly 20 percent above year ago levels, JetBlue's costs for terminal leases, aircraft maintenance and pilot training were advancing.

For example, in the fourth quarter of 2005, JetBlue's maintenance costs rose 40 percent, compared with a 2 percent increase at Fort Worth, Texas-based American. JetBlue's aircraft rent climbed roughly 14 percent, compared with a decline of 3 percent at American.

"When you take a legacy carrier with all the inefficiencies that they have collected over decades of operation, it's really easy to cut costs," Owen said. "We started with low costs and our goal is to keep them as low as we can."

JetBlue's per-seat flying costs are still some of the lowest in the industry, but the trend is moving in the wrong direction, analysts said.

"The decision to grow as rapidly as they have, and simultaneously induct a new fleet type - the Embraer 190 - has caused them to incur substantial ... costs for training, development and support," said Robert W. Mann, a Port Washington, N.Y.-based airline consultant. By contrast, low-fare leader Southwest Airline Co.'s entire fleet is made up of Boeing Co. aircraft.

Prudential Equity Group analyst Bob McAdoo said he sees the potential for a "financial meltdown" at JetBlue based on an extensive analysis of the newest markets the airline has entered. The fundamental problem, according to McAdoo, is that JetBlue is taking delivery of one new plane every 10 days, but lacks enough gates at New York's John F. Kennedy International Airport - its hub - to deploy them profitably.

Instead, McAdoo hypothesizes that JetBlue has been forced to work around the constraints by flying more long-haul flights in order to minimize the number of takeoffs and landings at JFK. Trouble is, 17 of the last 20 markets JetBlue has introduced since early 2004 have been unprofitable, according to McAdoo.

While Neeleman disputes McAdoo's arithmetic, he agrees that JetBlue would be better off flying shorter routes. Aside from saving fuel, increased ticket sales would more than offset the marginally lower fares on short hops, he said.

Indeed, adjustments are underway.

Roundtrips between JFK and Long Beach, Calif. are now six daily, compared with eight last year; roundtrips between JFK and Ontario, Calif., are down to one a day from two and executives say they are planning further cuts to transcontinental service by fall.

Planes freed up from cross-country trips will mainly be redeployed for service east of the Mississippi, Neeleman said. The company recently launched service to Richmond, Va., Pittsburgh, Pa., and Jacksonville, Fla.

Neeleman regrets not protecting the company from rising oil prices by locking in long-term fuel-purchasing agreements - a strategy employed most effectively by Southwest, which remains profitable.

But he also sees a silver lining in the experience. The fuel issue exposed otherwise hidden mistakes the company had made in market selection and revenue management, and JetBlue plans to correct them.

"If we need so many cheap fares in a market to stimulate traffic during a certain part of the year, maybe we shouldn't have so many flights," he said.

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