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JetBlue Faces Problem With Rising Costs: How the Spirit Merger Won’t Help

Edward Russell
August 2nd, 2022 at 2:04 PM EDT

JetBlue Airways posted blockbuster revenues second quarter. Total revenue, as well as unit revenue, rose to historic levels amid strong travel demand across its network.

“I’m pleased to see record demand to travel with JetBlue and the solid underlying momentum in our recovery,” JetBlue CEO Robin Hayes said Tuesday during the airline’s second-quarter results call. That strength has continued into the third quarter, and is expected to keep the pace this fall as well, he added.

But the New York-based carrier still lost $151 million during a quarter when many — though not all — of its competitors made money. And it had the second worst operating margin of U.S. airlines that have reported results at negative 2.8 percent. Why? Costs.

Expenses jumped nearly 38 percent compared to 2019 to $2.56 billion, on a revenue increase of 16 percent to $2.45 billion in the second quarter. While fuel was the single largest contributor — up 88 percent to $910 million — JetBlue saw labor, airport, and other expenses also rise more than 20 percent. Unit costs excluding fuel rose 14.5 percent on a 13.5 percent increase in unit revenues.

Yes, these increases came amid a historic run up in oil prices following Russia’s invasion of Ukraine in February. All airlines, except those with large fuel hedge books, are feeling the pressure. For example, Alaska Airlines saw overall expenses increase 29 percent and fuel expenses 54 percent year-over-three-years in the second quarter, and Frontier Airlines saw expenses jump 70 percent on a fuel increase of 141 percent. But the difference was that both Alaska and Frontier brought in enough revenue to offset the increases and posted profits in the quarter, which JetBlue did not.

And it was not just fuel for JetBlue. Labor expenses rose 21 percent year-over-three-years as the airline implemented new contracts with its pilots and flight attendants that have been ratified since December.

JetBlue’s cost problem is not new. The airline has repeatedly outlined plans to cut expenses, or at least bring their growth under control, to Wall Street in recent years. It completed a program that reduced costs by roughly $300 million annually in 2019 but the pandemic, and subsequent operational issues, have so far reduced its benefits.

The issue now is the proposed merger with Spirit Airlines. Setting aside the headline $3.8 billion purchase price, airline integrations cost money — often a lot of money. The most recent example was Alaska’s merger with Virgin America that closed in December 2016. Seattle-based Alaska recorded $366 million in one-time merger-related expenses from 2016 through 2019, and that did not include the added cost of bringing Virgin staff up to Alaska’s pay scales. The integration also benefitted from similar onboard products that did not necessarily require immediate changes.

JetBlue will arguably face more integration expenses. Spirit is a drastically different airline from it with a bare-bones onboard product that is nothing like JetBlue’s product that includes more space, personal inflight entertainment screens and other inflight amenities for passengers. In addition, Spirit crews earn less than their peers at JetBlue — for example, pilots earn 12 percent less — and will receive an immediate bump. Unit costs excluding fuel were 9.87 cents at JetBlue and 6.68 cents at Spirit in the first quarter, the latest period when results from both airlines are available.

J.P. Morgan analyst Jamie Baker wrote on July 28 that a post-merger JetBlue will likely face “meaningful upward [unit cost] pressure,” especially in the second year after the deal closes. JetBlue targets a December 2023 close. After which, revenue synergies that the airline estimates at $600-700 million annually, will begin being realized and the year-over-year cost comparisons will ease.

That timeline pushes the financial benefits of the merger out to some point in 2025 or beyond — an at least three year wait in an industry that waits for no one.

JetBlue does have a plan to reign in costs. Chief Financial Officer Ursula Hurley outlined a two-year effort to slash annual expenses by $250 million through primarily operational savings, and the replacement of its Embraer E190 fleet with new Airbus A220s by mid-2025, a year earlier than previously planned. “This new program focuses on cross-functional costs and is more about gaining operational and planning efficiencies,” she said, adding that it would allow JetBlue to achieve flat or better unit cost excluding fuel growth over the next few years.

Raymond James analyst Savanthi Syth, speaking during the call Tuesday, called the long-term cost outlook “a little bit disappointing” compared to JetBlue’s pre-pandemic plans of falling unit costs.

Hurley acknowledged cost “headwinds” that a standalone JetBlue faces — she made no mention of the proposed merger in relation to expenses — but said the operational savings program, plus added revenues primarily from its alliance with American Airlines, would help counter them.

On the proposed Spirit merger, JetBlue executives said little new. The airline anticipates a lengthy regulatory approval process but is confident in eventual approval of the deal. They also touted the network benefits of the combination that will help “diversify,” as JetBlue President Joanna Geraghty put it, its network outside of the northeastern U.S. and Florida where it is currently concentrated.

The deal will be financed with a $3.5 billion a short-term bridge facility that JetBlue already has in place, said Hurley. The facility carries an interest rate of roughly 6 percent with step ups the longer it is in place. The airline will evaluate options to take out the facility after the merger closes, or in late 2023 or early 2024.

Near-term, JetBlue has been chastened by its operational difficulties this spring. The airline plans capacity that is flat or down 3 percent compared to 2019 in the third quarter — far less than its previously planned growth. However, unit revenues are forecast to rise 19-23 percent and unit costs excluding fuel 15-17 percent. JetBlue anticipates a profit in the third quarter.

Capacity has also been slashed for the full year to flat to up 3 percent compared to 2019. Prior to its April operational issues, JetBlue planned to grow by as much as 5 percent that was already as much as 10 points lower than its guidance at the beginning of the year.

Edward Russell
August 2nd, 2022 at 2:04 PM EDT

Photo credit:  Wikimedia / Michael Gray

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