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Morningstar | Hybrid Carriers Stand to Benefit From Product Initiatives, but Budding Competition Raises Concerns. See Updated Analyst Note from 03 May 2019

We are initiating coverage of JetBlue Airways and Alaska Air Group with no-moat ratings and respective fair value estimates of $19 and $66. JetBlue and Alaska operate a hybrid model that overlaps with domestic legacy carriers and traditional low-cost carriers, in relatively small niche markets. Dissimilar to incumbent legacy carriers, JetBlue and Alaska have avoided bankruptcy over the last two decades and instead reaped the benefits of the industry's consolidation. Like legacy carriers, JetBlue and Alaska have increasingly called on ancillary revenue and favorable loyalty program economics to improve overall returns while also attempting to maintain budget carrier savings schemes. Between JetBlue and Alaska, we believe Alaska is better suited to compete in a domestic travel environment mostly dictated by four carriers that control 80% of the market.

We model JetBlue and Alaska based on available seat miles, revenue passenger miles, and passenger yields. We expect mostly flattish passenger yields through our midcycle period on oil prices normalizing toward our $60/barrel Brent midcycle price and pressure from increasing competition in core markets. Alaska faces pressure from Delta in its Seattle hub and Southwest in its California markets. Meanwhile, JetBlue is challenged by Delta’s ever-growing presence in the Boston market, fierce low-cost carrier competition in Florida markets, and steep barriers deployed by alliance-backed joint ventures in trans-Atlantic markets.

That said, we expect near-term margin expansion thanks to initiatives that will increase unit revenue and slash overhead costs. JetBlue and Alaska plan to rely increasingly on noncore ticket items that helped improve margins at full-service domestic U.S. airlines like route upgauging (adding larger aircraft), product segmentation, and fare unbundling.

Alaska is our top choice of the two hybrid carriers because it holds a more defensible position in its West Coast and Pacific Northwest market, boasts an investment-grade balance sheet, and has a dividend yielding 2.3%. We anticipate margin accretion as Alaska pulls higher ancillary revenue from exit row sales, higher bag fees, and tighter change fee policies. Introducing its saver fare, a more generous basic economy, should also make the carrier more competitive versus bare-bones basic economy fares from legacy carriers. Amid strong but decelerating demand and restrained capacity additions during the early stages of our Stage I forecast period, we expect decent expansion in passenger revenue per available seat mile. In 2019 and 2020, we have PRASM inflating 3.5% and 1.5% in each respective year before flattening and turning negative in our 2023 midcycle year.