One Airline to Avoid

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As with most sectors, airline stocks generally trade in the same general direction whether up in bull markets or down in bear markets. Typically the better company in the sector outperforms, but for an investor picking the right group is the major battle. In the case of the airlines, the whole sector is gaining as historically strong profits and reduced competition from consolidation promises to continue the profits streak. In addition, the group as a whole trades at sub-market multiples.

The one stock to avoid in the group has to be JetBlue Airways (NASDAQ: JBLU). A leading low-cost provider in the northeast corridor continues to struggle, having missed earnings estimates for three straight quarters now, as it continues to face higher expenses than expected.

The company competes in the low fare segment versus companies such as Republic Airways (NASDAQ: RJET) and Spirit Airlines (NASDAQ: SAVE). Both of those stocks have outperformed JetBlue over the last three years.

<img alt="" src="http://media.ycharts.com/charts/d45a97403ae764f06749b650f4818c77.png" />

JBLU data by YCharts

Higher expenses

JetBlue continues to face the historical problems of airlines while the sector has solved the profitability equation. The company reported record Q2 operating revenues, yet its income plunged from $52 million last year to only $36 million this year. The concerning part was the 7.5% increase in operating expenses.

According to a Businessweek report, the culprit is significantly higher expense due to increased engine maintenance expenses. The maintenance expense for Q2 2013 increased $26 million over last year as the company spent to fix performance issues with General Electric engines. Worth noting is that revenue only gained $51 million over last year.

Another issue is the $6 million of charges related to a fuel-hedging program that might not be very effective. The company reported fuel related expenses increased 3.3% despite such a program. In general though, all the operating expense items gained more than the revenue grew.

Missing earnings

Even knowing issues existed with the performance on the engines and the higher cost, analysts were still unable to derive an accurate estimate for Q2. This following JetBlue reporting a major miss in Q1 and an initial miss back in Q4 2012.

Analysts are still forecasting $0.20 for Q3 though one has to wonder how the number can be maintained. Miraculously the company would have to report a 43% gain in earnings per share in order to match current analyst estimates. Especially considering Businessweek states the company still has 10 of the 30 engines to fix.

More interesting peers

For investors, the industry has much better performing peers, such as Republic Airways and Spirit Airlines, that either provide more value or growth.

Republic Airways has been executing better lately having recently exceeded Q2 earnings estimates by nearly 10%. On top of that, the stock trades at only 7.6 times forward earnings providing a much better value than JetBlue trading at nearly 10 times unpredictable forward earnings.

Spirit Airlines offers revenue growth nearly triple that of JetBlue’s limited 8% growth. More importantly, Spirit has shown the ability to manage the faster revenue growth better with earnings that consistently match or exceed estimates. The stock trades at a higher multiple, but it offers a better valuation considering the much faster growth rate.

Bottom line

Generally I would advocate an investment thesis of buying the underperformer with the expectations of a reversion to the mean, but this case is different. The outperformers remain cheap while the underperformer is continuing to struggle meeting expectations. JetBlue is one airline stock to avoid in a sector that remains red hot.

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Mark Holder and Stone Fox Capital Advisors, LLC have no positions in any stocks mentioned. The Motley Fool owns shares of Spirit Airlines. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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