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Key valuation: Why JetBlue’s share price increased in 2Q14

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Share price performance

JetBlue’s share price has increased by more than 40% from the beginning of the year to $12.28 as of August 21, 2014. The share prices of most U.S. airline companies increased during the period due to positive macro-economic factors, strong demand for air travel, and improvements in company operations and financials.

 

Valuation multiples

Valuation multiples help investors compare the prices of different companies in an industry against specific variables that drive the market value of the stock. While enterprise value multiples consider all claims on a business, equity multiples such as the price-to-earnings multiple consider claims to only equity holders.

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As the graph above shows, the enterprise value multiple can produce conflicting results compared to valuations using the price multiple. Although JetBlue’s forward price-to-earnings multiple is very high, its forward EV/EBITDAR multiple is the lowest among its peers. These peers include Delta (DAL), United (UAL), American (AAL), and Southwest (LUV). This trend shows that JetBlue is undervalued. The conflicting results are primarily due to differences in capital structure.

JetBlue’s debt accounted for more than 50% of its total capital. The price-to-earnings ratio is calculated as market capitalization divided by net income. Since JetBlue has high leverage, the denominator reduces due to higher interest expenses apart from other non-operating expenses and taxes, thereby increasing the price-to-earnings ratio.

The denominator in the case of the EV/EBITDAR ratio, however, is higher. This is because rent, depreciation, interest, and taxes are added back to net income to arrive at EBITDAR. The numerator (enterprise value) will be higher if net debt is positive, since net debt is added to market capitalization to arrive at the enterprise value.

Apart from debt, the ownership pattern of JetBlue’s aircraft also affects its P/E. If companies have a higher number of aircraft on operating leases, their P/E ratio will be higher, as operating lease rentals will further reduce earnings. Since airline companies have high debt and lease obligations, EV/EBITDAR is more appropriate. It makes companies comparable and makes the comparisons more meaningful.

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