Although the first quarter was weak for the airline industry overall, JetBlue (JBLU) surprised the markets last Thursday with a 19% jump in revenues for its first quarter driven by a 1.5 point improvement in load factor, a 6.6% rise in fares and a 12% jump in capacity. The company also managed its costs effectively to achieve operating margin of 7.4%, a 3% rise year-over-year. The stock jumped after the announcement, but has since settled back to close May 1 at $4.72.

Sitting on strong top-line growth and improved operational efficiency, the carrier reported a net GAAP income of $30 million. JetBlue outshined several of its peers that include Southwest (LUV) and United Continental (UAL) with robust earnings.

Going forward, the company is well equipped to adopt an expansion strategy with focus on the Caribbean and Latin American markets. However, the main concern is its declining cost advantage from a young and fuel-efficient fleet.

Capacity expansion to drive international markets

With cash and cash equivalents of $1.2 billion combined with robust demand, JetBlue is well suited for capacity expansion. The carrier plans to initiate a new nonstop service from Boston to Dallas/Fort Worth and expand into Bogota, one of its most profitable markets. Other promising markets are Caribbean and Latin America where the company is planning a 15% capacity expansion this year. All these capacity addition exercises are expected to generate a 4-6% available seat mile (ASM) growth in 2012.

Maintenance costs threatening JetBlue's cost advantage

JetBlue's 15% increase in operating expenses is mainly attributed to the rise in fuel expense and maintenance expense. The carrier has adopted the best possible measures to cover fuel price turbulence through optimum hedging strategies and a fuel efficient fleet. However, its cost benefits through maintenance savings on a relatively young fleet are slowly fading away.

The carrier incurred maintenance expense of $88 million this quarter, a whopping 67.5% increase. This rise in costs is attributed to heavy maintenance checks for A320 aircraft acquired in mid-2000s. The carrier's key maintenance provider, Aveos, liquidated in March and, because of this, the maintenance bill for the rest of the year is expected to inflate as JetBlue seeks alternate repair options. Overall, the maintenance costs for the airline will continue to rise significantly as the fleet grows old.

The carrier has hedged 26% of the anticipated jet fuel requirements for Q2 and 21% of fuel consumption for second half of 2012. As a result, the estimated fuel price including the impact of hedging is an expected $3.30/gallon. Should the revenues continue to rise at this pace, the operating expenses can be easily offset through strengthening top-line.

We have a Trefis price estimate of $7.84 for JetBlue, well above the market price. We are in the process of revising our price estimate incorporating the Q1 earnings.