JetBlue, Elon Musk, Disinflation, and Japan

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Again, the premise for this whole merger is to take the seats off the plane, redesign to the JetBlue specs, which just eliminates 10 to 11% of all seats. And that seems like a non-starter to me, but I don't know, we'll see what the government has to say.

Welcome to the Barron Streetwise Podcast. I'm Jack Howe. The voice you just heard, that's Connor Cunningham. He's an airline analyst at MKM Partners, and like many airline analysts at the moment, he's trying to figure out what JetBlue was thinking this past week when it made a big bid for Spirit Airlines. In a moment, we'll hear more about that and the broader outlook for airline stocks. We'll also say a few words about Elon Musk, Warren Buffett, disinflation, and Japan. It's a financial smorgasbord. Try not to fill up on bread. Listening in is our audio producer Jackson. Hi Jackson.

Hi Jack.

Frontier was going to buy Spirit Airlines. I have not yet had the pleasure of flying either one.

Yeah, I've flown Spirit before and I'm just about to fly Frontier.

How was Spirit?

Spirit was good, but I think it was because I had prepared for it. I didn't bring any carry-ons and I wasn't expecting much legroom.

Do you have to wrestle people on the plane for where you're going to sit?

Yeah, no wrestling, but some people were upset before they got on the plane about extra baggage fees.

And with Frontier, did you get— do you feel like you got a very good deal?

Yeah, I'm flying to Cancún from Rhode Island direct for less than $200.

Round trip?

Round trip. That's if I can keep the baggage fees low.

Does part of the plan involve you wearing 7 pairs of pants?

No more than 4.

Got it. We'll come back to low-cost airlines in a moment. Let's start with the words "grab the popcorn." That's what one analyst wrote this past week after investors learned that Tesla founder Elon Musk had bought 9.1% of Twitter. Grab the popcorn means what happens next could be dramatic and fun to watch. Maybe we should have grabbed a slushie and a Junior Mints too, because it's already been quite a show. Twitter stock jumped 27% on the news. That's a huge move. It means Elon is already up more than $1 billion on his investment. He posted a poll on Twitter asking whether users want an edit button, and Twitter's CEO said that users should vote carefully, which suggests he might take actions based on the results. And then Twitter invited Elon to join the board. There were only two problems. One is that when investors take a 5% or larger position in a stock, they're supposed to file a form stating their intentions, and the form Elon had filed said he'd just be a passive investor. But right out of the gate, he wasn't looking all that passive. So he filed a different form, the kind that an active investor uses. The other problem, which is potentially bigger, is that his forms appear to have been filed late. That might sound like nitpicking, but Elon has already been put in the naughty corner by the Securities and Exchange Commission. In a 2018 tweet, he wrote, am considering taking Tesla private at $420, funding secured. The number 420 is an inside reference among cannabis enthusiasts. It reportedly dates back to 1971 and 5 California high school students who used to meet at 4:20 PM each day to smoke grass. Jackson, if I call it grass, is that cooler or less cool than if I say weed? And where does pot come in?

Grass has come back around. It's cool again.

Good to know. Now, the SEC was less interested in hidden grass references than in whether funding for a Tesla takeover had actually been secured. It sued for securities fraud and there was a settlement, and one of the terms was a so-called Twitter sitter. Elon is supposed to have some of his tweets previewed by a lawyer. Then last November, Elon sent a tweet asking the public whether he should sell 10% of his Tesla stock. The SEC is looking into whether he used his Twitter sitter for that tweet. Elon's lawyers have argued that the Twitter sitter is a free speech violation, but the SEC says it has a legitimate interest in Elon's tweets because he uses them to distribute information to investors. So back to Elon's purchase of Twitter shares and the timing of his regulatory filing. It appears to have been 11 days late. The subsequent jump in the stock price from around $39 to $50 makes that significant because it means that Elon was able to buy stock at the lower price for longer than he would have been able to if he wasn't filing late. As the Washington Post put it in the headline, Elon Musk delayed filing a form and made $156 million. Now, is there any of that popcorn left? Because There's more than just SEC stuff to watch here. Elon has a long record of sending meme stocks and parody crypto coins soaring with his tweets. He once tweeted two words, "Use Signal." That was a reference to a messaging app, but it ended up sending shares of a totally unrelated company called Signal Advance up more than 6,000% over 3 days. So now it's unclear what his presence as a big Twitter shareholder will mean. Beyond whether he comes up with good ideas for the company. Will Twitter turn into a meme stock, or is it too big and too established? This past week, one analyst downgraded the stock to neutral from buy at about $49, writing that risk and reward looked fairly balanced after the post-Elon price jump. But B of A Securities stuck with its buy rating, writing that Twitter's valuation of 5.5 times revenues looks attractive relative to its history. Twitter has had a new CEO since November and has set ambitious 2023 goals for growth in users and revenue. It'll be interesting to see whether it meets those goals, whether Elon comes up with any money-making ideas, and whether his mere presence continues to push the stock higher, or whether the whole thing fizzles and Twitter falls back to its earlier price. By the way, Elon and Warren Buffett appear to have something in common beyond their vast wealth. Their attachment to an investment can send the price soaring. That's a handy thing for returns if whatever you buy goes straight up just because you bought it. I mentioned that because on Thursday, investors learned that Buffett's company Berkshire Hathaway had bought a stake in HP, or Hewlett-Packard, the computer and printer maker. The stake was worth more than $4 billion, and that stock was trading about 15% higher by midday. Jackson, I checked Frontier stock, by the way. It didn't move after you mentioned about your Cancun flight.

It's down about a penny.

I want to say a quick word about disinflation, and I understand we also had a listener question on Japan.

That's right. Here's Tyler.

Hey, Jack. Love the podcast. Could you explain how Japan entered a period in the '90s called the Lost Decade? It seems there are some similarities between that period in Japan and where the US is right now. Both have high valuations in stocks, rising interest rates, and possible stagflation. Let me know when you get a chance. Thank you.

Thank you, Tyler. As far as music genres go, Monetary bluegrass is not a big one. In fact, there's only one monetary bluegrass artist I know of. He's a Nashville money manager named John Shane. He performs under the name Merle Hazard. That's a play on Merle Haggard, the late country star, and on moral hazard, which is an economic term for when you can take loads of risk without personally bearing the consequences of that risk. The song that put moral hazard on the map was 2009's "Inflation or Deflation," and I can't play a clip because Jackson tells me that's a royalty hazard, but the words go, "Inflation or deflation, tell me if you can. Will we become Zimbabwe or will we be Japan?" That was shortly after the housing bust and policymakers were spending massive sums to revive the economy. Zimbabwe is a reference to that country's experience with hyperinflation, and Japan refers to that country's so-called lost decade. We've talked about both of those cases in past episodes. Japan grew faster than the US in the 1980s and ended that decade with epic stock and real estate bubbles. Its central bank raised rates, sending stock prices lower, but real estate kept rising, so the central bank kept hiking. The result was a long and painful period of slow growth and falling asset prices. Land values fell 70% over a little more than a decade. The Nikkei 225 stock index still hasn't recovered to peak levels. But the answer to Merle's question about whether the U.S. will become Zimbabwe or Japan has so far been neither. The U.S. certainly didn't experience meaningful inflation during the decade after its housing bubble popped, and although economic growth was slow, it wasn't lost-decade slow. A 2018 paper published by the Federal Reserve Bank of St. Louis looked at that very question and concluded that the U.S. experienced more of a one-time shock to economic activity, not a lost decade. But Tyler, you're asking whether the US could be headed for a lost decade now that the Federal Reserve has begun what is expected to be an aggressive pace of interest rate hikes to control inflation. What's different between the US now and Japan then? A few things. First, Japan's asset bubbles were more extreme. Japanese stocks in 1989 sold for more than 50 times earnings. For comparison, the S&P 500 index in the U.S. was recently about 20 times this year's projected earnings. For land, there's not really any comparison. I realize there's a lively discussion now about whether houses in the U.S. have gotten too expensive, and I noticed that the 30-year mortgage rate has been flirting with 5% versus less than 3% last summer. So maybe the housing market is set to cool. But sale prices for land in Japan in the late 1980s implied that all of the country's land was theoretically worth 4 times the value of U.S. land, even though the U.S. is about 25 times as large. Apart from bubble prices, I also think of the U.S. economy as being structurally stronger and more diverse than Japan's economy, but maybe that's just my home country bias talking. What we could certainly have in the U.S. is a long slump if the Fed can't pull off what some investors refer to as a soft landing. That is, if it can't cool inflation without squashing economic growth. And we might find out about that soon. This past week, economists at UBS published a note predicting that U.S. inflation, which was 7.9% year over year in February, already peaked in March. Now, the March number is due out soon. UBS estimates 8.5% inflation for March, but by next year, it thinks the inflation rate could plunge below 2% on falling used car prices, slowing rent growth, a shift in demand from goods to services, and the lapping of fast inflation from the past year. That's a pretty bold claim. Slowing inflation is called disinflation. If UBS is right, it'll be interesting to see what effect such rapid disinflation will have on growth. To my knowledge, Merle Hazzard hasn't done any songs on disinflation, so if anyone out there is looking to get into the monetary bluegrass game, Now's your chance. Time to hear about JetBlue's deal and the outlook for airlines. That's next after this quick break.

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Welcome back. The early reviews are in for JetBlue's offer for Spirit Airlines, and the critics are confused. JPMorgan calls the merits of the deal not abundantly clear. UBS used the word head-scratcher. And Connor Cunningham at MKM Partners wrote in the title of his note on the deal, "Wait, what?" I recently caught up with Connor. Thank you for making a few minutes to speak with me.

Of course.

So what's—

why is it—

let's start there. Why? Why would JetBlue want to do— how does this deal make sense for them? What do you think?

I mean, it's the million-dollar question. I, to me, um, I struggle with the idea in a pretty big way. You know, Spirit is like your ultra low-cost, high-density airline. Then you got JetBlue, who's, you know, up and down the product rung. I mean, you have a tweener versus an ultra low-cost carrier. So, you know, it doesn't make a lot of sense from that perspective.

JetBlue CEO said in a press release that it and Spirit are different but that they also have much in common, including trying to keep costs low. But when Conner says tweener, he means JetBlue is more expensive than an ultra-low-cost carrier like Spirit and cheaper than a legacy carrier like Delta. It's trying to move up in services, going after more business travelers, for example. JetBlue flights generally have more legroom and more frills than Spirit flights and bring in more revenue per mile. So what's in the deal for JetBlue? One possibility is planes. JetBlue flies Airbus planes, including the A320. There's a 7 or 8 year wait for those now. Spirit flies Airbus planes too, and JetBlue would get those planes and Spirit's order book. Sometimes an airline merger can get a company into airports where new slots are difficult to come by. That doesn't appear to be a big driver in this case. One possibility is that the deal is defensive. JetBlue's offer for Spirit tops a previous offer by Frontier Group. Connor estimates that Spirit and Frontier would have been on a path to overtake JetBlue in size in 5 years. That's a big deal, he says. JetBlue had talks years ago to acquire Virgin America. But it was beaten out by Alaska Air Group. Connor says the Spirit deal looks defensive to him and that it might be a difficult sell to the Department of Justice, which would have to give its approval.

You know, the government has been very vocal about the airlines not necessarily getting larger and driving prices higher. And again, the premise for this whole merger is to take the seats off the plane, redesign to the JetBlue specs, which just eliminates 10 to 11% of all seats right out the door immediately. So it's an immediate capacity reduction.

A capacity reduction would mean less supply for customers, which is not the kind of thing that regulators like to see when reviewing deals. What's even more remarkable is that the Justice Department is already suing both JetBlue and America Airlines over something called the Northeast Alliance, which would allow the two to coordinate schedules, but not fares, in the Northeast. It's unusual for a company facing regulatory backlash over one deal to try for another. So we'll see what happens. JetBlue investors don't seem to love the deal because the stock tumbled after it was announced. And Spirit investors don't seem nearly convinced that JetBlue will be successful because that stock is trading well below the proposed deal price. Speaking of airline investors, Is there any reason to become one now? I sometimes hear strong sweeping opinions about investing in airlines, either don't do it, or if you do, think of it as a short-term trade, not a long-term holding. I asked Connor what he thinks about that.

Yes, they've been historically challenging stocks to own, but yeah, I mean, I do think that when all the dust settles and we get to an actual full-blown recovery in demand, which every day feels like this pandemic is over, You know, business travel down only 35%. You look back last year, uh, in the amount of ink that was dedicated to the demise of business travel was exceptional and how it was never going to recover. And reality is, is that like it's going to, it may just look a little bit different.

Connor says he expects flights to remain expensive through summer and that as demand recovers, the most difficult part for airlines to keep up with will be hiring. He has a neutral rating on Spirit and a sell on JetBlue. One issue for JetBlue is that it's based in New York, where the cost of jet fuel at the moment happens to be much higher than it is in other markets. Another issue for Connor is that he thinks JetBlue's near-term growth plans look too ambitious.

They need to hire 5,000 net people. Delta is going to hire 4,000 net people, and they're like 5 times the size of JetBlue. So one, that's like, this is a tight market in general. You need a lot of pilots to do a lot of what they're doing. Alaska, for example, just lowered their second quarter, uh, capacity growth. One, because jet fuel's high, and then two, because they couldn't hire to get the— to get to the needs. So if Alaska can't do it, it seems unlikely that JetBlue is going to do it.

Let's talk about some airline stocks that Connor recommends. He says that investors should focus now on areas that have lagged during the pandemic, which means international travel and corporate travel, and the legacy carriers have high exposure to both. Delta has an excellent hedge against high fuel prices. It owns a refinery. We've talked in previous episodes about how the crack spread, the difference in price between crude oil and refined products, is high now, and that makes it a profitable time to be a refiner. Here's Connor.

Delta owns a refinery. It actually benefits them. I think they're going to have a great story to tell next week with earnings. We like that one quite a bit. That's our top pick.

Connor also has buy ratings on American Airlines and United Airlines. He says United is facing some high costs to grow, but that investors have already priced that in.

So they're gonna have an incredible summer in Europe, and that's gonna be great for them. They will have some cost problems, I think. I think investors right now kind of understand that, but it definitely is a concern that some have.

And American carries a lot of debt after refitting its planes. Which makes investors nervous, but Connor is optimistic.

The worst seems to be behind them. Now it's about returning to profitability, strong operations, and then improving the balance sheet.

Thank you, Connor and Tyler, and thank all of you for listening. If you want to hear your question on the podcast and become the envy of your friends like Tyler, you just tape on your phone, use the voice memo app, and send it to jack.houw@jackhowe.com. That's H-O-U-G-H, at barons.com. Jackson Cantrell is our producer. If you need him, he'll be sipping frozen Coco Locos down at the Señor Flip-Flops in Cancún. Jackson, when you're dressing for that Frontier flight, is it swim trunks on the inside or outside?

Definitely outside.

All right, well, bring a doctor's note for the snorkel you wear. Just tell them it's medically necessary. Subscribe to the podcast, write a review on Apple, and follow me on Twitter I'm only $80 million behind Elon. It's @jackhoug. See you next week.

Data is everywhere, but is it ready for consumption? Morningstar developed the language of global investment data so you have the right ingredients to help you shine. Morningstar, where data speaks.