JetBlue Airways (NASDAQ: JBLU) has had some good news to crow about lately: May passenger volume rose by more than 10%, and revenue per seat, the industry’s all-important measure of profitability, soared a whopping 19%. Add to that high marks for customer service, expanded routes to the Caribbean and new investments on more fuel-efficient jets, and it’s easy to assume the JetBlue stock is headed for a higher  altitude.

But those rosy developments don’t tell the whole story about JetBlue stock – or its potential upside in a competitive market that balances on razor-thin margins. Although JBLU has generated a lot of positive buzz, investors would be well served to delve deeper into the sustainability of JetBlue’s innovative business model.

At $6.01, JBLU is trading more than 21% below its 52-week high of $7.60 last November. Morgan Stanley analysts downgraded JetBlue stock to “underweight” in a research note on Tuesday, citing concerns that the airline’s margins could be hurt by competition.

JetBlue’s potential vulnerability to competition is a factor few industry observers would have predicted. Just four years ago, JetBlue was being hailed as the airline most likely to sink the fortunes of legacy-carrier killer Southwest (NYSE: LUV). After all, JetBlue taught Southwest, Master of the Low-Cost Model, a thing or two about cutting costs even more.

Then the company went a step further: steering a middle course between the low-cost carrier and legacy airline model. JetBlue began offering perks like more legroom, unlimited snacks, free in-flight entertainment and robust customer service. Those value-adds fly in the face of conventional wisdom about how to play the low-cost carrier game.

But despite its high-flying past, here are three reasons JetBlue still could stall under competitive pressures:

Sustainability of the Business Model

While JetBlue’s hybrid business model has won kudos from passengers, the degree to which the airline can sustain the low-cost/high-value model is in question. Added frills, international expansion, hub costs (particularly its dominant presence at New York’s JFK) and costly, complex codeshare arrangements eventually will strain margins. By steering this middle-of-the road course, JetBlue risks flying into the competitive teeth of legacy airlines like Delta (NYSE: DAL), American (NYSE: AMR) and United Continental (NYSE: UAL).

High Debt Levels

At $1.77 billion, JetBlue’s market cap equals American’s but is nearly $6 billion less than Delta and United Continental – and nearly $7 billion less than Southwest. The bigger difference is JetBlue’s debt picture compared to its competitors. Southwest boasts $4.46 billion in cash compared to just $3.38 billion in total debt – fabulous numbers in such a capital-intensive industry. JetBlue has only $1.11 billion in cash compared to total debt of $3.08 billion – much more in line with the leverage profiles of legacy airlines like United Continental and American.

Escalating Fuel Costs

JetBlue cemented its brand with the low-cost, value-added business model in 2008. But back then, oil was a mere $60 a barrel, and there is little chance that prices will return to anything close to that level in the near term. Since fuel costs account for at least a third of an airline’s operating expenses, that’s a problem for all carriers. But if your market niche is delivering high value for a low price, something’s got to give. JetBlue has hedged 35% of its fiscal 2011 fuel requirements, but that might not provide much relief. Expensive crude oil prices would have a devastating impact on JetBlue’s profitability and growth outlook.

As of this writing, Susan J. Aluise did not hold an interest in any of the stocks mentioned here.