WJA.TO - WestJet Airlines Ltd.

[mikazo]

"WestJet Airlines Ltd. is a Canada-based company engaged in the provision of airline service and travel packages. The Company offers scheduled service to approximately 93 destinations in North America, Central America, the Caribbean and Europe."

 

I've owned WestJet for almost a year now, and I am considering adding to my position. I saw that there was no thread for it, so I thought it would be a good way to refresh my memory and consider any new developments before buying more.

 

My initial/current reasons for buying WestJet:

 

• Consistent revenue/net income/retained earnings growth over the past several years
  
• SG&A expenses shrinking year over year
  
• Return on Assets ~6% annually
  
• Return on Equity ~16% annually
  
• Buying back shares annually - especially a good deal now
  
• Enjoys a duopoly with Air Canada for airlines in Canada
  
• Has been adding new routes to Europe and other destinations
  
• In December 2015, WestJet set a new single-day record for number of passengers flown
  
• In January 2016, Revenue Passenger Miles (traffic) increased 4% year-over-year
  
• In January 2016, Available Seat Miles (capacity) increased 6% year-over-year
  
• In January 2016, 6% increase in on-time performance
  
• Total number of passengers flown in 2015 reached an all-time high
  

 

Risks:

 

• Signficant decline in demand in Alberta, related to the decline in the oil industry
  
• Entry of low-cost airlines in Canada - although this has been hard to do, see http://www.cbc.ca/news/business/newleaf-transport-canada-1.3409142
  

 

My most significant reason for buying WestJet is that their most significant operating expense is jet fuel costs, consisting of 31% of total operating expense. Additionally, as of December 31 2014, WestJet had no outstanding fuel derivative contracts. This means that WestJet has been and continues to take advantage of low oil prices.

 

Not only that, it's trading at a P/E of 6! I use other valuation methods in addition to this, but WestJet seems pretty cheap to me. I think the market could be overreacting to the dependence on oil executives and the chaos in the oil industry. WestJet flew over 20 million passengers in 2015, and I don't think they were all oil executives!

 

I'd be curious to hear others' thoughts on this.

[Nelson]

I've been doing a bunch of work on Westjet over the last couple months. Not quite ready to buy yet, but getting close. Some stuff I like that mikazo didn't mention:

 

1. Approximately 25% lower costs than Air Canada because it has no unions and no legacy costs.

2. Only has about a third of the domestic market, and less than that on cross border flights. Plenty of opportunity to take market share close to home, never mind internationally.

3. Auxiliary revenue (the high margin stuff) is growing like crazy, and should continue to do so when it adds wifi to its whole fleet this year.

4. Actual good service (not that Air Canada is nearly as bad as everyone says, but Westjet is better)

 

The downfalls:

 

1. The same reasons everyone says you should hate airlines.

2. Taking delivery of something like $1.5 billion worth of new planes in the next two years, and $5.5 billion in the next decade. (These numbers might be wrong, I'm going strictly by memory here. The point is these commitments do exist and could stretch the balance sheet)

 

Everyone is concerned about Alberta, but the nice thing about 2016 compared to 2008 is Westjet has a big enough eastern presence that it can just move its planes onto better routes.

 

Everybody likes to talk about how airlines have no moat. But I really think that Westjet, Southwest, Spirit, etc. actually do have one with the low cost model. The difference between Westjet and LUV or SAVE is a big chunk of its business is in a protected duopoly.

 

 

[KCLarkin]

My thoughts on WestJet are attached.

 

It is interesting to compare WestJet with U.S. airlines using 10 yr cyclically-adjusted PE:

 

WestJet: 13x

JetBlue: 53x

Alaska: 37x

Southwest: 41x

 

WestJet's future might be much worse than the past. JetBlue's future might be much better. But I am pretty sure at least one of these is mis-priced.

WestJet-thesis-2015.pdf

[KCLarkin]

Ignoring company specific issues, there are macro forces at work.

 

The Canadian stock market is in a bear market. The Canadian exchanges are dominated by financials and resource companies. The loonie is weak. The housing market is possibly in a dangerous bubble. Short Canada is a hot macro play. Canadian investors are sitting on the sidelines (or investing in U.S. stocks). I think WestJet is a victim to these investment flows.

 

--

 

Or I am just making the classic error of investing in a cyclical at the peak of the cycle.

[intothebreach]

KC, Thanks for sharing your thesis (and position size as well) and also to mikado for starting the thread.

 

On the topic of the Canadian market, I would argued that it is exactly for the reasons you mention that it is precisely the time to go against the grain and start investing in the Canadian market (still need to pick our spots carefully though). As I said on the thread on "value vs indexing", I'll be moving back ETFs I rebalance for a family member from USD to CAD this year.

 

This is completely OT, but some Canadian preferred shares start to look compelling. To bring myself back on topic, I'll take a long look at Westjet this week-end.

[bizaro86]

 

Not only that, it's trading at a P/E of 6! I use other valuation methods in addition to this, but WestJet seems pretty cheap to me. I think the market could be overreacting to the dependence on oil executives and the chaos in the oil industry. WestJet flew over 20 million passengers in 2015, and I don't think they were all oil executives!

 

 

I really like this idea, and have been watching it. However, I think it might be a bit early yet. Oil executives (of my acquaintance, anyway) most often fly private on business. The risk to lower oil prices is that functionally everyone in Alberta (their base and biggest hub) is affected by oil prices. I work for a large oil company, and a bunch of my coworkers go laid off at the end of last year. They aren't booking travel. But even those of us who are left are saving more money (cutting discretionary spending like travel) in case we're next. There's a huge trickle down as well. I was chatting with the optician when I picked up my new glasses, and he said that their business is way down. People are cutting back on second pairs, sunglasses, etc, and switching down to cheaper frames. So he decided to stay home for the Feb long weekend instead of going to Disneyland with his kids. (We have a long weekend the same day as President's day).

 

Anyway, I think it's likely that Westjet will see both loads and yields decline, and that the market will punish their stock when they do. This is especially likely considering the large capacity growth.

 

Interestingly, their customer friendliness also hurts them on the downturn. I have a Calgary-Maui flight booked for the spring, and the prices have come way down. They refund the difference (as a credit) which will mean my fall vacation flights (which I would have booked with them anyway, but downgraded from Hawaii to Palm Springs) will now be mostly free.

 

TLDR: Oil 'execs' are not the only ones deeply affected by commodity price weakness in W. Canada.

 

PS. I should also mention that I do think this company has a moat, based on branding. The mind share they have here is ridiculous. Many, many times I've had people say to me the prices for a flight they want are very high, and they've sucked it up and bought anyway. Then I check the flights, and WJ is like 2X the price of AC for the flight, and I ask why they didn't book AC. Invariably, the answer is that "Oh, I didn't even think of that." Not, I like WJ better, or WJ is usually cheaper, just that when they book flights they only consider one provider.

[KCLarkin]

Anyway, I think it's likely that Westjet will see both loads and yields decline, and that the market will punish their stock when they do. This is especially likely considering the large capacity growth.

 

You are correct. They just released Q1 guidance (with Q4 earnings).

 

RASM down 10 to 12%

CASM (ex fuel and profit share) up 7.5 to 8% (presumably USD impact)

 

I haven't listened to the call yet, but I am surprised that they are still planning to increase capacity up to 10%. This is a cyclical, so the drop in earnings isn't alarming. But the market is going to punish the perceived lack of capacity discipline.

 

---

I have updated my 2016 forecast (with what I hope are extremely conservative estimates):

 

EPS (2016) = 1.47      (prior consensus for 2016 was $2.89)

PE (fwd) = 11.5

ROE = 9%

P/B = 1.06

 

---

If earnings bottom in 2016, this is very cheap. With current momentum, it seems very likely you will be able to get this below book value.

[longlake95]

You are right, the market doesn't like the capacity growth - and they haven't for a while. It's concerned about a downward pressure in ticket prices from excess capacity and new entrants. What the market is missing - for now - is that most of the capacity growth is in low-risk markets. Eg. YYZ-YFC, frequency recently increased to Freddy, it's a gov't and university town - stable demand. New capacity into regional markets like BNA,YXU,BOS are all low risk. The new 767 service to LGW (Gatwick, UK), is lower risk, it's a huge market, with some 2 million Canadian going to the UK per year. New 737 YYZ-LAX, low risk. There is no doubt loads are weak in the west. Loads in the East (YYZ,YUL,YHZ,YOW) to the south are firm to strong. Executive management is very good at revenue management - maximizing rev on a particular route and balancing the need to fill the plane.

 

I can tell you that I haven't had any commuting employees sardined into the jump seat for over a year - that happens when planes are full and employees need to get home/to work. When that changes, loads will have turned upwards, and the bottom will be in. Also, I see the real-time loads everyday when I'm at work - I'll see the turn.

 

WJA is definitely cheap, nice to see the NCIB increased. 45% of my overall comp is in stock/options, so I'm very tied to the stock price - long term.

[bizaro86]

You are right, the market doesn't like the capacity growth - and they haven't for a while. It's concerned about a downward pressure in ticket prices from excess capacity and new entrants. What the market is missing - for now - is that most of the capacity growth is in low-risk markets. Eg. YYZ-YFC, frequency recently increased to Freddy, it's a gov't and university town - stable demand. New capacity into regional markets like BNA,YXU,BOS are all low risk. The new 767 service to LGW (Gatwick, UK), is lower risk, it's a huge market, with some 2 million Canadian going to the UK per year. New 737 YYZ-LAX, low risk. There is no doubt loads are weak in the west. Loads in the East (YYZ,YUL,YHZ,YOW) to the south are firm to strong. Executive management is very good at revenue management - maximizing rev on a particular route and balancing the need to fill the plane.

 

I can tell you that I haven't had any commuting employees sardined into the jump seat for over a year - that happens when planes are full and employees need to get home/to work. When that changes, loads will have turned upwards, and the bottom will be in. Also, I see the real-time loads everyday when I'm at work - I'll see the turn.

 

WJA is definitely cheap, nice to see the NCIB increased. 45% of my overall comp is in stock/options, so I'm very tied to the stock price - long term.

 

Are you a Westjet pilot/employee? If so, I completely agree that you would have an insiders view on the performance that should allow you to catch the turn.

 

I was pretty sure this Q was going to be bad and the stock would be down (and posted such) I should probably have traded on that. In the end, I'm still watching, but will probably wait for a lower entry point.

[longlake95]

Yes, I'm a pilot on the 737. I too knew the Q was going to be weak, but I was surprised at the market reaction. I thought the lousy business conditions were already baked in. I try not to focus to much on quarters - but years. The overall results for 2015 @ $2.92/share we not bad.

 

I also wanted to add, the timing of entering the long haul market is smart on management's part - low cost, low risk. There is a glut of wide body airplanes on the market. You can buy a 12 year old 777 for $12M.

 

[kab60]

Thanks for the interesting input longlake. Is it usual with that much (45%) compensation tied to the stock? And what about cabin crew? I like alignment of interests and reading Carl Icahns biography and how he seemingly messed up an airline by screwing the employees and thought it's interesting if there's anything special about WestJets compensation.

[longlake95]

Its not usual to have that  kind of comp set-up in the airline biz. WJ is a different animal. Cabin crew can opt for the 20% ESP along with the company match, however they don't receive options/RSU like pilots. They also are eligible for the profit share plan as well.

 

I think Icahn took over TWA in the 80''s, and took a lot of heat for how he managed the business. He and the employees didn't  see eye to eye.

 

 

[KCLarkin]

You are right, the market doesn't like the capacity growth - and they haven't for a while. It's concerned about a downward pressure in ticket prices from excess capacity and new entrants.

 

After listening to the call, here are my thoughts:

 

I think WJA could bottom by Q3. Load factor will be up in Q1 due to deep discounting in Alberta. And WestJet capacity in Alberta will be down 5% YoY in Q3. I assume Air Canada has some unprofitable flights in Alberta with WJA's aggressive fares, so they will cut capacity too.

 

6% of the 2016 capacity growth is from the 767. This should be accretive to earnings. Given Boeing's strong backlog for 737s, WestJet should be able to defer deliveries, if demand softens.

 

Potential investors in ULCCs must be re-considering given the aggressive fare discounting.

 

I think the Canadian dollar has bottomed, so that will help CASM (ex-fuel).

 

Mr. Market was right on the macro call. Analysts were wrong. Estimates will come down and momentum will probably take this below book value. But I think we should find bottom soon.

[longlake95]

I'd say we hit bottom over the past few weeks.

[intothebreach]

I agree. I bought an initial position on the 22nd. Timing just dumb luck (so far).

 

However my appreciation of this stock may well be biased by the degree to which I despise their main competitor...

[KCLarkin]

I'd say we hit bottom over the past few weeks.

 

Yes, unfortunately it moved too quickly off the bottom for me. I bought a bit on Friday but had raised some cash to buy big.

 

Anyway, there were some positive developments since my last post:

- deferred 3x 737

- will return 9x 737 leases

- Air Canada confirms shifting capacity out of Alberta

- Canadian dollar showing further signs of bottoming

[mikazo]

http://www.winnipegfreepress.com/business/discount-airline-newleaf-ready-to-take-flight-373935021.html

[KCLarkin]

Traffic looks very good. Pricing is still week but RASM is better than expected. Q3 should be even better since they have cut capacity in Alberta.

 

WestJet today announced June 2016 traffic results with a record load factor of 80.4 per cent an increase of 3.5 percentage points year over year. Revenue passenger miles (RPMs), or traffic, increased 12.3 per cent year over year, and capacity, measured in available seat miles (ASMs), grew 7.5 per cent over the same period.

...

WestJet now expects its RASM for the second quarter of 2016 to decline between 5.5 to 6.0 per cent year over year, as compared to its previous guidance of a decline between 7.5 to 9.5 per cent year over year, with the difference primarily driven by a higher second quarter load factor than previously expected.

 

Oddly, stock didn't move much on the news yesterday. But up 4% today.

 

 

[KCLarkin]

After listening to the call, here are my thoughts:

 

I think WJA could bottom by Q3. Load factor will be up in Q1 due to deep discounting in Alberta. And WestJet capacity in Alberta will be down 5% YoY in Q3. I assume Air Canada has some unprofitable flights in Alberta with WJA's aggressive fares, so they will cut capacity too.

 

6% of the 2016 capacity growth is from the 767. This should be accretive to earnings. Given Boeing's strong backlog for 737s, WestJet should be able to defer deliveries, if demand softens.

 

Potential investors in ULCCs must be re-considering given the aggressive fare discounting.

 

I think the Canadian dollar has bottomed, so that will help CASM (ex-fuel).

 

Mr. Market was right on the macro call. Analysts were wrong. Estimates will come down and momentum will probably take this below book value. But I think we should find bottom soon.

 

Yup, it looks like Q3 was the turning point. They just announced record Q3 earnings. Up 14% YoY. They are now expecting RASM growth to return in Q1.

 

If so, you are paying 9x trough earnings for an airline that hasn't lost money in 46 consecutive quarters.

 

I haven't listened to the call yet, so I might be missing something.

[KCLarkin]

I guess this could explain the big drop yesterday:

 

http://www.theglobeandmail.com/report-on-business/canada-to-boost-foreign-ownership-cap-in-airlines-to-49/article32656455/

 

Mr. Garneau announced on Thursday that the Liberal government plans to introduce legislation to ease foreign ownership restrictions on domestic airlines to 49 per cent from the current 25 per cent.

 

He also said that exemptions will be issued to two upstart airlines – Canada Jetlines Inc. and Enerjet – so that they can benefit immediately from the easing of foreign ownership restrictions.

 

“I expect fares to go down” as a result of increased competition resulting from the easing of the rules, Mr. Garneau said at a news conference after his presentation on the government’s new transportation policy to the Chamber of Commerce of Metropolitan Montreal.

[KCLarkin]

Bad news day for WestJet:

 

CEO retires effective immediately

Reduces Q1 guidance due to "weather"

Pilots Union prevents Swoop subsidiary from negotiating directly with pilots

 

Some speculation that the CEO's sudden and unexplained retirement is related to issues with the union. Regardless, this is very unsettling for a company in the midst of a very significant strategy shift.

 

[KCLarkin]

Well this was unexpected...

https://business.financialpost.com/transportation/airlines/onex-signs-agreement-to-buy-westjet-in-deal-valued-at-5b-including-debt

 

+61% today

[wisowis]

Well this was unexpected...

https://business.financialpost.com/transportation/airlines/onex-signs-agreement-to-buy-westjet-in-deal-valued-at-5b-including-debt

 

+61% today

 

Any chance the takeover gets blocked?

[KCLarkin]

Well this was unexpected...

https://business.financialpost.com/transportation/airlines/onex-signs-agreement-to-buy-westjet-in-deal-valued-at-5b-including-debt

 

+61% today

 

Any chance the takeover gets blocked?

 

Based on transport minister’s comments today, it seems very very unlikely this gets blocked. Also very, very unlikely there is a higher bid.