Company:

WestJet Airline Ltd, is a Canadian low-cost carrier, was founded in 1996. It is a publically traded company with around 9600 employees. Its working fleet currently consists of 110 Boeing 737 and Bombardiers aircraft carriers. To cater to expanding service WestJet is in the process of acquiring new aircraft which number to 105 and will be delivered post 2017.

 

Business model:

WestJet currently operates in two models namely – WestJet and WestJet Encore. WestJet started with a low cost air transportation strategy directly competing with Air-Canada. Over the years, WestJet has successfully addressed improved customer service and higher customer retention. Rather than target its effort to individual customer, WestJet emphasized on business travellers and corporate houses attracting them with higher service and satisfaction with resulted in higher profit margin. Encore, with is wholly owned subsidiary of WestJet, on the other end focused on minimizing operation cost, air fare and increase connectivity. WestJet Encore now flies to locations that were previously deemed less profitable due to limited access. One of the key motivators for expanded coverage and increased capacity is provided end-to-end flight connectivity to onboard passengers. This improves customer retention and increases RASM.

 

WestJet, unlike it Canadian competitor, is not unionized. This gives higher flexibility of managements to address many employee related issue efficiently as compared to unionized labour forces. WestJet had introduced various program such as Plus and code-share alliance with other airline carriers, that directly elevate customer flying experience with WestJet. The management has communicated a positive landscape for company’s streamlined operation and continues growth in revenue for the coming years. Management in the recent MDA have assured that increased capacity and addition flight routes have been well planned and will not impact it current or future operations

 

Strategy: The current strategy targets increasing capacity and servicing wider geographic locations, while maintaining focus on customer service. WestJet plans to achieve this by expanding its fleet capacity, the Encore business to service 12 cities and increasing bi-lateral code sharing airline partnerships to 33[1]. Addition of new locations have boosted the revenue as the company can leverage on shorter flight time and reduced flight lead times. Last year revenue from partnerships accounted to 50% increase and WestJet is projecting the same for the upcoming years due to addition of more partners.

 

One of the factors to be considering is the projected increase in the operational costs factored in due to expansions.  Increasing fleet capacity will not result in immediate revenue gains as noted by the decrease in Revenue per Available Seated Mile (RASM) and decreased load factor for Q3 2013.  There will be greater wear and tear from frequent short distance flights serviced by Encore, this will result in increased maintenance costs of the new Bombarder Q400 aircrafts.

 

In January 2013, WestJet launched a “business transformation” initiative to reduce annual costs by $100M by the end of 2015; the company predicts to be one year ahead of schedule as of Q3 2013.  WestJet plans to control costs by focussing on 3 main areas: aircraft utilization and distribution, overhead efficiency, productivity

 

Financial strength: On November 2010, WestJet began share buyback and dividend payout initiates resulting in over $400M returned to shareholders.  Since the start of these initiatives, the share price of WestJet have more than doubled by 104%[2].  This is further reflected in the return on equity which has doubled in the past three years to 17.1% in 2012.

WestJet has maintained its strong liquidity position through the initiative, maintaining a current ratio of approximately 1.13 while also paying down nearly $875M in debt since 2008.  The adjusted debt-to-equity sits at 1.35, which includes over $1B in off-balance sheet aircraft lease commitments. As of Sept. 30, 2013, WestJet has over $6.2B in contractual obligations and commitments, of which approximately $4B is due after 3 years.

 

Industry Overview

Air Canada is the largest Canadian airline and direct competitor for WestJet.  Air Canada has begun to streamline its operations in an attempt to meet challenges posed to it by WestJet, including controlling its fleet size and labour union.  Air Canada has seen increased revenues and controlled costs through recent initiatives, in response to growing competition domestically and internationally.  Air Canada has begun shifting its operations to combat the loss of market share to WestJet.  In 2013, Air Canada launched subsidiary Rouge Airlines, servicing holiday destinations at low cost[3].  Rouge offers Air Canada a means to both expand, curtail costly routes from its main operations, and find a work around from its higher labour costs.  Air Canada has begun to lower rates on select routes to combat WestJet Encore operations.

 

Air Canada has maintained its fuel hedging program to protect against volatility in the market, but also adds additional costs as these hedges are neither perfect nor timely in their predictions.  Air Canada’s unionized labour contracts are a differentiating burden, as compared to non-union WestJet.  Maintaining several pension plans, both defined-benefit and defined-contribution, as well as other retirement benefit programs will continue to account for a growing obligation on the part of Air Canada.  This risk though, has become manageable by financial support from the Canadian government, and in leveraging new labour agreements with unions for strictly defined-contribution plans for future employees.

 

JetBlue is a leading value-based carrier that is still recovering from substantial losses in the mid-2000’s. Once an industry leader, non-unionized JetBlue has begun a re-expansion of its services and locations through international partnerships.  Recently, JetBlue has expanded to target holiday travelers from its traditional eastern-US market. JetBlue has petitioning the FAA to allocate landing shares away from the recent mergers in the US airline industry[4].  JetBlue does not service Canada currently.

 

SouthWest is the 4th largest airline in the U.S, and the world’s largest lcc.  Similar to WestJet, SouthWest maintains only one type of airplane (Boeing 737) in its fleet to streamline maintenance, flight and crew training, and cost management.  SouthWest is attempting to take advantage of potentially open flights from the recent mergers in the US airline industry, as well as targeting smaller location services that can feed into larger its hubs[5], similar to WestJet’s Encore business model. A planned code-sharing partnership between SouthWest and WestJet was cancelled in 2010. SouthWest does not service Canada currently.

 

Sunwing & Air Transat are both private Canadian based airlines competing directly with WestJet’s vacation package business. Sunwing follows a similar model to WestJet, in operating solely Boeing 737 aircraft, and has the second youngest fleet in Canada. Both airlines are moving to offer services in Alberta and British Columbia, and working on cost cutting initiatives such as such as fewer flight attendants.

 

Canadian Market, Economy, & GDP: Domestic airlines revenues are highly correlated with the general economy, and so are dependent on sustained economic growth to feed into leisure and business travelers.  The Bank of Canada in October 2013 lowered economic growth forecasts for the second half of 2013, and further possible revision for 2014 growth projections[6].  Real GDP is expected to grow by 1.6% in 2013, then 2.2% and 2.5% in 2014 and 2015[7][8].

 

Air Travel in Canada has potential for growth: Canada currently represents the 7th largest market for air travel in the world, propelled largely by diffused population centers and a high standard of living.  Year on year growth shows that that Canadian market has maintained the 3rd highest year-on-year growth, at 11.3% globally.

 

Outlook

Earnings Outlook
Revenue ($ million)	3,427.41	3,667.33	3,924.04	4,198.72	4,492.63	4,807.12
EBITDAR ($ million)	737.78	733.69	777.01	821.84	868.01	915.29
Net Income ($ million)	242.39	264.87	281.25	297.52	313.48	328.88
Revenue per ASM	0.1553	0.1535	0.1565	0.1595	0.1625	0.1656
Cost per ASM	0.1385	0.1366	0.1396	0.1426	0.1457	0.1490
Avail. seat miles (ASM)	22,064	23,884	25,078	26,332	27,649	29,031
Load factor	82.80%	82.80%	82.80%	82.80%	82.80%	82.80%

 

 

Risks

Global oil price: The airline industry is notoriously susceptible to fluctuations in world crude oil prices.  Oil prices have experienced high volatility and growth over the last five years, and is projected to see compounded growth of 2.9% in the next five years[9]. Continued political unrest within the Middle-East and North Africa, or a sharp increase in global demand, could potentially see higher than anticipated Global Oil prices.   Although the risks of volatility remain, stagnant demand from Europe and China, and increasing production from the US, will continue to allow a stable growth in prices[10].

 

Exchange rate: WestJet generate the majority of their revenues in Canadian dollars.   World oil prices are pegged to the U.S. Dollar as are orders for aircrafts, translating into risks from USD-CAD exchange rate fluctuations[11].  The continued devaluation of the USD over the last five years is projected to continue, and will have a stabilizing effect on USD-CAD exchange rates through 2016.

 

Interest rate: Due to the significant capital expenditures expected within the industry, WestJet often takes loans to purchase aircraft, this can leave the company vulnerable with its variable rate loans.  WestJet has entered into interest swap agreements to mitigate this risk.

                                                                                                

Unionization: WestJet’s ability to control labour costs by mitigating unionization has been a tremendous cost control.  Although there is still a risk that WestJet employees may attempt to organize a union, management believes tying employee compensation to financial results will encourage employees to become personally vested in the future of the company[12].