Westjet plenty of headwinds in the near term – westjet airlines ltd. (otcmkts wjaff) seeking alpha electricity song lyrics

#

WestJet ( OTC:WJAFF) ( OTC:WJAVF) (TSX:WJA) is one of the two leading airlines in Canada. The carrier has an expansion strategy to grow its revenue, initiatives to reduce its cost, and a healthy balance sheet to support its expansion program. However, benefits of its cost-saving initiatives and expansion strategy won’t be realized in the near term. Meanwhile, the company may still need to combat with rising cost per available seat mile ("CASM") and declining revenue per available seat mile ("RASM"). The light at the end of the tunnel might still be a few quarters away. Investors may want to wait until some of its headwinds dissipate before jumping in.

WestJet’s RASM growth rate is showing signs of deceleration (see chart below). Its Q1 2018 RASM year-over-year growth rate of 2.5% was much lower than its guidance growth rate of 4.5% to 5.5%. Looking forward to Q2 2018, the company now expects its RASM growth rate to be in the range of 0% to -2%. This is because its peers will have more domestic capacity than a year ago.

WestJet’s CASM is expected to rise significantly in Q2 2018. According to management’s recently released guidance, its CASM, excluding fuel, and employee profit share is expected to grow in the range of 7.5% to 8.5% year-over-year. As can be seen from the chart below, its CASM growth rate has been accelerating lately. The expected increase is primarily due to start-up costs related to its ultra-low-cost airline, and maintenance provisions from lease extensions. Please note that the graph below does not include fuel expense. Given the significant increase in fuel expense in the past few months, its CASM could increase even more if we include fuel expense in the calculation.

Besides WestJet’s forecast of declining RASM and rising CASM, the possibility of a pilot strike continues to worry investors. It has so far resulted in many of its customers booking flights on other airlines. Even if there is no strike, WestJet is still losing millions of revenue.

WestJet expects to add 10 new Boeing 787s to its fleet starting in 2019. While the new fleet will allow it to add higher-margin premium seats, it will weigh on its free cash flow in the near term due to rising capital expenditure. Should we be concerned?

WestJet has an investment grade balance sheet. Despite an increase in its leverage in the past few years, its trailing 12-months net debt to EBITDAR ratio of 1.84x is still quite good (lower than the ratio of 1.90x a year ago). Its healthy balance sheet means that the company will have no problem to fund its expansion initiatives.

As previously mentioned, WestJet will be adding 10 new Boeing 787s starting in 2019. This will allow it to expand its routes internationally in the next few years. Boeing 787s will actually help it to add premium cabins to its current cabin configurations. Management expects to add about 50,000 higher-margin premium seats in the first year of the launch of 787. This will have the potential to improve its margin in the long term.

The company will launch its ultra-low-cost carrier, Swoop, on June 20. This is one of the reasons why the elevated CASM growth rate in Q2. Fortunately, management indicated in the conference call that Swoop is fully ramped up now and ready to go. Management also indicated that its CASM growth rate (excluding fuel price) should drop significantly in the back half of 2018 and next year. This should be a good sign.

The company has recently accelerated its cost reduction plan. Instead of the previously announced plan to achieve an annualized cost savings of C$200 million by 2022, WestJet now expects to achieve this goal by 2020. This will be two years ahead of its original schedule. The company plans to achieve its goal through fleet reconfiguration, savings from airport operations, optimized maintenance plans, implementation of digital & self-service, etc. The annual cost reduction is equivalent to about C$1.69 per share in savings. Consider the fact that WestJet currently earns about C$2.42 per share in 2017, the addition of another C$1.69 will improve its EPS considerably.