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In our view, WestJet is a true gem amongst its peers, consistently achieving financial performance in the top tier of North American airline companies. A cornerstone of the company’s business plan is its single fleet operation, which minimizes training, staffing and maintenance. The current fleet consists of 96 Boeing Next-Generation 737 series aircraft, and Westjet has firm commitments to take delivery of an additional 39 aircraft over the next six years. With certain aircraft leases set to expire, the company has the flexibility to end 2018 with a fleet size between 102 and 135 aircraft. At present, WestJet operates one of North American’s more modern fleets, with an average age of 5.6 years.
As we have seen time and again, the airline industry is an inherently difficult business to operate. In recent history, several North American airlines, including Delta Airlines, US Airways and AMR Corporation, as well as Air Canada, have filed for bankruptcy protection. Faced with a challenging economy, complex scheduling, price-sensitive consumers, rising fuel costs, and union issues, many airlines have faced financial distress over the past few years. Conversely, WestJet’s Q3 2011 financial results represented the 26th consecutive quarter of profitability for the company, which demonstrates its ability to sustain consistent earnings through all economic cycles.
WestJet’s growth strategy includes new scheduled flight routes, airline partnerships, and its WestJet vacations business. Consistent with this objective, on November 23rd, 2011, the company announced it had been the successful bidder for eight slot pairs at New York’s LaGuardia airport. We believe this is a significant announcement for WestJet, as it provides the company with a regular daily service route to New York, and to compete head-to-head with Air Canada in a very lucrative market.
WestJet is continuing to execute on its strategy of establishing partnerships with airlines around the world. At mid-December, the company had established interline relationships with 17 airline carriers globally and code sharing agreements with four airlines, including Cathay Pacific, American Airlines, KLM, and Japan Airlines.
A key point of differentiation between WestJet and other airline carriers is the company’s exceptionally strong balance sheet. At Q3 2011, WestJet had $1.3 billion in cash and $894 million in debt. The company’s strong financial position allowed it to initiate a $0.05/share quarterly dividend in Q2 2010 and to actively repurchase shares in 2011. Although WestJet has not recently been active on its normal course issuer bid, given its current discounted valuation, we would not be surprised if the company reconsiders the repurchase of its stock.
With respect to financials, although WestJet’s Q3 2011 revenue increased by approximately 13%, the impact of rising fuel prices, which increased 27% year-over-year, had a negative impact on the company’s operating margin. The reduced margin contributed to a year-over-year decline in Q3 2011 EPS to $0.28 compared to $0.30 last year. However, it is worth nothing that in 2010, WestJet generated an EBT (earnings before tax) margin of 7.8%, ranking it one of the most profitable carriers in the industry.
At its current share price of $12.20, we believe WestJet’s valuation is compelling. At present levels, the stock is trading at a 2012 P/E multiple of only 10.0x. Applying the 5-year industry average P/E multiple of approximately 15x suggests the stock could trade considerably higher in better market conditions.
In summation, we have a significant amount of confidence in WestJet’s business prospects and management team, and continue to believe the stock is undervalued at current levels.
ABC Funds
January 27, 2012
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