WestJet Airlines Ltd.

: Investment Strategy

Stephen Lau, portfolio manager of Resolute Fund, is left with certain choices regarding the treatment of
WestJet Airlines for his mutual fund portfolio. Low expectation as to the airline industry that resulted
from the economic recession of 2008 indicates a 9 billion-dollar net loss for 2009 and 15% decrease in
revenue due to expected mismatches between demand and capacity. But improving conditions
reflected from the S&P 500 index suggests a glimmer of hope for WestJet. This led to Stephen Lau asking
his team to gather WestJet’s and its competitors’ data as of August 2019 to help proceed with the
following decisions:

1. Sell investments in WestJet and shift to other airlines.

2. Hold Investments in WestJet Airlines
3. Buy more shares of WestJet to take advantage of its current low shares price

Internal Analysis (YTD performance)

We analyzed WestJet’s performance to date in 3 categories (1) Growth and Profitability (2) Operational
Efficiency (3) Financial Leverage

Growth and Profitability

We analyzed WestJet’s financials in a 5-year span from 2004 to 2008. We can say that WestJet has
recovered well from their losses at 2004 which saw a period of recovery and growth from 2005 to 2007
despite declining sales revenues. It has also responded well from the economic crisis as it still reported
favorable margins, its steady decline is only expected to last mid-2009 as the whole economy recovers
from the crisis.
Exhibit 1 (Westjet’s Growth & Profitability over the years)
Efficiency

Across the years, WestJet has maintained an average of 2.92 (see Exhibit 2) days to collect its
receivables from their customers, this is a good indicator of financial liquidity which means that WestJet
has ample money to pay-off its liabilities and run its day-to-day business.

As far as inventory turnover is concerned, Westjet has maintained an average of 2.29 (see Exhibit 2)
days in converting its inventory to profit. It means that WestJet was effective in managing its operations
since it always kept with demand.

WestJet capitalized on its reputation as a cheap and budget-friendly airline thus they get to sell tickets
faster because of their cheaper prices versus industry competitors. Days inventory is lower in general as
seats (which is the airline’s inventory) are sold faster—still due to its lower prices versus competition.
However, days inventory from 2007 to 2008 increased; this unfavorable rise can be attributed to the
decline in demand caused by the economic crisis.
Exhibit 2 (Westjet’s Receivable and Inventory days)

5.0

4.0

3.0 Days receivables

2.0

1.0 Days of inventory

-
2004 2005 2006 2007 2008

Westjet maintained moderate days payable and saw an increase from 2005 as operations grew until it
saw an unusual 7-day increase in 2008 from 36 days to 43 days, its highest in 5 years (see Exhibit 3). This
may raise a slight area of concern as this indicates that it is taking WestJet longer to pay its current
liabilities; however, its positive current ratio can back these liabilities up (see Table 1) thus, downplaying
this area of concern.
Exhibit 2 (Westjet’s Payable Days)

50.0
40.0
30.0
20.0 Days payables
10.0
-
2004 2005 2006 2007 2008
 Table 1 (Westjet’s Liquidity ratios)

Financial Leverage

Westjet currently has a 41.3% DE ratio, its lowest in five years. This shows that despite the economic
crisis, WestJet was not forced to take on debt to sustain its operations and it translated profit without
relying too much on debt financing. Moving forward, we expect Westjet not to be tied up in interest
payments which makes its income more available to other aspects of the company’s operations (see
Exhibit 3). Profits are plowed back to operations that helped in working capital and debt payments.
From 2004 to 2006, the company relied on debt to finance its operations perhaps to recover from the
operating losses in 2004; but, the company showed a steep decline in debt from 2006 onwards as
Westjet began to rely less on debt to meet its operating needs and increase its margins even during the
economic crisis.
Exhibit 3 (Westjet’s Debt Leverage)
Stock Price Performance

Westjet’s stock price suggests that in

time of normal economic conditions,
company performance is always at an
upward trend. WestJet’s low stock points
(illustrated by L1, L2, L3 …..) was always
at an upward trend. Had it not been with
the global economic crisis, WestJet would
still perform better. Hence, as the market
recovers from the economic crisis and as
WestJet continues strong operational
performances mentioned in the previous
sections, we see WestJet’s stock price to
remain bullish. (See Exhibit 4)

Exhibit 4 (Westjet’s Stock Price)

Competitor Analysis

Scoping

Data from the following companies were gathered to support Lau’s decision. However, as per our
scoping, we only chose Southwest Airlines as the point of comparison since it is the only low-cost and
domestic airline from the source pool. (see Table 2)

Criteria Chosen:

a. Nature of business
b. Geography and market segmentation
c. Financial condition
Table 2 (Summary of Competitors)

Competitor Type Market Based in

Southwest Airlines Low Cost Carrier Domestic North America
Continental Full-line carrier Domestic and North America
International
Lufthansa Full-line carrier Domestic and Europe
International
Singapore Airways Full-line carrier Domestic and Asia
International
 Air Canada Full-line carrier Domestic and North America
International

We refrained from choosing Air Canada even if it satisfies criteria (b), since it failed to satisfy criteria (a),
being full-line carrier which caters both domestic and international market segments. There is no data
from the case to scope out its domestic component. In addition, it failed to satisfy criterion (c) as Air
Canada is currently operating at a loss, hence, we can’t compare WestJet with a company under
extraordinary financial situations.

Approach

We compared WestJet’s financials ratios with industry average which is derived by averaging
Southwest’s and WestJet’s ratios together in three categories (1) Liquidity & Asset Management (2)
Financial Leverage (3) Profitability.

(1) Liquidity & Asset Management

WestJet’s liquidity and asset management activities are favorable over Southwest’s in all aspects. This
means that they do a better job at collecting cash, realizing inventory and paying its obligations.
Moreover, the 197-day gap of day sales outstanding of WestJet over SouthWest is a deep area of
concern for Southwest as this indicates that they are poor in managing receivables.
Table 3 (Comparison of Operating Indicators)

Industry Average (Low Cost/Domestic

Southwest Airlines WestJet Airlines
Airlines)
WestJet vs.
2008 2007 % Change 2008 2007 % Change 2008 2007 Industry
Average
Liquidity
Current Ratio 1.03 0.92 12% 1.25 1.22 3% 1.14 1.07 0.11
Quick Ratio 0.96 0.86 11% 1.23 1.20 3% 1.09 1.03 0.14
Cash Ratio 0.64 0.57 12% 1.11 1.11 0% 0.88 0.84 0.23
Asset Mngmt/ Activity
Days Sales Outstanding 428.57 157.88 171% 34.86 28.37 23% 231.71 93.13 (196.85)
Inventory Days 7.40 11.10 -33% 2.93 2.12 38% 5.16 6.61 (2.24)
Days Payable 61.47 165.72 -63% 42.85 35.57 20% 52.16 100.64 (9.31)
Days Receivable 6.92 10.33 -33% 2.43 2.55 -4% 4.68 6.44 (2.24)

Who did better: WestJet

(2) Financial Leverage

Unlike Southwest, WestJet is not debt-reliant. A 12% decrease in long-term debt to equity ratio indicates
that Southwest has offloaded or paid a loan which is good news as this causes less financial strains
moving forward. The reduction in interest coverage for WestJet is understandable since they are
expected to incur lower interest payments moving forward.

The 84% increase in Southwest’s long-term DE ratio indicates that Southwest took a large loan, perhaps
to combat the economic crisis and maintain its operational performance. This is an area of concern for
Southwest’s investors since as they already have poor liquidity mentioned earlier, and they are still tied
up to interest payments moving forward.
Table 4 (Comparison of Leverage Indicators)

Industry Average (Low Cost/Domestic

Southwest Airlines WestJet Airlines
Airlines)
WestJet vs.
2008 2007 % Change 2008 2007 % Change 2008 2007 Industry
Average
Solvency/ Financial Leverage
Total Debt Ratio 0.65 0.59 12% 0.67 0.68 -2% 0.66 0.63 0.01
Equity Multiplier 2.89 2.42 20% 3.02 3.14 -4% 2.95 2.78 0.07
Long Term Debt to Equity 1.32 0.72 84% 1.34 1.52 -12% 1.33 1.12 0.01
Interest Coverage 13.27 53.84 -75% 8.41 8.37 0% 10.84 31.11 (2.43)

Who did better: WestJet

(3) Profitability

For two years in a row, WestJet was more profitable than Southwest. This indicates that Southwest was
affected more by the economic crisis than Southwest who only lost margin by 22% over Southwest’s
75% decline.

WestJet’s 16% ROE is a good indicator for potential investors as they can expect to profit more if they
get a hold of WestJet’s shares.

During recession, EBITDA decreased by 22% for Southwest Airline while no significant movement for
WestJet. EBITDA or the Earnings Before Interest, Taxes, Depreciation and Amortization, is a good
approximation of the cash flow generated by the enterprise in any year to cover financial obligations,
taxes and capital expenditures. Thus, financial flexibility of Westjet is high compared to its nearest
competitor.
Table 5 (Comparison of Profitability Indicators

Industry Average (Low Cost/Domestic

Southwest Airlines WestJet Airlines
Airlines)
WestJet vs.
2008 2007 % Change 2008 2007 % Change 2008 2007 Industry
Average
Profitability
Return on Equity 4% 9% -61% 16% 20% -19% 0.10 0.15 0.06
Net Profit Margin 2% 7% -75% 7% 9% -22% 0.04 0.08 0.03

Who did better: WestJet

Valuation Metrics

Despite favorable performance over industry averages mentioned earlier, WestJet’s PE ratio is
significantly lower than Southwest’s (11.51 vs 35.7); a low P/E ratio means low expectations as to
WestJet’s shares since investors are only willing to pay 11.51 USD for an additional dollar of profit. Since
we ascertained earlier that WestJet’s performance over its competitor is better in all facets of liquidity,
asset management, financial leverage and profitability, a possible key driver on why its PE ratio is low is
because it may have low market value over Southwest. This indicates that WestJet’s stock is
UNDERVALUED while Southwest’s stock is OVERVALUED.
Table 6 (Comparison of Stock Prices)

Industry Average (Low Cost/Domestic

Southwest Airlines WestJet Airlines (Converted to USD)
Airlines)

2008 (@1 2007 (@1 WestJet vs.

2008 2007 % Change CAD = 1.224 CAD = 0.998 % Change 2008 2007 Industry
USD) USD) Average
Profitability
Price to Earnings Ratio 35.7 14 155% 11.51 15.02 -23% 23.60 14.51 (12.10)
Share price 8.61 11.76 -27% 16.06 22.24 -28% 12.33 17.00 3.72

Buy, Sell or Hold?

We have decided that the best course of action for Lau is to Buy more shares of WestJet to take
advantage of its current low share price.

To summarize the good points and to support our argument to buy are the following reasons:

a.) The economy is improving; WestJet has a history of performing well under normal economic
conditions. (See Exhibit 4)
b.) WestJet has more stable operations than competitors. (Table 3)
c.) WestJet is not debt reliant, its future income and cash management won’t be tied up heavily to
interest payments. (Table 4)
d.) High ROE, its high ROE of 16% is a good indicator of potential returns moving forward. (Table 5)
e.) Undervalued stock price; a lower price today means higher prices in the future once WestJet
realizes its expected earnings because of the indicators mentioned earlier. (Table 6)

- End -