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WestJet: adjusting its fleet to restore margins and returns

Canada’s second largest airline – WestJet – is working to ensure that it regains lost financial footing in 2019 after posting declines in key metrics during 2018. The company has opted to defer narrowbody aircraft in order to bolster its returns and margins. 

The airline is also making some more nuanced changes to its fleet through lease extensions and the sale and leaseback of its first three Boeing 787-9s, which are scheduled for delivery in 2019. 

WestJet’s overall forecast capacity growth for 2019 seems high, given its quest to bolster its financial performance, but the airline is stressing that the bulk of its growth is driven by the addition of widebodies and fleet expansion at its new ULCC subsidiary, Swoop.

But with new domestic competition entering the market in 2019, and with incorporating the new 787s into its fleet and working to mature Swoop, WestJet could face hurdles in convincing markets that its long term vision will produce results.

Summary

  • 2018 has been a challenging year of adjustment for WestJet as its performance in certain financial metrics has fallen.
  • As a result, the airline is deferring aircraft deliveries as a means to shore up margins and returns.
  • WestJet is taking a cautious approach to its 787 roll-out, perhaps applying lessons learned from its 767 deployment. 
  • WestJet is balancing its long term vision with short term doubts about its ability to execute a number of strategy changes. 

WestJet struggles in key financial metrics during 2018 

During the past six years WestJet has launched a regional subsidiary, Encore, created and refined segmented fares, inaugurated widebody flights to Europe, debuted a new ULCC subsidiary Swoop and ordered Boeing 787 widebodies. 

The airline has also experienced labour strife and during 2Q2018 its pilots, who joined the Air Line Pilots Association (ALPA) in 2017, threatened to strike, which resulted in book-aways from the airline. 

Employee issues, overcapacity in Canada’s domestic market and other challenges have coalesced to pressure WestJet’s financial performance in 2018. The airline posted its first loss in 13 years during 2Q2018 and has recorded an ROIC performance well below its stated targets for the year. Its 12M trailing ROIC at the end of Sep-2018 was 5.5% – significantly below its stated goal of 13% to 16%. 

WestJet’s operating margin fell 7.5ppt year-on-year for the 9M ending Sep-2018, to 3%, and its EBIT margin during that period dropped 6.9ppt, to 2.7%. 

WestJet to defer narrowbody deliveries to restore margins and lift returns 

WestJet has taken several measures to bolster its financial performance, including cutting its planned 4Q2018 capacity growth by 6ppt. 

The airline has also opted to defer four Boeing 737 MAX 8 aircraft originally scheduled for delivery in 2019 and now the aircraft are being delivered in 2020 and 2021.

WestJet mainline fleet summary, as of mid-Dec-2018

WestJet executives recently stated that the decision to defer delivery of the narrowbodies was driven by its “assessment of both the economic and competitive environment for next year [2019]”. 

The airline has also said that “this year [2018] has not turned out the way we expected it to be”, and aircraft deferrals would help WestJet to return to margin expansion, as well as improving the company’s returns. 

WestJet forges sale/leaseback deals on three 787s to fund capex 

WestJet has also forged lease agreements on two MAX 8 jets scheduled for delivery in 2019, and has executed extensions on four leases set to expire in 2019 – two 737-700s for one year and 11 years, and two 737-800s for additional terms of five and seven years.

The company has also opted to enter into sale-leaseback agreements on its first 787-9 jets delivered in 2019, and the proceeds from those agreements will fund half of its projected capital expenditures for 2019: USD1 billion to USD1.2 billion. 

WestJet adopts a cautious approach to its 787-9 deployment 

WestJet has stated that it is planning to deploy its new 787-9s from its largest base in Calgary to London Gatwick (daily), Paris (three to four times weekly) and Dublin (two to three times weekly). 

The airline is launching its new 787 flights from Apr-2019 to Jun-2019. It faces competition from Air Transat on Gatwick flights (both Air Canada and British Airways serve London Heathrow from Calgary). Air Transat has also operated seasonal service from Calgary to Paris in the past, and there are currently no flights between Calgary and Dublin

WestJet has served all of those routes in some capacity on a seasonal basis and, as of mid Dec-2018, it has operated flights from Calgary and Toronto to Gatwick.

When it launched its first direct, nonstop flights from multiple Canadian destinations to London Gatwick in 2016, WestJet faced significant operational challenges with the aircraft, which resulted in the airline hiring Omni Air International to operate flights when the older 767 used on the operations needed repairs. 

Eventually, WestJet worked out the teething problems, and its executives consistently touted that the long haul flights were beating expectations. 

Given that the 787 is an entirely new fleet type for WestJet, the airline is likely taking a cautious approach with deployment on known routes in order to ease any teething problems that could emerge with the new widebodies. 

“We are taking a measured approach to international growth, concentrating the initial 787 deployment from our home hub of Calgary to European destinations that we are familiar with, and where we have already built infrastructure and brand network strength.” WestJet CEO Ed Sims recently explained.

WestJet’s 787s feature 320 seats – 16 lie-flat business seats, 28 in premium economy and 276 in economy. 

Company executives stated that since the launch of sales for the 787 routes the average fare booked in the premium economy section of the 787 had been nearly 15% higher than the equivalent on its 767 jets. 

WestJet pledges unit revenue growth in 2019 after a tough 2018 

WestJet probably took some time to highlight the premium economy performance in order to allay concerns about its capacity growth for 2019, and to assure its revenue performance will improve next year. 

The company is planning 6.5% to 8.5% capacity growth in 2019, driven by the addition of the three 320-seat 787s, and expanding Swoop’s fleet from six to 10 737 narrowbodies. Domestic growth is capped between 1% and 3%, and WestJet is pledging 2% to 4% unit revenue growth in 2019, after RASM fell 1.7% for the 9M ending Sep-2018. 

WestJet continues to juggle a lot of changes as markets look for an inflection 

WestJet seems to be working hard to restore a financial performance that garnered the airline an investment grade credit ranking. 

But even as it pledges unit revenue expansion and tempered domestic growth in 2019, the ULCC Flair Air is planning expansion next year, and the start-up Canada Jetlines is aiming to make its long-awaited debut in 2019, resulting in more domestic growth and heightened competition for Swoop

WestJet is making moves to leverage its strong position as Canada’s second largest airline, and its expansion should produce returns in the long term. The challenge is working to allay concerns in the short term that it has bitten off more than it can chew. 

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