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Morningstar | Investors Swoop Up WestJet Shares Following Solid 1Q Results; Maintaining FVE

Westjet beat consensus expectations with first-quarter results that benefited from materially higher ancillary revenue and guest revenue over the prior year. During its call, Westjet updated investors on 737 MAX-related disruptions during first-quarter flying and gave contingency plans for cancellations through peak travel months. We maintain our CAD 19.70 fair value estimate after Westjet booked solid results on first-quarter cancellations and readied its fleet for groundings through August without punishing operating margins. We now believe a nine-month suspension is as probable as a three-month suspension, but we conservatively assume MAX aircraft are grounded for 6 months in our models. Shares traded squarely in 3-star territory after increasing 4% on solid first-quarter results.

Amid MAX groundings, Westjet grew top line revenue 5.5%, thanks mostly to robust capacity growth in its transborder and international markets. The first quarter was marked by international route commencements on newly delivered wide body aircraft. Since international and transborder traffic logged high-single-digit capacity growth versus March quarter last year (11%), we decided to modify our full-year expectations for this capacity. Our latest models show international supply improving 9%, with diminished impacts from MAX disruptions in leisure markets, and consolidated capacity growing 5%. Previously, we modeled consolidated capacity growth of around 4%.

Yield inflation was unimpressive during the quarter, but we assume this was a function of suboptimal flying and last-minute route reorganization on the heels of MAX service termination. Management reinforced this idea, noting missed opportunities in high revenue closed-in yields following systemwide MAX cancellations. We model 2% revenue per available seat mile growth for 2019, thanks in part to booking curves firming up in coming months, but also our belief that management can reach its targeted RASM goal, albeit at the bottom.

We believe Westjet demonstrated an ability to mitigate the impact of MAX disruptions with its on-time performance (3.6% improved over the same period last year) and slightly higher completion rate, which reached 96.7% when adjusted for unplanned MAX groundings. What’s more, its consolidated capacity growth of 5% happened on domestic ASM (available seat mile) contraction of 3% during the first quarter and international expansion of 11%. We believe Westjet proved the ability to drum up additional capacity without incurring cost inflation on diminishing labor and asset productivity. Unit costs, excluding fuel and profit sharing, increased by just under 1%.

Westjet’s 2019 guidance remains suspended, but we have higher confidence that its full-year outlook from the start of the quarter can be realized. After adjusting our model for today’s results, we raised ASM growth in our latest forecasts but still fell over a hundred basis points short of our original assumptions for 2019. We now model 2019 capacity growth of 5%. We also raised our RASM expectations back to the low-end of management’s initial expectations of 2%. We were impressed with performance in international markets and we find little reason for demand to falter over the next two quarters.