OT WestJet runs into turbulence
By MATHEW INGRAM
Globe and Mail Update
By now, investors have grown used to a certain pattern in the financial results of WestJet Airlines, in which the Calgary-based carrier routinely beats estimates for profitability, passenger traffic and so on, month after month and quarter after quarter. Unfortunately, that pattern ran into a wall with the latest news from the company. WestJet reported that its load factor – that is, the number of seats it filled on its planes – fell significantly in May compared with the same period last year, and the stock was downgraded by several brokerage firms.
Late Thursday, WestJet said that the overall capacity of its network — known as the available seat-miles or ASM — rose by 31.2 per cent in May, but its actual passenger traffic only increased by 18.3 per cent. As a result, the airline's overall load factor dropped to 65 per cent from 72 per cent, a substantial drop for the airline. The stock lost about 11 per cent of its value after the news. To make matters worse, Air Canada's traffic climbed 25 per cent in May on a 14-per-cent rise in capacity — producing an overall load factor of 78.5 per cent, its highest ever for the month.
The main reason for the drop in traffic, WestJet said, was that it cut the number of seat sales offered during the period, in part because it is trying to compensate for higher fuel costs without raising fares. "Although we are somewhat disappointed by this lower load factor," chief executive officer Clive Beddoe said, "it has come about ... as a result of WestJet reducing the number of seat sales we have intentionally offered in the market. We have pursued this approach as a way to improve yields without further increasing base fares in the face of the extremely high price of fuel."
It's not just jet fuel prices that have been eating into WestJet's business model, however. Price competition with Air Canada as well as startups such as Jetsgo and Canjet has been intense, and industry analysts say the Western-based airline is trying to restore some sanity in its price structure rather than getting locked into a price war forever. Scotia Capital said that the drop in load factor suggests that "WestJet is attempting to take a leadership role in pricing and has sacrificed traffic as a result."
One of the things that makes fighting a price war against Air Canada difficult for WestJet, of course, is that the country's national carrier is going through a financial restructuring, and during that process it is to some extent released from the usual concerns about profitability. In fact, WestJet has criticized Air Canada in the past for taking advantage of its restructuring in order to engage in pricing that wouldn't make sense if it were not protected from its creditors by the courts.
A lot of competitive pressure on prices has also been coming from Jetsgo, however, which has been running $1 promotions and seat sales in an attempt to steal market share from Air Canada and WestJet in the crucial Toronto-Montreal-Ottawa triangle. As a result of those competitive pressures and other factors, including rising costs, WestJet's first-quarter earnings missed Bay Street estimates by 6 cents a share. And to make matters worse, WestJet is continuing to add new planes and routes, and has moved its Ontario hub from Hamilton to the much more costly Pearson airport on the outskirts of Toronto.
All of these factors — fuel costs, price wars, new planes and an expensive airport — are putting the squeeze on WestJet, industry analysts say, and so the airline is trying to recover more from each ticket it sells in order to prevent its all-important "yield" from falling too much (as it did in the first quarter). But as Scotia Capital described it, WestJet is wrestling with a "load-yield tradeoff." If it keeps its prices low, its load factor may improve but its profitability will nosedive. If it tries to keep prices higher, its profitability looks good but then its load factor deteriorates.
In the wake of WestJet's decision, Scotia cut its estimates and reduced its price target. The firm said it now expects the airline to earn 50 cents a share in 2004 instead of its earlier estimate of 60 cents, and 89 cents in 2005 compared with 96 cents. Scotia said that it believes "price competition will persist" whether it comes from Air Canada with its lowered cost structure once it emerges from court protection, or Jetsgo and other startups. Canaccord Capital also cut its profit estimates for the company and reduced its rating on the stock to "hold," saying May's traffic was "surprisingly weak" and that it was reducing its load factor estimates for 2004.
It remains to be seen whether Air Canada and Jetsgo will be willing to ease up on their price wars in the interest of protecting their own yields. RBC Capital Markets, which rates WestJet "outperform," said current prices in the market are unsustainable, and that Air Canada will have to raise fares so that it has enough cash on hand to act as a buffer when it emerges from court protection. WestJet is no doubt hoping that proves to be the case.
