Tag: TRZ

Air Canada / Air Transat / Westjet

A tale of market timing…

Air Canada (TSX: AC) was going to buy out Air Transat (TSX: TRZ) for $18/share, but of course COVID-19 hit. They will instead do so for $5/share, and also with shares instead of cash (the details of this were not clear from the press release, but a typical provision is for people to elect to take cash up to a certain aggregate amount and after they will receive cash). The shares option has Air Canada equity valued at a level that is higher than Friday’s closing trading price.

Financially, Transat is not in terrible condition, with a whole bunch of cash and equivalents that are paid in the form of customer deposits (good luck getting those ticket refunds, customers!). They are still bleeding cash by virtue of their revenues going down to nearly nothing, but Air Canada is striking while the iron is hot (or rather, while the Covid craze is hot) and removing a future source of competition. The implied value in international ticket pricing they will gain will probably be a lot higher than the immediate costs of the costs they are paying.

We contrast this with Onex’s acquisition of Westjet, which closed in December 2019 for $31/share in cash (or $5 billion, debt included). Air Canada’s equity took a 3/4 haircut after Covid, and there wouldn’t be much reason to believe that Westjet would have fared any better had they still been public. Onex is a huge entity so their financial solvency is nowhere threatened, but still, they probably took an implied $3 billion haircut if they were to float Westjet to the public again.

This, and also an examination of Cineplex’s proposed takeover (at CAD$34/share), goes to show you that timing is everything.

I don’t buy airlines, nor do I particularly care for the sector as a whole. Almost everything associated with the retail side of commercial aviation is miserable. Other components of the industry have somewhat more promise.

Canada Airlines – Westjet, Air Canada, Transat

The words from Warren Buffett resonate within my mind when I recall him saying that the cumulative retained earnings out of the airline sector is negative.

This brings us to Westjet’s (WJA.TO) and Air Canada’s (AC.B.TO)’s relative good performance over the past year – shareholders are up 150% and life is good:

wja

acb

I won’t examine Air Canada because there are a whole bunch of other messy variables to take into consideration (pension liabilities, special government regulatory business, the fact that it is Air Canada, etc.) but we will take a very superficial look at Westjet.

Looking at their year-end results, the corporation has an existing market capitalization of $3 billion, $1.46 billion in cash, $739 million in debt (thus enterprise value of about $2.3 billion) and delivering about $452 million in free cash flow to its investors – a multiple of about 5 times free cash flow. What is not to like about this?

The profits were generated through high seat loading factors (Westjet did 82.8% of seats filled in 2012) and fare rates being sufficiently high, in addition to fuel costs being moderate through the year.

In other words, everything is going quite well for Westjet and they had a banner year. It looks like this is continuing in 2013 – in February they announced a load factor of 86.1%.

An investor will ask – what is the upside from here? The only upside I see is through sheer trading momentum – this is why I would not want to short the stock at present. The higher the stock price goes, the more tempting the short case may seem under the inevitable basis that eventually competition will eventually catch up to the airline and there will once be some overcapacity in the industry. Until then, there is no reason for the stock to not go higher – they could reach $30 or even $40 a share and you could make a “numbers” case for the company’s valuation just based off of free cash flow. The lack of solvency risk (i.e. cash higher than debt at present) is also another bullish case.

Interestingly enough, Air Transat (TRZ.B.TO) has not exhibited the same trajectory, so some inferences can be made on the vacation destination market vs. regular North American travel.