Oil Price Still a Concern: Will WestJet Implement Fuel Hedges in Q4?

With the rapid decline in oil prices boosting investor interest in airlines, WestJet Airlines Ltd. (WJAVF.PK) could reap the benefits since it may use as much as five million barrels of fuel in 2009.

RBC Capital Markets analyst Nick Morton estimates that every $10 per barrel decline in the price of oil adds C$56-million to the airline’s earnings before interest, taxes, depreciation, amortization, and restructuring or rent costs [EBITDAR].

While WestJet implemented fuel hedges for the third quarter of 2008, Mr. Morton does not think it is hedged for the fourth quarter. However, he believes it has began a systematic hedging policy that could see 30% to 40% of its estimated 2009 needs hedged.

Recent results from U.S. airlines show that fuel continues to be a concern. “Despite the recent decline in oil prices, they remain above year-ago levels and continue to pressure industry margins,” the analyst said, citing Southwest Airlines Co.’s (LUV) industry-leading hedging success. For example. 85% of its fourth quarter fuel exposure is hedged at $62 per barrel oil. The price of jet fuel has dipped from a third quarter average of $3.54 per gallon to around $2.38.

But why has the AMEX Airline Index outperformed the S&P 500 year-to-date even as oil prices rose from $100 to a peak of $145 in July?

Mr. Morton said the decline in airline stock prices in late 2007 due to already high oil prices, sent them to levels as if they were bankrupt and “the investor was paying for the ‘option’ that the airline would survive.”

He expects WestJet’s share price will likely be volatile given the dramatic fuel prices swings and its inherent operating leverage. While considering it attractively valued, the analyst cut his price target from C$20 per share to C$17, while maintaining an “outperform” rating. The stock is currently trading around C$11.50.