WestJet: 5-Year Minimum Annual Gross Return Of 17%

| About: WestJet Airlines (WJAVF)

Background and Thesis

The purpose of this article is to calculate the returns one can reasonably expect by buying WestJet Airlines (OTC:WJAVF). We believe the stock offers excellent growth prospects in relation to price.

WestJet is one of the most profitable airlines in North America and has been continuously expanding its fleet. Over the next 5 years, the company has commitments to take delivery of 58 new aircraft. Assuming it does not extend its existing leases, we would expect to see it expand its fleet by 35% over the next 5 years. That equates to 7% minimum capacity growth.


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WestJet Overview

Strong historical cash flow generation ...


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Increased focus on returning excess cash to shareholders (decrease in capital stocks=buybacks and dividends) ...


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How cash is deployed ...


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Stable levels of invested capital ...


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Revenues/Invested Capital are increasing from 2009 cycle lows ...


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Margins continue to expand since cycle lows. At current growth rates, we expect to see margins return to 12% at cycle highs ...


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Given the increases in Revenues/Invested Capital and NOPAT Margin, Returns On Invested Capital are increasing ...


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Using maximum, minimum and average historical Returns On Invested Capital (NASDAQ:ROIC) in the previous chart, we have calculated based on the historical levels of invested capital possible ranges for where NOPAT could have been (see below). This gives us an indication as to where in the cycle the business has been and where it might currently be. Right now, NOPAT is slightly above average ROIC levels. We do however believe that given the current slow but sure growth in North America, the stock will hit its maximum ROIC of 14% which would imply a current NOPAT of almost CAD$ 350m (current NOPAT is CAD $273m). Please note that this is based on current levels of invested capital and we expect invested capital to continue to grow going forward that should result in an even higher NOPAT.


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Historically, WestJet has traded on an average relative p/e of 0.96 to the S&P 500. Applying this to the current multiple of 15.47 gives us 14.86x earnings. We multiplied this P/E by the historical NOPAT levels (derived from minimum, average and maximum ROIC levels) to get a sense of where the market cap for the company can trade. In the chart below you can see the actual market cap of WestJet plotted against the market capitalisation calculated using NOPAT derived from the minimum, average and maximum historical ROIC. We can see that right now the market cap of WestJet is right in the middle of its range. We believe that as ROIC expands, the market cap has the potential to almost double. We also believe this will take place over the next 5 years.


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EPS Assumptions

Our annualized average EPS estimate for the next 5 years is between 14.6%. Specifically we expect the company to grow revenues around 10% (7% from capacity increase and 3% from pricing gains) and for margins to expand by 1% per year. The various components can be seen below.


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Expected Return

Assuming WestJet will trade on its average relative P/E of 0.96 x S&P 500 which would equate to 14.86x trailing earnings, then we are looking at an 17% IRR over the next 5 years with a CAD$52.63 price target. In the event that multiples expand to the market level (15.47x trailing earnings), then the IRR would be 18% with a CAD$54.79 price target.


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Risk Factors

Oil price volatility can have a significant impact on the earnings of the stock even against the backdrop of continued economic expansion.

Disclosure: I am long OTC:WJAVF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.