Fitch Ratings - Chicago - 14 Apr 2020: Fitch Ratings has downgraded WestJet Airlines Ltd.'s Long-Term Issuer Default Rating (IDR) to 'B+' from 'BB-'. The Rating Outlook is Negative. The rating action reflects the sharp change in market conditions due to the impact of the coronavirus pandemic. Fitch views it unlikely that WestJet will be able to delever as previously anticipated in this environment, and also consider several of their strategic initiatives to be more challenging to achieve. Fitch also recognizes WestJet's position in Western Canada where it is exposed to the oil and gas sector as well as FX headwinds.
KEY RATING DRIVERS
Fitch has taken negative rating actions across the North American airline sector. The depth of the decline in traffic related to coronavirus is causing substantial cash outflows for airlines in the near term. Looking past the worst of the crisis, it has become increasingly likely that the economic impact of the virus will cause a much slower than previously anticipated rebound in air traffic. The combination of a longer period of depressed airline traffic with additional debt being raised to manage liquidity will cause all carriers to operate with weakened credit metrics and reduced financial flexibility at least through 2021. Airlines are one of the hardest hit sectors globally. While exogenous shocks have always posed risks for the sector, the severity of this disruption is materially different than what was contemplated in our ratings prior to the outbreak, contributing to the ratings downgrades.
Fitch has revised its forecasts to include revenues down roughly 90% through the second quarter of the year, more than 50% through the third quarter and nearly 40% for the fourth quarter. Fitch's assumptions include the possibility of periodic restrictions on international travel in the second half of the year driven by potential resurgence of the virus in the fall or winter. Global economic impacts of the virus will likely lead to reduced levels of traffic for longer than previously expected. Our current base case reflects traffic only slowly recovering towards 2019 levels by the end of 2021, with a full rebound to 2019 levels only occurring by 2022 or 2023.
The rating downgrade reflects Fitch's expectations that a slower recovery in demand will push WestJet's credit metrics outside levels that support a 'BB-' rating during 2020 and remain outside such levels through 2021. WestJet's rating had been contingent on its ability to swiftly delever through FCF generation, which no longer appears possible given the current environment. Fitch believes that WestJet should have sufficient liquidity to manage through the crisis assuming a modest recovery, which begins in the second half of 2020 which continues into 2021. The Negative Outlook reflects the still-evolving situation with coronavirus, and the possibility of a material impact to its credit metrics should a substantial recovery be delayed beyond 2021. Fitch expects WestJet's exposure to the energy-centric Western Canadian economy to be a weight on performance, and we expect FX headwinds to continue through 2020.
The company's liquidity position remains solid, with a cash balance of $1.7 billion following a full draw on its US$350 million revolver. Its sale-and-leaseback strategy continues to move forward.
The company laid off slightly more than 50% of its staff, which it plans to rehire under a Government of Canada program which replaces earnings with a partial government subsidy. The government program is essentially cash neutral for WestJet for the previously furloughed employees and defrays remaining wage and salary costs. Fitch expects some 2020 capex will be delayed until 2021, and the company has announced that it is working with suppliers on cost reductions or deferrals.
WestJet's 'B+' rating is two notches below its primary domestic competitor, Air Canada, and is in line with American Airlines. The two notching difference between WJET and Air Canada reflects WestJet's higher near-term leverage, and relative size. Those factors are partially offset by WestJet's favorable cost structure, liquidity, and its plans to delever over time.
WestJet's 'B+' rating reflects significantly higher debt following its purchase by private equity sponsor Onex, and near to intermediate term execution risks involved with the evolution of the company's business model. Fitch also recognizes WestJet's dominant position in Western Canada where it is exposed to the oil and gas sector as well as FX headwinds.
Somewhat offsetting near-term risks are WestJet's very healthy liquidity for the rating category, history of profitability, sizeable market share in a largely duopolistic market, and low cost structure. Further, Fitch believes some of the risks from the LBO are lessened by Onex's relatively conservative approach compared with other LBOs.
Key assumptions in Fitch's rating case include a steep drop in demand through 2020, with full recovery only occurring by 2022-2023. During 2020, Fitch's base case includes revenues down roughly 90% through the second quarter of the year, down as much as 50%-60% in the third quarter, and down around 40% for the fourth quarter. Our base case reflects traffic only slowly recovering toward 2019 levels by the end of 2021, with a full rebound to 2019 levels only occurring by 2022 or 2023. Jet fuel prices for the year are assumed at around US$1.50/gallon, and rise to about US$1.65/gallon in 2021.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
- Longer than expected drop in demand due to coronavirus leading to longer-term impact on the balance sheet/ financial flexibility;
- Total adjusted debt/EBITDAR remaining above 4.5x;
- FFO fixed charge coverage trending towards 2x;
- Adoption of more aggressive financial policies such as slowing the planned pace of debt repayment or maintenance of lower liquidity balances;
- Debt-financed M&A activity.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
- Total adjusted debt/EBITDAR at or below 3.5x (estimated to hit around 4.5x post acquisition);
- FFO fixed charge coverage at or above 3x;
- EBIT margins increasing towards 10% (providing evidence that the company's strategic initiatives are being implemented effectively);
- Maintenance of liquidity above 20% of LTM revenues;
- The company works to re-build its base of unencumbered assets.
BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
LIQUIDITY AND DEBT STRUCTURE
Debt Structure: Onex' purchase of WestJet was funded via a new USD1.955 billion TLB along with CAD542 million in rollover loans owed to Export Development Canada (EDC), and CAD 1,649 in new equity. The term loan allows for incremental facilities (either in the form of term loans or increased sizing on the revolver) subject to a minimum collateral coverage ratio of 1.25x.
Liquidity: WestJet has over CAD1.65 billion cash and equivalents currently, after drawing fully on its US$350 million revolving facility. The company had YE 2019 liquidity of more than 28% of LTM revenue, which is rather healthy and superior to several peers. While WestJet has essentially no unencumbered assets given the collateral pool supporting its TLB, we note this facility is overcollateralized and the company could pull some assets out of the collateral pool in order to issue new debt.
Debt maturities through the early 2020s are manageable, consisting of principal amortization on the EDC loans and a 1% annual principal amortization under the TLB, which combined total roughly CAD89 million per year.
KEY RECOVERY RATING ASSUMPTIONS:
The recovery analysis assumes that WestJet would be reorganized as a going concern in bankruptcy rather than liquidated. We have assumed a 10% administrative claim.
Going-Concern (GC) Approach:
The GC EBITDA estimate reflects Fitch's view of a sustainable, post-reorganization EBITDA level upon which we base the enterprise valuation.
The GC EBITDA is marginally below the forecast from two years in the future from our current stress case reflecting a scenario where WestJet comes under financial distress because of the coronavirus crisis, and then experiences more normalized levels of profitability once the crisis has passed.
An EV multiple of 5.5x EBITDA is applied to the GC EBITDA to calculate a post-reorganization enterprise value. The choice of this multiple considered the following factors:
The historical bankruptcy case study exit multiples for peer companies ranged from 3.1x to 6.8x.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG issues are credit neutral or have only a minimal credit impact on the entity(ies), either due to their nature or the way in which they are being managed by the entity(ies). For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.