WestJet Airlines Ltd. Upgraded To ‘B’ From ‘B-’ on improved credit metric and refinancing

• Calgary-based WestJet Airlines Ltd.'s credit measures have been trending better than expected, supported by passenger traffic growth, particularly on transborder and international routes.
• The company also issued a new US$1.5 billion first-lien secured term loan B due 2031, with net proceeds used to repay a significant portion of its existing US$1.995 billion term loan B due December 2026, thereby extending its debt maturity profile.
  
• As a result, S&P Global Ratings raised its issuer credit rating on WestJet by one notch to 'B' from 'B-'.
  
• At the same time, we raised our issue-level rating on the company's term loan B due 2026 and revolving credit facility by two notches to 'B+' from 'B-', stemming from the upgrade of WestJet, along with our estimate for stronger recovery prospects in a default scenario following the refinancing.
  
• The stable outlook reflects our expectation for adjusted funds from operations (FFO) to debt to be at or above 12% over the next couple of years.
  

S&P Global Ratings today took the rating actions listed above.

Credit measures have been trending better than expected, supported by passenger traffic growth, particularly on transborder and international routes.

We forecast adjusted FFO to debt to be just under 12% in 2023 with good prospects to improve further to above 14% by 2025, which we believe is commensurate with a 'B' issuer credit rating and supports our upgrade of WestJet. We expect WestJet's passenger traffic growth to exceed our prior assumption for 2023, contributing to adjusted EBITDA of about $1 billion, up modestly from $930 million in our July 2023 forecast. This primarily reflects higher load factors and capacity increases throughout the year that more than offset pricing pressure from ultra-low-cost carriers (ULCC), particularly in WestJet's domestic markets. Much of this traffic growth has been in WestJet's transborder and international routes (about 55% of WestJet's passenger revenue during the first nine months of 2023), which experienced a significant increase in demand, resulting in better fleet utilization (i.e. more frequent flights, flying more routes, higher load factor, etc.). Passenger traffic growth on these international routes, which mostly comprise of sun destinations, was driven by pent-up demand for Canadians, who faced more COVID-19-related restrictions on international travel through most of 2022.

Beyond 2023, we expect modest EBITDA growth stemming primarily from WestJet's plans to increase capacity with firm orders for 58 new Boeing 737 Max aircraft, of which we assume about 15 will be delivered over the next two years and about 30 in the subsequent two years. We assume a portion of this additional capacity will replace WestJet's older 737-800 NG aircraft and contribute an annual average increase in available seat miles of about 5% through 2027, along with better fuel and cost efficiencies. We forecast adjusted EBITDA margins to remain relatively flat going forward on a pro forma basis, reflecting our view that cost savings from the new Max aircraft, along with lower jet fuel prices and increased fleet utilization, should largely offset higher wages negotiated with its pilots last summer and continued yield pressure we anticipate as more capacity enters the market and Canadians cut back on discretionary spending.

New aircraft investments are expected to contribute to negative free operating cash flow (FOCF) generation and increased debt levels over the next few years.

We assume capital expenditures (capex) will remain elevated over the next few years as the company takes delivery of new aircraft. As of Sept. 30, 2023, WestJet estimated that its commitments for the purchase of 737 Max aircraft and spare engines over the next five years was about $4.2 billion. We assume the company will use sale leaseback transactions and additional debt to finance just over half of its capital expenditures, with the remainder from operating cash flows. Still, we expect adjusted FFO to debt and adjusted debt to EBITDA to gradually improve over the next couple of years to above 14% and below 5x, respectively. We also acknowledge that despite our expectation for FOCF deficits over the next few years owing to elevated capital expenditures, most of these investments are growth related and WestJet has multiple ways to fund them. It's worth noting that there could be delays in the timing of these deliveries, either due to manufacturing delays at Boeing or if weaker air travel demand leads WestJet to renegotiate its delivery schedule.

WestJet's refinancing transaction meaningfully reduces refining risk.

WestJet issued a new US$1.5 billion secured term loan B due 2031 through its subsidiary, WestJet Loyalty L.P. The new debt is secured by WestJet's loyalty program and brand intellectual property. Net proceeds from the issuance will be used to repay a large portion of WestJet's existing US$1.995 billion term loan B due December 2026, thereby extending the company's weighted average maturity to more than six years from about three years. The interest rate on the new term loan will be SOFR plus 375 basis points and follow a 1% annual debt amortization schedule, which is consistent with what we had previously assumed.

The stable outlook reflects our expectation for WestJet to continue benefiting from higher fares and passenger traffic, spurred by pent-up demand for air travel. As a result, we expect WestJet's adjusted FFO to debt to be at or above 12% over the next couple of years.

We could lower the ratings within the next 12 months if we excepted adjusted FFO to debt to be sustained well below 12%. This could occur if passenger revenue were lower than we expected, potentially owing to increased competition or challenging macroeconomic conditions. It could also occur if higher operating costs contributed to weaker profitability.

We could raise our rating within the next 12 months if we expected adjusted FFO to debt to be sustained in the high-teens area percent area supported by passenger traffic growth and relatively steady profitability. In this scenario, we would need to believe that the company's sponsor policies are aligned with sustaining such leverage. We would also expect WestJet to fund a significant portion of future aircraft deliveries with internally generated cash flow, thereby limiting increases in its debt levels while preserving liquidity.