Fitch Ratings has assigned ratings of 'BB-'/'RR2' to WestJet Loyalty LP's proposed senior secured term loan.

The proposed debt issuance will be secured by WestJet's loyalty program assets and brand intellectual property. Proceeds from the issuance will be used to partly refinance the company's existing term loan.

In November 2023, Fitch upgraded WestJet's Long-Term Issuer Default Rating to 'B' from 'B-'. The upgrade reflected continuing improvement in demand for Canadian air travel that is driving top line growth and improved profit margins for WestJet. Results through the first part of 2023 outperformed Fitch's prior expectations, and the agency now anticipates that EBITDAR leverage and coverage metrics will be consistent with 'B' rating tolerances in the 2024-2025 timeframe.

Key Rating Drivers

Loyalty Program Debt Rating: WestJet's planned debt issuance will be secured by a priority interest in its WestJet Rewards loyalty program and brand intellectual property. WestJet will act as a parent guarantor, while the notes will be issued by WestJet Loyalty LP, a new Alberta based SPV.

The 'BB-'/'RR2' rating for the notes is driven by a bespoke recovery analysis. Fitch's recovery analysis is based on a going-concern scenario in which the agency uses an estimated sustainable EBITDA of CAD600 million and an EV multiple of 5x. Fitch's going-concern EBITDA estimate reflects a post-restructuring scenario where margins are structurally impaired, potentially by a weak operating environment, rising costs and competition, or a combination thereof. The choice of this multiple considers the historical bankruptcy case study exit multiples for peer companies ranged from 3.1x to 6.8x

Fitch believes the core nature of the collateral represented by the loyalty program and brand IP provide compelling motivation for the airline to affirm its obligations in a bankruptcy scenario. Fitch also expects the value of the collateral to grow over time as WestJet's fleet and topline revenues grow. However, the value of the assets largely rests on WestJet continuing as a going concern. Liquidation of the airline would materially affect the collateral values and weaken recovery.

Solid Recovery in Traffic: Canadian air traffic showed solid momentum in 2023, driving much improved financial results for WestJet. Traffic first rebounded sharply in 2022 after initially lagging the recovery in the U.S. relative to 2019 levels. The Canadian recovery is now largely in line with the U.S. Fitch's prior forecasts anticipated some weakness, with persistent inflation dampening consumer demand. However, air travel demand continues to hold.

Fitch expects Canadian air traffic growth to slow from its recent pace but to remain positive based on expectations for modest macroeconomic growth, potential improvement in business travel, and positive impacts driven by sizeable levels of migration into Canada.

Credit Metrics Improving: Fitch calculates WestJet's gross EBITDAR leverage at roughly 5.6x at Sept. 30, 2023, which remains elevated from pre-pandemic levels but is better than prior expectations. Fitch anticipates that leverage will decline further as operating margins continue to improve, driven by relatively stable demand and the benefits of the company's strategic network reconfiguration. WestJet also benefits from additional EBITDA acquired through its integration of Sunwing, following the close of the acquisition in May 2023. EBITDAR fixed-charge coverage, which had also been depressed post-pandemic, is expected to rise toward 2x within the forecast period, from below 1x in 2022.

Derivation Summary

WestJet's 'B' IDR is two notches below its primary domestic competitor, Air Canada. The difference reflects WestJet's higher near-term leverage prospects and smaller relative size. WestJet's liquidity position is also not as strong as Air Canada's, which likely has better access to funds given its size and unencumbered assets. These factors are partially offset by WestJet's favorable cost structure, and relative exposure to business demand, which is taking longer to recover from the pandemic.

Key Assumptions

Rebounding traffic in 2023, leaving total RPMs down in the single digits below 2019 levels;

Traffic continues to grow modestly in 2024 despite softer economic conditions;

Operating margins improve sequentially but remain below pre-pandemic levels through Fitch's forecast period, reflecting higher operating costs and modest assumptions about unit revenues.

Recovery Analysis

The recovery analysis assumes that WestJet would be reorganized as a going concern in bankruptcy rather than liquidated.

Fitch has assumed a 10% administrative claim.

Going-Concern (GC) Approach

Fitch has assumed a going-concern EBITDA of CAD600 million The GC EBITDA estimate reflects Fitch's view of a sustainable, post-reorganization EBITDA level upon which Fitch bases the enterprise valuation.

Fitch's going-concern EBITDA estimate reflects a post-restructuring scenario where margins are structurally impaired, potentially by a weak operating environment, rising costs and competition, or a combination thereof. The EV multiple is reflective of prior airline bankruptcies. An EV multiple of 5.0x EBITDA is applied to the GC EBITDA to calculate a post-reorganization enterprise value. The choice of this multiple considers the historical bankruptcy case study exit multiples for peer companies ranged from 3.1x to 6.8x.

These assumptions lead to an estimated recovery of 'BB-'/'RR2' for the senior secured debt.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Total adjusted debt/EBITDAR below 4.5x;

Operating EBITDAR/gross interest + rent above 2x;

EBIT margins sustained in the mid-single digits or higher;

Evidence of increasing financial flexibility, potentially including an increasing base of unencumbered assets.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Operating EBITDAR/gross interest + rent toward 1.5x;

Total adjusted debt/EBITDAR sustained above 5.5x;

Heightened liquidity risks, including cash + revolver availability falling toward $800 million and/or decreasing likelihood of ability to access contingent liability options.

Liquidity and Debt Structure

Solid Liquidity: Fitch views Westjet's liquidity as supportive. The company ended the third quarter with CAD1.4 billion in cash and cash equivalents and full availability on its USD350 million revolver. Maturities are manageable, largely consisting of the 2026 maturity of the company's term loan B. Capital spending will step up over the forecast period, but capex primarily consists of financeable aircraft.

Issuer Profile

WestJet Airlines, Ltd. is Canada's second largest airline.

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 Considerations

The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.

(C) 2024 Electronic News Publishing, source ENP Newswire