Earlier this year I said goodbye to WestJet (WJA on TSX). I realized a 40% gain on average that essentially matched the market. WJA was cheap and so was the market. I sold because I think the new CEO at Air Canada (WJA biggest competitor) is pretty smart. At the time it seemed that Air Canada’s unions and Air Canada were going to come the a compromise that would close the gap that WJA has over AC.A.
WJA was about 30-40% below my fair value target, but I was also getting nervous about the economy. Not that I have any insight on the macro side, but I noticed that market participants were getting comfortable with some of our large imbalances again. Confidence has returned and it makes me nervous.
WJA is a very well run company in a tough space. The share price may decline in a slower economy, but so will many other company’s. WJA is well followed as well. This makes it tougher for the share price to stray too far from intrinsic value.
In order for me to be interested in WJA again, I would have to see some sort of disaster specific to WJA. This would cause forced selling. I’m not too optimistic that something like that would happen though.
I have ended Q1 2011 almost at the exact same spot as I left 2010. Still trailing my target portfolio by almost the exact same amount. Though both me and the mock portfolio ended up around 3.7% for Q1 2011. There has been some changes to the portfolio so I would expect the underperfomance to continue, especially if this rally in the equity market continues.
I have sold WJA, FES and EQI (formerly GHC). WJA was around 25% below my low end fair value. The same with FES. EQI was almost at fair value. None of the companies have done anything wrong, but I am finding better value in smaller names. I added to MGO and have bought a few new companies. I hope to have write-ups on them in the coming weeks.
The markets have had a very nice run. The higher they move, the less I like them. I start to get nervous about my holdings in large companies. QE2 is ending soon, and we will this economy on its own footing for the first time. I think that “the economy” is no longer a catalyst going forward. Picking specific companies that have their own internal catalysts will be more important than just plowing money into what’s hot. I don’t think that you will see another recession, but I doubt the mean reversion growth rates in GDP continue. Some large US companies are cheap and some look cheap. Looking back over the last 10 years you see excess. Excess borrowing and spending. I don’t think that profit margins and growth rates will look so rosy over the next 10 years. Profit margins are quite high and have the potential for mean reversion to the downside. With steady revenue and closer to normal margins will take away any margin of safety in the broader market. That is why I am focusing more and more on small companies with their own internal catalysts.
Given the extreme debt levels, a small increase in interest rates will dramatically increase the cost to service those debts. That’s money that won’t be spent further to buy more flat-screens, cars, or other discretionary items.
Japan was horrible. The damage isn’t completely tallied yet. The Nikkei is off 7-8%. That’s not really that much. Japan is not a long term investment. Their companies are not shareholder friendly. The have an even worse debt/GDP ratio than America. Their aging demographics are the worst in the first world. Japan would be nothing more than a sentiment trade. In order to minimize risk on that type of a trade you need panic. I don’t see panic. As soon as Buffett says “buying opportunity” you money flowing in whether it’s warranted or not. Maybe the eventual trade would be uranium, but again I see no panic.
Reviewing your companies is extremely important. When your are like me and have many undervalued companies (at least I think so), you have to keep tabs on all of them. This doesn’t mean you should sell when they miss a quarter, but it is important to monitor the businesses through their various cycles.
Well WestJet didn’t miss their quarter, but I still think there are some things I think I should point out.
WJA is running like a well oiled machine. Imagine an airline that didn’t lose a ton of money during the recession, in fact WJA earned a profit every quarter.
- WJA has generated cash currently of $8.58 per share and net cash of $0.85. This is a company that generates cash every quarter (if you smooth out lumpy capex).
- They now have an interline agreement with American airlines. This may lead to a code share agreement in the future, which is possible in the next couple of years.
- WJA has now been authorized to buy back 5% of its shares. This is good news, but the diluted share count can still grow from the employee profit-sharing agreement.
- WJA has introduced a new bag fee when checking a second bag, of $20. This shows WJA ability to pass on costs, and should add $8-10 million in revenue.
- WJA is going to pay a dividend of $0.05/share each quarter. This gives WJA a yield of 1.5%.
- Capacity growth is more muted than in previous quarters.
WestJet and Air Canada operate a duopoly here in Canada. WJA has the advantage and knows it, this is very important. I’m not an expert on game theory, but I’m sure someone will write a book on the these two airlines and the strategic moves they make. WestJet announced a new bag fee, this is actually bigger news than it seems. In the past WJA has been more reactive, but this shows that WJA has the opportunity to raise prices and knows it.
The rapid expansion is over, and all the very low hanging fruit has been picked. WJA can still pick up market share, but it will be more muted. The airline has the lowest cost advantage, and has made the right moves to please shareholders. It is refreshing to see them allocate the excess cash on the balance sheet to me and my fellow shareholders.
I still think that WJA is worth (at minimum) $20/share. The fair value didn’t change, but I have more confidence in my previous assumptions. I think WJA around $11.25 is worth buying.
The author is long WJA at time of writing.