Re: Norwegian apre Malpensa-Los Angeles
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Investors fret over Norwegian Air’s rapid growth
Low-cost airline wants to crack long haul but debt has ballooned to buy planes
By the end of 2017 Norwegian will have 145 aircraft operating on 512 routes
Tanya Powley in London and Richard Milne in Oslo
DECEMBER 8, 2017 15
Earlier this year, budget airline Norwegian Air Shuttle painted the face of Freddie Laker, the late pioneer of “no-frills” flying, on one of its planes as a signal of its ambitions to crack the low-cost long-haul transatlantic market.
The fast-growing group has become a disruptive force within the European airline industry over the past few years, leading the charge in bringing down the cost of long-haul flying and forcing rivals to respond with their own budget services.
But analysts and investors are starting to worry about Norwegian’s rapid expansion, after a difficult year.
“They are not profitable this year in what is a very good year for the airline industry,” says Andrew Lobbenberg, an aviation analyst at HSBC. “The underlying business is losing considerable sums of money. This is not sustainable, something has to change.”
Norwegian’s desire to lead the market in low-cost transatlantic flights has led to turbo-charged growth over the past five years.
In 2012 it was relatively small in Europe, with 68 aircraft flying 330 routes. But that changed after it placed a mammoth order the same year for more than 200 planes and laid out plans to bring no-frills flying to long haul.
By the end of 2017 Norwegian will have 145 aircraft operating on 512 routes. This year alone it is adding 32 planes to its fleet. By the end of 2019, the total fleet will have increased to 193 — a long way from its humble beginnings in 1993 when it operated just three Fokker 50 aircraft on four domestic routes in Norway.
The speed of its expansion is putting pressure on costs. Analysts point to a poor summer, with Norwegian reporting a 6 per cent rise in unit costs for the third quarter. That followed a dismal second-quarter cost performance, with an operating loss of NKr863m ($104m).
Worries over Norwegian’s numbers have also hit its share price: it has dropped 40 per cent in the year. At the same time EasyJet shares have risen 44 per cent, Ryanair 19 per cent and IAG, which also offers long-haul flights, 42 per cent.
“[Norwegian Air’s] unit cost has been creeping up. For a low-cost airline that’s not really ideal,” says Jonathan Wober, analyst at CAPA — Centre for Aviation.
According to Bloomberg consensus forecasts, the combination of falling unit revenue and increasing unit costs will result in an operating loss this year of NKr1.482bn.
Hans-Marius Lee Ludvigsen, an analyst at Kepler Cheuvreux, says Norwegian’s 2017 performance has been worse than expected, “particularly considering the rather profitable times among other European names in a year with low oil prices, low funding costs”. He adds: “This should have been a year for an airline to make money, really.”
Even in 2016, when Norwegian made an operating profit, its operating margin was 4.8 per cent — 16th of 28 listed European airline groups. This year, margin is forecast to fall to minus 4 per cent.
“If Norwegian is not able to improve its operating margins going forward, if there’s a negative demand shock in the industry then there’s huge downside risks for them,” says Mr Ludvigsen.
Leif Eriksrod, head of Norwegian equities at Alfred Berg, a top 20 investor in Norwegian, said it had been reducing its stake in the airline over the past year — from about 600,000 shares at the beginning of 2017 to about 230,000 today because of concern over its performance. “The strategy is good but the execution is not. They need to focus more on operations,” he says.
For many analysts, Norwegian’s problems come down to its glut of planes.
“They are growing too fast and they can’t execute it,” says Mr Lobbenberg. “They are currently doing whatever they can do to absorb the planes. They’ve started leasing some to Hong Kong Express, selling older aircraft, setting up an Argentine airline. It’s very much the tail wagging the dog in terms of the strategy, or more simply the entire strategy of the airline ends up being dictated by the fact they need to digest the aircraft order.”
Mr Wober agrees that while Norwegian’s starting principle — that there are a lot of underserved and overpriced long-haul markets — is true, the airline’s execution has yet to be “fully convincing”.
The rapid fleet expansion has caused a big increase in net debt — from almost NKr3.8bn in 2012 to NKr21.1bn in 2016. Mr Wober points to concerns over the balance street “getting more and more stressed”.
In September Michael O’Leary, Ryanair’s chief executive, said both Monarch, the UK’s fifth-biggest airline, and Norwegian were running out of cash and perhaps would not survive the winter. A month later, Monarch collapsed after it failed to find a buyer for some of its assets.
One of Norway’s most senior bankers says: “Norwegian are in trouble. They are over-extended and it’s clear that they have to do something.
“The danger with their business model is that their margins are pretty thin so they can’t afford too big problems.”
Norwegian could solve its problems by selling all the aircraft it owns, he says, but “they don’t want to do this as they believe there’s a lot of value locked up there”.
Instead, he expects a series of smaller measures including increased leasing of planes and perhaps a capital raising. “They have to do something,” he adds.
Norwegian has defended its recent performance, stressing that it is “building for the future”.
Tore Ostby, Norwegian’s acting chief financial officer, notes that while its capacity growth will peak in 2018, it will then come down to more “sustainable” levels. “As we reach critical mass in long haul, I think we will prove to the market we have quite a strong set-up and the necessary scale to yield good returns,” he told the Financial Times.
Mr Ostby says Norwegian has a “number of things” it can do if it needs to strengthen its balance sheet, including selling additional older aircraft or further reducing the 17.5 per cent stake it owns in a Norwegian bank — both of which have helped the airline raise money this year.
Some analysts agree that fears are overblown and Norwegian is unlikely to succumb to a Monarch-like collapse.
“I would say their current scenario from a financial perspective is dangerous but not life threatening,” says Ross Harvey, analyst at Davy Stockbrokers. “The reason it is not life threatening is because they still own a large amount of aircraft in their fleet. With that equity, they still can perform a large number of sale and leaseback transactions.”
Jomar Kilnes, a portfolio manager at Forte Fondsforvaltning, a Norwegian shareholder, says the airline needs to reduce costs. “We do think they will succeed eventually. It’s been a bit of a rollercoaster but, in the long run, we think they’ll come true and it will pay off.”
However, analysts also agree that Norwegian will need to do something to improve its profitability if it is to make low-cost long-haul flights a sustainable business.
Established carriers rush to compete
After 50 years of failed attempts to make the low-budget transatlantic flight business work, the market finally seems to have taken off.
Since 2013, Norwegian has used Boeing 787 Dreamliners for services between Europe and the US. Canada’s WestJet and Iceland’s WOW Air have also entered the market.
Established carriers have rushed to protect their large market share in response.
In June International Airlines Group, owner of British Airways, launched Level, a low-cost service that flies from Barcelona to four destinations, including Los Angeles. Last month it disclosed plans to expand to Paris Orly airport.
Meanwhile, Air France-KLM last week launched Joon for lower-cost long-haul flights, while Lufthansa continues to expand its “no frills” subsidiary Eurowings.
While Norwegian and its peers have proved there is demand for cheap transatlantic flights, there continues to be concern about whether this business can be profitable in the long term.
For Norwegian, the use of new narrow-body aircraft could make a big difference.
New technology means the next-generation narrow-bodies will be able to fly six to eight-hour routes at a lower cost than even the most fuel-efficient wide-bodies.
As well as the narrow-body Boeing 737 Max 8, which it started using this summer, Norwegian is planning to use a new long-range version of Airbus’s A321 to offer services between regional European airports and smaller US hubs.
But some remain sceptical. John Strickland, aviation consultant, noted that some of the new routes from regional European cities were likely to experience “significant seasonality with weakness in winter”, which he said could be a problem for profitability.
It is clear, however, that airline groups are now focused on expanding this part of their business. Willie Walsh, chief executive of IAG, has signalled plans for Level’s fleet to rise to 30 by 2022, and expects the unit to be profitable this year.
https://www.ft.com/content/a013d226-daa8-11e7-a039-c64b1c09b482?sharetype=share