Analysis: Norwegian pays price of aggressive expansion | Analysis | Airfinance Journal

Analysis: Norwegian pays price of aggressive expansion

Norwegian is clearly disrupting the long-haul market, where its introduction of transatlantic services has prompted other airlines to launch their own low-cost, long-haul operations.

But the Scandinavian carrier’s unit costs have surged as it struggles to maintain cost discipline across a rapidly expanding fleet.

Norwegian Air reported its second-quarter results late last month and the headline figure appears encouraging: Net profit jumped 45% from the same period last year, to NOK 1.08 billion ($131 million), while operating revenue increased 17% to NOK 7.77 billion.

However, EBITDAR earnings for the period were NOK 1.19 billion, 21% lower than in the second quarter of 2016.

Even worse, Norwegian’s first-half EBITDAR totalled NOK 382 million, a huge drop from NOK 2.02 billion a year ago. As a result EBITDAR margin was 2.9%, compared with 17.5% a year ago.

Operating expenses, meanwhile, jumped 45% to NOK 6.78 billion as the low-cost carrier expanded rapidly.

Fuel was the biggest expense at NOK 1.74 billion, a 38% rise on last year, as jet fuel prices increased by 15% in the quarter.

Labour cost of NOK 1.26 billion was up 34% as staff numbers rose to handle increased flying. Maintenance expenses rose by 56% to NOK 647 million due to the airline’s bigger fleet.

Norwegian flew 8.62 million passengers in the quarter, up from 7.72 million in last year’s corresponding quarter. RPK (revenue passenger kilometre) traffic rose 19%, as did the airline’s ASK (available seat kilometre) capacity.

Results for the first half to the end June were less positive as the first quarter’s NOK 1.5 billion loss outweighed second-quarter profit. Interim net loss amounted to NOK 412 million, compared with a NOK 54.7 million loss in the first half of 2016.

Norwegian added four leased Boeing 787s and 19 leased 737-800s to its fleet over the 12 months to 30 June. At the end of June it also received its first two 737 Max aircraft, which took its fleet total to 133.

Norwegian is aggressively investing in transatlantic services. The carrier will increase long-haul capacity by 60% this year and growth will double next year, according to broker firm Davy.

“Not for the first time, the main takeaway from Norwegian’s quarterly results is a negative ex-fuel cost surprise - this time down to additional leasing/maintenance and personnel costs,” writes the firm.

“While Norwegian’s rates of growth make the scaling process difficult, the continuing scope for negative cost surprises is a concern for investors and will limit the stock’s multiple potential.”

According to its latest forecast, Norwegian expects a 25% growth in ASKs in the third quarter and a 30% growth in the final quarter of this year.

Unit revenues down, unit costs up

Norwegian says unit revenue was NOK 0.32 for the first half while unit cost reached NOK 0.44. A year ago unit revenue was NOK 0.36 for the first half while unit cost was NOK 0.41.

Norwegian says second-quarter unit cost excluding fuel rose 7% year-on-year, while it was up 9% with fuel. Staffing cost climbed 12% due to the ramp up of international operations.

Norwegian has now reached its highest second-quarter cost per available seat kilometre (CASK) since the second quarter of 2010.

More expensive fuel, a 16% increase per ASK, was driven by spot prices and a weaker Norwegian crown against the US dollar, says the carrier.

Leasing cost, up 22% per ASK, was due to a higher proportion of leased and wetleased aircraft, says the Scandinavian carrier.

The carrier was also hit by a higher technical cost (31% increase per ASK) due to price escalation on engine maintenance, a higher proportion of leased aircraft and ground damages.

Cost guidance for 2017 is now at NOK 0.42 per ASK versus the airline’s previous guidance of NOK 0.39-0.4.

Norwegian’s mounting costs weigh on cash flows and therefore its debt-encumbered balance sheet.

Shareholder equity represented only 8.7% of its total liabilities at the end of the second quarter. At the end of 2016 it represented 12% of its total liabilities.

Equity at the end of the second quarter was NOK 3.54 billion compared with NOK 4.05 billion at the end of last year. Equity decreased mainly due to net losses in the period of NOK 412 million and exchange rate losses from subsidiaries of NOK 105 million.

There are also questions about the departure of chief financial officer Frode Foss, who has been at Norwegian since October 2002. His successor will have a difficult task to keep costs under control while continuing Norwegian’s growth strategy.

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