Does Norwegian Q2 earnings slump suggest it maybe growing faster than its means?

Low cost carrier Norwegian saw its shares slip at one stage by almost 15% on July 13, 2017 before recovering to a daily 6.8% decline after the carrier reported a much larger than anticipated slump in earnings. Its second-quarter adjusted operating profit before leasing and depreciation (EBITDAR) dropped 21% to 1.19 billion crowns ($144 million) for the three month period, mainly due to increasing costs facilitating its ambitious growth strategy. Its share price ended the day at 181.0, its lowest level since August 2014 and more than a third (-36.9%) less than its level at the start of the year.

Norwegian says its quarterly performance was mainly influenced by higher oil prices and the air passenger tax implemented by the government in Norway last year, the latter accounting for almost two thirds of a 0.1 percentage point (0.4 percentage points for the half) network yield reduction. It was also impacted by significant leasing costs during the quarter as it continued its significant growth.

CHART – Norwegian Share Price (August 2016 – July 2017)Source: Oslo Børs

Total operating costs rose 45% in the quarter versus the same period last year with fuel costs up 38% (accounting for just under a quarter of total costs), technical maintenance related to fleet growth up 56% and leasing up 45%.

Although the airline has now adjusted its capacity growth, measured in ASKs, to 25% for the full year, down from a planned 30%, it remains upbeat for the second half of the year thanks to strong bookings. These are running ahead of the same period last year with 90% of capacity sold for July and upwards of 65% for August. “Bookings and pre-sales for the coming months are looking very good,” confirms Bjørn Kjos, chief executive officer, Norwegian.

CHART – Norwegian Growing Q2 Capacity OfferingSource: Norwegian

Speaking to investors, the airline’s acting chief financial officer, Tore Østby, says its capacity reduction will be partly facilitated by reduced Dreamliner flying due to engine maintenance and a reduction on short-haul flying in of the UK outside of London Gatwick during the winter. Mr Østby took up the position earlier this month following the abrupt resignation of Frode Foss, who had held the position since Norwegian’s formation as a LCC.

Norwegian has grown rapidly expanding international traffic and adding new bases, destinations and markets to its portfolio. The airline has now carried more than 200 million passengers since its transformation from a regional to full-scale budget operator in 2002.

This year it is adding 32 jets to its fleet, adding over 6,500 additional seats and growing to 144 aircraft after including the return of four older Boeing 737-800s. This includes the first of its new 737MAX-8s which will shortly be deployed on scheduled long-haul routes between Europe and the United States of America. It received its first two aircraft late last month and is due to add four more before the end of the year with 12 more due in 2018, 16 in 2019, 24 in 2020, 28 in 2021and 24 in 2022, growing to a fleet of 110 aircraft.

CHART – Norwegian Long Haul Low Cost Network Map (2017)Source: Norwegian

For its long haul low cost flying Norwegian still plans to have 21 787s by the end of 2017 to support a planned network of 55 transcontinental routes. But, it says in the future it “may decide to adjust capacity in order to optimise the route portfolio depending on the development in the overall economy and in the marketplace”. It is also receiving three Airbus A320neos this year which will all be placed with Asian LCC HK Express.

Analysis by The Blue Swan Daily of OAG data on Norwegian’s flight schedules shows that its summer schedule network capacity has grown more than five-fold in the past ten years, with annual capacity growth rates of between 12% and 15% in four of the past five years. This year it will be offering a record 25 million seats with a 12.8% year-on-year season growth, matching a similar 12.2% rise in 2016.

CHART – Norwegian Summer Network Capacity by AOC Holder (2007 – 2017)Source: The Blue Swan Daily and OAG Schedules Analyser

Noticeably flying on its traditional Norwegian AOC has declined for the first time this year, while the capacity flying under its Irish AOC has grown by more than two-thirds. The launch of its new London Gatwick – Singapore route in September 2017 will be the first to be flown on its UK AOC.

While Norway remains the airline’s largest country market (accounting for 31.8% of its summer 2017 departure seats), it is the slowest expanding of the top ten country markets being served this summer. The long haul focus on the United States of America is seeing this market grow by two-thirds (+67.9%) and now rank as the seventh largest in the Norwegian network. With both short and long haul growth out of Spain, Norwegian capacity there is growing by more than a third (+39.1%) rising to its second largest country market, while double-digit year-on-year growth is also been seen in Sweden (+15.2%), Finland (+14.3%), France (+20.8%), Germany (+17.0%) and Italy (+14.9%).

Many analysts will continue to question how sustainable Norwegian’s expanding global operation will be, especially the short-term profitably of its long haul operations given its significant financial outlay on acquiring new aircraft. The airline’s recent short and long haul growth has been spread around European cities and will reduce the exposure to individual markets, while proposed expansion into the likes or Argentina and other growing international markets will certainly support its development as it starts to build a global network that in the future could be offering feed at both ends of routes.

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