Throttling Back: Norwegian Changes Course

Norwegian Air Shuttle has expanded rapidly in the last few years to become Europe's largest low-cost airline and a transatlantic carrier, but it has increasingly over-extended its balance sheet to do so.

This week the airline announced a fully underwritten NOK 3bn(£268m) rights issue, equivalent to just over half of the airline's equity value, a sizeable sum and an admission of the cash-strapped airline's predicament. This comes on top of news of a preliminary operating loss for last year of over £300m, and confirmation that British Airways’ owner International Airlines Group (AIG) has decided not to proceed with a takeover bid and that it wants to sell its 4% stake.

Norwegian's shares have dropped by about 60% since last April as investors have become increasingly concerned about the company's cash flow.

From its early days as a small Scandinavian airline in the early 1990s, Norwegian has expanded aggressively to become Europe's third-largest no-frills carrier.  In 2012, it announced the largest orders of aircraft in European history and its plans to expand into transatlantic flights. It is perhaps these that have contributed most to its losses.

On flights across the North Sea, Norwegian has destroyed the cozy, pricey duopoly previously enjoyed by Scandinavian and British Airways. All its European flights offer free wi-fi and its fleet is young. I have to declare an interest - as a frequent passenger on this route, I for one would be sorry to see Norwegian go. But the chances of this appear to be becoming more likely. 

Last year, Norwegian launched 35 new routes, primarily between Europe and the U.S., and took delivery of 25 new aircraft, taking the total fleet to around 160 and carrying over 37m passengers. It has the youngest and most fuel-efficient aircraft of any long-haul carrier. 

Now Norwegian has said that it will alter its business strategy, moving its focus away from growth to profitability. CEO Bjørn Kjos, a former fighter pilot, said: 

Norwegian has been through a period with significant growth. Focus going forward will increasingly be on cost savings and CAPEX reductions. We will now get in place a strengthened balance sheet that supports the further development of the company.

The company intends to divest aircraft and postpone deliveries of new aircraft and focus on optimizing its route network (i.e. stopping less efficient services) and cutting costs. It believes that it can save 2m in 2019 with these measures, helped by compensation from Rolls Royce for more frequent safety inspections last year on the engines on its Boeing 787 Dreamliner engines. "With the strengthened balance sheet, the organization can now devote all its attention to further development of the company,” says Kjos.

This is a radical about-turn, given that the airline was still expanding last year, despite the increasing pressure on the balance sheet.  Last year Norwegian began operating a London-Buenos Aries route and connecting flights within Argentina.  At the time of writing, the lowest two-week return from London-Buenos Aries, leaving from March 1, is £482.50, compared with £1170 on British Airways, the main difference in price being the outward-bound flight.

However, Norwegian lacks the lucrative business and first-class passengers that make up the profits on other transatlantic carriers, although reviews of its 787 premium economy service, with 46-inch leg-room, compare favorably with other airlines'.  

It is hard to see how Norwegian can make money at these prices, even allowing for the fuel-efficiency of the Boeing 787s it uses to Buenos Aries and on many of its transatlantic flights. 

Meanwhile, in Europe, competitive pressures are intense for low-cost airlines:  Ryanair recently issued a profit warning while Hungarian airline Wizz Air's profits have dropped by nearly 90%.

For existing investors, the hope is that another airline, perhaps Lufthansa, will launch a takeover bid. In the absence of a takeover, the rights issue and scaling back are the only sensible option. Whether it will be enough is not yet clear.

Ryanair's Michael O'Leary has made no secret of his view that Norwegian will go bust in the near future, as my colleague Michael Goldstein reports, and he's not alone in thinking that. The worrying question is why Norwegian took so long to address its cash-flow problems.