Norwegian Sees Income Improvement, But The Balance Sheet Problem Looms
I realize that’s a headline only an accountant can love, but, well, it’s a nice summary of the issue at hand. A change in strategy has been great for Norwegian, but it took the airline far too long to realize the rapid growth under founder and previous CEO Bjørn Kjos was doomed to fail. Third quarter results are in, and they aren’t bad now that the strategy has changed. They aren’t exactly great either, however. That’s probably the nicest thing I’ve said about Norwegian’s finances in a long time.
The July-September quarter in Europe is the peak of the peak, and it better be a good quarter or else. This year, it was decent for Norwegian. If airlines like Ryanair and Wizz didn’t exist with their stratospheric profit margins, Norwegian might look better.
Pre-tax earnings were NOK 2.2 billion (~$240 million) on revenue of NOK 14.4 billion (~$1.6 billion). But there were “other gains” of NOK 249.9 million (~$27 million) which I removed. That gives the airline a third quarter margin of 13.6 percent. This may sound good, but when put into perspective versus previous years, it’s only the third best in the last five years.
The indicators are all pointing in the right direction. Year-over-year yield was up 3 percent with load factor rising 0.7 points to 91.2 percent. That led to a unit revenue increase of 3 percent despite the 3 percent increase in average sector length. (An increase in that usually brings unit revenue down.) This isn’t as strong of a gain as we saw in the second quarter year-over-year, but this is still good to see.
How did Norwegian make this happen? It’s simple. The airline implemented its new strategy to try to make a profit and stopped growing. Capacity was up only 3 percent year-over-year. With the exception of 2015 when Norwegian took a breath, this is the most rational growth we’ve seen by this airline. And this is the kind of thing that helps improve revenues.
Ok, so it’s not really THAT simple. Norwegian faced strong headwinds in its home market where demand has dropped. In fact, in the third quarter, the US surpassed Norway as the number one source of revenue for the company. Take a look at this chart. You can see the biggest drops in revenue percentage came from Nordic countries (can you say “flight-shaming”?) along with the UK.
It also had a unit revenue tailwind here in that it has 18 737 MAX aircraft on the ground with more deliveries being delayed. That’s one reason beyond even the new strategy that growth was so anemic. This only helps push up fares, though according to Norwegian it’s a net negative. The airline says for the full year, it will take a NOK 1 billion (~$109 million) hit to profits because of the grounding.
On the cost side, the news was also quite good. Excluding fuel, unit costs dropped a whopping 6 percent. Most staggering is an incredible reduction of 30 percent in maintenance costs over last year. When I see a number like that, I naturally assume that it’s due to maintenance timing or some other fluke, but Norwegian says it was due to “cost reductions related to renegotiated contracts.” That is some serious negotiation.
So what does all this mean? Is Norwegian in great shape now? No, of course not. Year-to-date, Norwegian is still in negative territory. Its pre-tax margin excluding other gains is -2.1 percent. And the fourth quarter isn’t great for anyone in Europe.
The airline spent so many years burning furniture to stay afloat that its balance sheet is weak. European leisure airline life is like that of a bear. They need to get fat and happy during the summer so they can survive through the winter. This result isn’t good enough to make that happen without help. And with each year that passes, it gets tougher and tougher to survive.
That’s why Norwegian had to beg its bondholders to restructure this year. The airline had $380 million in bonds coming due, and it asked bondholders to defer for two years so it could save cash. In exchange, it would pay a premium on the bond, and it would pledge its London/Gatwick slots as collateral. The deal is done, but it means Norwegian now has one less thing it can burn next time it needs help. Its debt costs also got became more expensive.
At this point, it’s really a race against time. There is a sustainable business somewhere at Norwegian, but it is burdened by years of bad strategy decisions. Will the airline be able to make it before it runs out of cash during a dark and dreary winter? This is annual game that we’ll continue to play for the foreseeable future.
