I may not cover earnings reports all that often here, but when one comes out that’s as bad as Norwegian’s, I take notice. Norwegian spent 2017 floundering as it has done for years, but 2017 was so bad that it actually lost money for the full year. Airlines that lose money in good times like these should be very concerned about the future.
How bad was 2017? Well, the airline lost nearly 300 million NOK (just over $38 million) which gave it a negative 1 percent net margin. Norwegian’s business is highly seasonal (as is the case in Europe in general), but its fourth quarter net margin of nearly negative 12 percent was particularly terrible. Last year, for comparison, Norwegian actually made money in the fourth quarter and for the full year. Those results weren’t great, but the results from this year are just… bad.
At least Norwegian isn’t pretending that this is an ok outcome. Here’s the quote the airline is floating around from its CEO:
We are not at all satisfied with the 2017 results. However, the year was also characterized by global expansion driven by new routes, high load factors and continued fleet renewal. Through our global strategy, we contribute to local economic boost and increased employment at our destinations, as well as ensuring that more people can afford to fly – not least between the continents. In 2017, we received several major international customer awards, which would never have been possible without our dedicated colleagues at Norwegian.
Talk about blowing smoke. This year, as in every year, was indeed characterized by a “global expansion” but that’s only a good excuse if there’s a real end-game here. Saying that Norwegian contributes to local economies through increased employment and lower fares is only a good thing if it’s sustainable. It’s increasingly difficult to see how that’s the case.
It’s true that 2017 was another insane year for expansion. Available seat kilometers (ASKs) increased by 25 percent on the year. Some of that is due to a lot more seats on a lot more flights while the rest is due to flights being longer with all this intercontinental expansion. For 2018, things aren’t going to get any better with a predicted increase in ASKs of 40 percent. Let me say that again… 40 PERCENT.
Norwegian says that it’s in a better place in 2018 despite that number. How so? Well, it says bookings are stronger and labor issues have been resolved. But I’m still having trouble seeing a way out of this predicament. Here’s the chart from 2017 that sums things up.
As you can see, unit revenues dropped in 2017 while unit costs went up. And these aren’t just any unit costs; these are unit costs without fuel. If you include the increasing price of fuel, things look even worse. What’s most important to remember here, however, is that the average flight distance increased by 9 percent. When that increases, you expect the unit revenue and cost metrics to go down. Unit revenues obliged but costs did not.
So, what’s the way out of this? Well, it’s pretty obvious. You either increase your revenues or you decrease your costs. Simple, I know, but actually making that happen is a different story.
On the cost side, well, Norwegian says unit costs excluding fuel will magically drop next year by about 10 percent. (You have to do a little math on slide 26 to get there, but that’s roughly where the airline expects to end up.) I have yet to see any justification for how Norwegian is going to get to that number, though undoubtedly part of the plan is to rely on a further increase in the length of haul. That, of course, impacts unit revenue in the wrong direction as well.
On the revenue side, Norwegian is apparently looking toward the business traveler to boost revenue. That’s a time-honored tradition with low-cost carriers. When easy expansion dries up, airlines start moving upmarket to try to pick off those higher-dollar business travelers. Ryanair has done it, and so has easyJet, but they do it from a position of strength. They’re already making money and moving upmarket to keep fueling profitable expansion. Norwegian, not so much.
To improve its fortunes in this world, Norwegian is actually going to decrease aircraft density by adding more premium cabin seats on its 787s, especially out of London. It’s also going to throw in lounge access for premium cabin travelers, and it’s going to include free wifi. Additionally, Norwegian will beef up frequencies in many markets to appeal to the business traveler. This might (I repeat, MIGHT) make sense for an airline that’s already doing well and wants to try new things, but that’s not what we have here.
This all sounds nice, but there is a much better way to improve revenues. Norwegian could stop growing by 40 percent. The airline admits it can pull back if it wants, but I’m not so sure that’s true. See, Norwegian has found itself in a pretty nasty little cycle. Its cash balance increased in 2017, and that sounds odd for an airline that lost money. But you can see where the cash came from – airplanes. It has sold and leased back some airplanes while redelivering older airplanes elsewhere to increase its coffers. It’s able to finance those new airplanes since others will want them even if Norwegian goes under.
That means to keep raising cash, Norwegian has to keep growing. That’s going to continue to put pressure on revenues, and it’s going to make it harder for Norwegian to turn profitable. At the same time, liabilities will continue to grow and some day, it’ll have to repay them. Unless this business passenger-strategy magically turns into hugely-increased revenues, this seems like a problematic long term strategy.
In the meantime, Norwegian continues to tinker. It is moving full speed ahead on its Argentinian operation. That’s a market that has a lot of competitors coming out of the woodwork to take advantage of newly-liberalized rules. It’s hard to see how this is going to truly help the airline.
Some may say “just wait until the next downturn. People will start flying Norwegian more when they don’t want to pay big airline prices.” But that’s just silly. In a downturn, the big airlines will match Norwegian to prevent traffic from fleeing. (The big airlines already do match in many instances.) And Norwegian doesn’t have the kind of frequency needed to really be able to pull significant share away. (Chasing that by adding even more frequency will just make things worse.)
Norwegian is a machine that just keeps on growing for now, but at some point, the airline itself has to become a highly-profitable operation so it can start paying down those increasing liabilities. That doesn’t seem to be in the cards anytime soon.
