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Norwegian Air Shuttle: Asia's longhaul LCC model comes to the N Atlantic (but watch falling profits)

29-Oct-2013

Norwegian Air Shuttle reported a fall in 3Q2013 net profit, affected by Boeing 787 disruptions and weaker demand as a result of the good northern European summer weather. Nevertheless, Norwegian continues to build for the future and announced its first UK-US trans-Atlantic routes on 17-Oct-2013.

In Jul-2014, Norwegian will launch three long-haul routes from London Gatwick to Los Angeles, New York and Fort Lauderdale, in addition to the trans-Atlantic routes operated from its Scandinavian bases. The airline is already using 787-8s on its Bangkok service.

This will be the first modern attempt to introduce the successful Asian long-haul LCC model to the North Atlantic from the UK, a concept that Ryanair's Michael O'Leary has often floated in the past. Earlier this month Qantas subsidiary Jetstar took delivery of the first of a fleet of 787-8s that it will be using on long-haul routes in Asia. SIA subsidiary Scoot will receive 787-8/9s from late 2014 and AirAsia X will use A350-900s from 2018.

Norwegian's 3Q2013 profits fall

Norwegian Air Shuttle reported a 31% year on year drop in net profit for 3Q2013 to NOK436 million (EUR53.65 million). The result was adversely affected by wet-lease costs for replacement long-haul aircraft following Boeing 787 problems and low summer bookings as a result of unusually warm weather. In spite of the weaker third quarter, the cumulative result for the first nine months of 2013 was 19% above last year, at NOK516 million (EUR63.49 million).

Norwegian Air Shuttle financial highlights 3Q2013

Strong capacity growth continues, but load factor slips and RASK falls

Norwegian’s rapid capacity growth continued, with 3Q2013 ASKs up by 31%. Load factor fell by 1ppt to 81%, while the nine month load factor figure was stable at 79%. This is still a solid load factor, especially given the relentless pace of capacity growth, but it is lower than the Association of European Airlines' (AEA) nine month figure of around 81%. Moreover, Norwegian’s load factor has been on something of a downward trend in recent years: it was more than 84% in 3Q2011 and over 85% in 3Q2007.

Norwegian Air Shuttle traffic and operating data 3Q2013

Passenger numbers increased by 16% year on year in 3Q2013 and average sector length grew by 11%. The high rate of capacity growth appears to have weighed on unit revenue, which fell 13% in the quarter, an acceleration of the 3% decline seen in 1H2013. This is partly due to longer average sector length, although this grew at a similar rate in 1H2013.

The weakness in RASK also reflects increased competition in Norwegian’s leisure markets and the warm summer weather, which affected late bookings.

Norwegian Air Shuttle ASK (million) and passenger load factor (%) 3Q2004 to 3Q2013

Norwegian Air Shuttle share of available seats sold on typical leisure routes from the Nordics*

International traffic drives revenue growth and market share gains

Total revenues were up by 15% in the third quarter, driven by 21% growth in international traffic revenues. International traffic has been the main revenue driver for some years.

Norwegian Air Shuttle revenues (NOK million) 3Q2010 to 3Q2013

Norwegian again grew passenger numbers and market share at all of its main bases in 3Q2013. At its home base of Oslo, it recovered its previous 3Q peak market share of 39%, which it had last reached in 3Q2010. At Stockholm, Copenhagen, Helsinki, London Gatwick and in Spain (Malaga, Palma and Alicante), its share continues to grow consistently.

At its new Gatwick base, Norwegian accounted for 90% of the year on year growth in the total marker in the quarter and it now has a market share of 6% of passengers.

Norwegian Air Shuttle development of passenger numbers and market shares in selected markets 3Q2008-3Q2013

Norwegian’s three new London-US routes: long-haul low-cost arrives on the North Atlantic

On 17-Oct-2013, Norwegian announced three new trans-Atlantic routes from London Gatwick: to Los Angeles, New York and Fort Lauderdale, to be launched in Jul-2014. These will not be Norwegian’s first trans-Atlantic routes, but will be its first long-haul routes not to involve one of its Scandinavian bases. Like its existing long-haul routes, they will be operated with Boeing 787-8 equipment.

It operates its Dreamliner aircraft with a total of 291 seats, including 259 in economy and 32 in premium economy.

Norwegian Air Shuttle new North Atlantic routes from London Gatwick for summer 2014

Route

Launch date

Weekly freq

Gatwick-Los Angeles

02-Jul-14

2x

Gatwick-New York JFK

03-Jul-14

3x

Gatwick-Fort Lauderdale

04-Jul-14

2x

London Gatwick is already a base for Norwegian and it currently offers 25 European destinations from the airport (source; Innovata, week of 28-Oct-2013). In addition to the three new US routes, it will add five more European destinations in summer 2014 (Santorini, Corfu, Catania, Cyprus and Budapest) and increase frequencies to nine existing destinations.

Feed at Gatwick will be a key factor for success

London is the largest O&D market from Europe to the US and Norwegian may tap into latent demand there for low fares across the Atlantic. Nevertheless, long-haul operations tend to require at least some feeder traffic from elsewhere to supplement local demand. This has been an issue in the past for long-haul LCCs from Asia, even when operating into London.

Norwegian’s growing Gatwick network should help to feed its long-haul routes from its London base, where it can also benefit from the substantial short-haul networks of easyJet and British Airways (respectively the number one and number two at Gatwick). Nearly 70% of all seats operated into Gatwick are on LCCs, according to Innovata.

AirAsia X initially used Stansted for its Kuala Lumpur-London A340 service and then later moved to Gatwick. Both airports have an array of good connections possible on LCCs and AirAsia X saw significant self-connection traffic (it was high fuel prices and the aircraft type which made the route unviable).

As Norwegian CEO Bjorn Kjos says: “We have a lot of feeder flights in and out of Gatwick. Gatwick probably has the biggest network in all of Europe if you take account of all of the routes flown by easyJet and Ryanair....it is an ideal base.” The airport's CEO Stewart Wingate considers the operation a “significant game-changer". Thomson too will be operating 787s from Gatwick starting from 1-Nov-2013, so Mr Wingate has cause for optimism on that score.

Norwegian Air Shuttle routes from/to London Gatwick

Over time optimising the potential of Gatwick as a hub will require some considered tweaking of procedures. Certainly, the experience of long-haul LCCs in Asia, such as Scoot and Air Asia X, is that properly structured connections are preferable to relying on passengers self-connecting - even though a very large proportion does.

More importantly, Norwegian may lack feed at the other end of these routes. It has been reported that JetBlue may consider an interline or codeshare arrangement with Norwegian. According to JetBlue spokesperson Anders Lindstrom (TheStreet.com, 11-Oct-2013), “Norwegian is a strong and popular brand among customers with a great product, which would make them a natural fit as a partner for JetBlue.”

A partnership with JetBlue could be beneficial to Norwegian, as well as the US LCC. JetBlue already has bases at two of the three initial Norwegian US destinations from Gatwick, New York JFK and Fort Lauderdale. It also has a base at Orlando (where it will operate from Oslo in Summer 2014) and an operates from Oakland (Oslo and Stockholm).

Fort Lauderdale and Orlando would be used by Norwegian mainly for connections to the Caribbean and Latin America while New York is JetBlue's largest hub with a vast array of domestic and some international connections. Connections at Oakland would be limited to Long Beach, JetBlue's only west coast destination from Oakland and its west coast base. JetBlue also serves Los Angeles but only from the east coast, leaving no feasible connections for Norwegian. But Los Angeles is a large enough destination market to support service from the UK and Scandinavia, with connections on the European end.

Long-haul network of 14 routes, biased towards the US, in summer 2014

The new US routes will bring Norwegian's total long-haul network to 14 routes: six from Oslo, three from Copenhagen, two from Stockholm and three from London Gatwick. The bulk of its long-haul network, 12 routes, will be to the US, with just two to Asia (Oslo and Stockholm to Bangkok). It will have 15 weekly round trips from New York alone from the summer of 2014.

The long-haul network is still relatively small compared with a total of 382 routes across its entire network, but Norwegian plans significant growth. According to Norwegian’s projections, long-haul should grow to account for 4% of departures, 8% of passenger and 46% of ASKs in 2015, when the long-haul fleet will rise to eight aircraft.

Norwegian Air Shuttle long-haul network summer 2014

Norwegian's low share of the UK-US market means market power is limited

Norwegian’s planned London-US operation is not large compared with the activities of existing competitors. On London to Fort Lauderdale, there are no other competitors at present, according to Innovata, although British Airways, American Airlines and Virgin Atlantic all operate to Miami (only 23 miles away). Norwegian’s planned 582 weekly seats to Fort Lauderdale in Jul-2014 compares with BA’s 4,396, AA’s 3,584 and Virgin’s 2,634 weekly seats flown in Jul-2013 (week of 1-Jul-2013, source: Innovata).

On its other two new US routes, Norwegian would have a share of seats of 3% (London to Los Angeles) and 2% (London to New York), assuming that the existing competitors’ capacity were to remain the same in Jul-2012 as in Jul-2013. Putting it in the wider context of the overall UK-US market, Norwegian’s planned capacity will be less than 1% of this market.

Moreover, Heathrow’s importance in this market has grown substantially, accounting for more than 80% of US-UK passengers in 2012, from around 60% in 2007. Schedules and connections at Heathrow are much better attuned to trans-Atlantic operations. That said, Heathrow is full and Gatwick, via Norwegian, could well attract additional demand for trans-Atlantic air travel.

Norwegian Air Shuttle weekly seat capacity on new North Atlantic routes from London versus competitor capacity

London to:

Norwegian

BA

Virgin

AA

United

Delta

Air New Zealand

Competitor airport pair

Los Angeles

582

6,594

4,424

2,170

1,904

 -

2,324

LHR to LAX

New York JFK

873

18,710*

14,742*

7,668

6,692**

4,984

 -

LHR to JFK, except where indicated

Fort Lauderdale

582

-

-

-

-

-

-

-

Share of weekly seat capacity on Norwegian’s new North Atlantic routes from London

London to:

Norwegian

BA

Virgin

AA

United

Delta

Air New Zealand

Los Angeles

3%

37%

25%

12%

11%

0%

13%

New York JFK

2%

35%

27%

14%

12%

9%

0%

Fort Lauderdale

100%

 -

 -

 -

 -

 -

 -

Price will be Norwegian’s USP

Clearly, Norwegian will not be selling its London to US network on the strength of its schedule, nor on the breadth of its network and partnerships, but it will be targeting a mainly leisure market on the basis of low fares. This will represent its best hope of competing in a market that is dominated by the global alliances.

So, how low are its fares? Norwegian has announced introductory one way fares of GBP199 to Los Angeles, GBP149 to New York and GBP179 to Fort Lauderdale. In order to compare prices with competitors, we sampled currently available fares from the websites of each of the competitors on London to New York for the week of Norwegian’s planned route launch. While this does not necessarily give a totally robust basis for analysis of their respective pricing strategies, it does provide a useful illustration.

As of 28-Oct-2013, Norwegian's website is offering an economy class fare of GBP543 for a return trip to New York, departing on 3-Jul-2014 and returning on 10-Jul-2014. This compares with competitor prices in a tight range of GBP860 to GBP884 and represents a significant discount offered by Norwegian.

London to New York lowest round trip web fares for travel in Jul-2014 (GBP)*

Norwegian’s premium economy fare (it has no business class fare) is around half that of the competitors’ business class fares. Note that United is currently offering a significantly lower business class fare for this trip than the other competitors – presumably reflecting a short term promotion – but, otherwise the existing competitor fares are very similar to each other and all are well above Norwegian's.

Lower surcharges, taxes and fees too

Not only is Norwegian’s base fare in economy significantly lower than that of the competition (GBP371 versus GBP506 to GBP527), but it also imposes a lower fuel surcharge and charges less in respect of external taxes and fees, according to the breakdown of its fare provided on its website.

Lower airport and handling charges at Gatwick account for some of this, but presumably this means that Norwegian is subsidising the external charges, which are broadly identical for each of the competitors.

London to New York lowest economy round trip web fares for travel in Jul-2014, split by base fare, surcharges and taxes (GBP)*

London to New York lowest business class round trip web fares for travel in Jul-2014, split by base fare, surcharges and taxes (GBP)*

Combined Landing / Terminal Charges with Baggage / Check-in (USD) for LondonGatwickAirport Off Peak, LondonGatwickAirportPeak, LondonHeathrowAirport

Norwegian’s fare will generate around half the revenue per passenger of competitors on LON-NYC

In terms of the proportion of the fare kept by the airline (i.e. excluding external taxes and fees), Norwegian’s pricing of this illustrative trip will generate a bit less than half the revenue per passenger of its competitors.

The competitors’ prices for a round-trip business class fare to New York, net of external charges, are a multiple of around three times or more those of their economy fares. By contrast, Norwegian’s premium economy fare is only 2.6 times its economy fare.

London to New York lowest round trip web fares as percentage of British Airways fare Jul-2014, excluding external taxes and charges (GBP)*

The source of significant cost advantage: a combination of factors

Given that the approach of traditional network carriers is effectively to subsidise economy passengers with highly priced business class fares, this raises questions over Norwegian’s ability to cover its costs with these low fares. The key to long-haul low-cost is to find meaningful sources of cost advantage. Airport charges can provide some differential, but not to the same extent as the use of secondary airports on short-haul intra-European routes.

Labour costs can also make a difference, and Gatwick should be a lower-cost base for Norwegian in this respect than its Scandinavian bases, where wage rates are much higher, but London is not a low wage economy in an absolute sense. The absence of legacy pension costs and a more flexible workforce than those of traditional carriers may allow Norwegian to have lower labour unit costs than British Airways, for example.

However, productivity improvements and lower cabin crew wage rates at BA in recent years reduce the potential advantage in this area. Moreover, Norwegian will reportedly not base its 787 aircraft for these routes at Gatwick, but at the US destinations, although it is not yet clear where its crew will be based. Having aircraft and crew located at different ends of a route could lead to significant crew accommodation costs, although presumably there is method in this strategy.

Aircraft operating costs can also be a source of cost advantage if the most modern, fuel efficient equipment is deployed. Norwegian has this, in the form of the Boeing 787-8, but it is not unique in operating such aircraft. BA already has four in service, United seven (and both have more on order), while both American Airlines and Delta Air Lines have ordered 787s for future delivery.

Costs will be the key to Norwegian's success

Wherever it may come from, a sustainable cost advantage will be key to Norwegian’s success, or otherwise, in operating a low fares strategy on the Atlantic.

Cost per passenger versus average sector length for selected European airlines 2012

Current data on Norwegian’s operating costs are not directly comparable to those of the likes of BA, due to their very different average sector lengths. Nevertheless, a plot of cost per passenger versus average sector length for European LCCs and legacy carriers gives some useful pointers (see chart above).

If its cost per passenger were to grow along the LCC trend line as its average sector length increased, Norwegian's cost per passenger would be well under half that of British Airways, based on 2012 data.

This is by no means a given and would require Norwegian to achieve healthy load factors and efficient operations, but it does suggest it may not be beyond the realms of possibility for it to generate less than half the revenue per passenger of its competitors and still be profitable. That would be a telling advantage.

Over to you Mr O'Leary.....

If Norwegian is profitably successful in its London-US operations, might that tempt other LCCs to enter the trans-Atlantic market?

None has shown real interest in doing so any time soon. Ryanair’s Michael O’Leary has long mooted the idea of setting up a new vehicle to do this, separate from Ryanair, but he has conditioned that on waiting until aircraft prices are low enough to offer a significant ownership cost advantage.

That one of the industry’s greatest cost cutters does not yet see an opportunity to enter the long-haul LCC arena suggests that the concept is yet to be proved. But you can bet that both Mr O'Leary and nearby Stansted Airport, where Ryanair currently accounts for 80% of the 430,000 weekly seats, will be watching very intently. Getting hold of a handful of the tightly held 787s in the short term will be a challenge, even for such a big Boeing customer, and Mr O'Leary could well find himself wishing he had been prepared to take a bit more of a risk.

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