01-May-2015 1:42 PM

Norwegian Air Shuttle narrows its 1Q2015 loss thanks to lower fuel, but it's still a heavy loss

Analysis

Norwegian narrowed its losses in 1Q2015, the first quarter in over a year when its adjusted operating result improved on a year-on-year basis. This was achieved as growth in unit revenue was higher than growth in unit costs although the loss was still its second highest first quarter loss.

Moreover, the containment of unit costs was entirely due to lower fuel prices, whereas non-fuel unit costs increased. Norwegian can point to costs related to a pilot strike as contributing to this, and adverse currency movements also hurt its result, but it does underline the need for cost efficiency improvements.

Meanwhile, Norwegian is still awaiting a definitive decision regarding its Ireland-registered subsidiary Norwegian Air International's US foreign carrier permit application. Approval would be positive for labour productivity on its long haul network. As the US DOT continues to drag its feet, Norwegian may soon be forced to consider alternative plans.

Summary

Norwegian narrowed its losses in 1Q2015, with adjusted operating result improving on a year-on-year basis.
The containment of unit costs was due to lower fuel prices, while non-fuel unit costs increased.
Norwegian is still awaiting a decision on its US foreign carrier permit application for its Ireland-registered subsidiary.
Passenger numbers increased by 2% and load factor reached its highest ever first quarter level.
Total revenue grew by 13.6%, with ancillary revenue performing strongly.
Operating costs increased by 7.4%, with non-fuel costs growing faster than capacity growth.

Adjusted operating loss narrows by 19%

In 1Q2015, Norwegian narrowed its net loss by 9% to NOK538 million (EUR62 million). The reported operating result (EBIT) was a loss of NOK722 million (EUR83 million), 7% less than the loss a year earlier. Revenue increased 14% to NOK4,034 million (EUR462 million).

Adjusting for the item 'Other losses and gains', which do not reflect the underlying operating performance of the business, the adjusted operating result was a loss of NOK725 million (EUR83 million), 18% narrower than the equivalent loss a year earlier. This was still a very heavy loss (a margin of loss of 18.0% and Norwegian's second biggest 1Q loss), but a welcome reversal of the declining year-on-year trend in adjusted operating profit seen in every quarter of 2014.

Norwegian estimates the total pre-tax profit impact of the pilot strike at NOK260 million (EUR30 million) in 1Q2015 and NOK350 million (EUR40 million) in 1Q2015 and Apr-2015 combined. This includes NOK110 million of extra costs in 1Q2015 and NOK240 million in lost revenue in 1Q2015 and Apr-2015. The company also estimates that adverse currency movements had a net negative impact of NOK444 million (EUR51 million) on 1Q2015 pre-tax profit.

Norwegian Air Shuttle 1Q2015 financial highlights (NOK million)

Norwegian Air Shuttle revenue and operating profit* (NOK million): 1Q2009 to 1Q2015

ASKs up 6.7%, deliberately slower than 2014 and also muted by strike action

Norwegian increased its ASKs by 6.7% in 1Q2015, considerably slower than the 35% growth recorded in FY2014. Growth in 1Q2015 was adversely affected by an eleven day pilot strike in Mar-2015 (ASKs fell by 1% in the month), particularly in Norway and Sweden, but Norwegian had previously planned ASK growth of just 5% in FY2015. Most of the ASK growth achieved was on the long haul network and in Norwegian's new bases outside Scandinavia. Average sector length grew by 10%.

Passenger numbers increased by 2% and RPK growth was 15%, with load factor up 6 ppts to 83%, Norwegian's best ever first quarter load factor figure. Load factor gains were achieved across all three months, although, paradoxically, the strike action helped March to the highest year-on-year gain in load factor.

The industrial action by pilots was the result of a dispute over working conditions and group structure, including Norwegian's separate operating subsidiaries employing pilots in each of the three Scandinavian countries. The strike led to 2,000 flight cancellations and a reduction in passenger numbers by 190,000 in Norway and Sweden. CEO Bjorn Kjos told Dagens Næringsliv that there was no longer any adverse affect on bookings as a result of the strike action.

Norwegian Air Shuttle 1Q2015 traffic data (NOK)

Norwegian Air Shuttle ASKs and passenger load factor: 1Q2005 to 1Q2015

Revenue up 13.6%

Total revenue grew by 13.6% in 1Q2015, faster than ASK growth, and passenger revenue grew by 11%. Ancillary revenue again performed strongly, growing by 29.4% and increasing its share to 17% of total revenue in 1Q2015, up from 15% a year earlier.

Ancillary revenue per passenger grew by 25% to NOK138 (EUR16.31), mainly driven by an increase in the sale of bundled packages as a result of long haul growth. Nevertheless, short haul ancillary revenue per passenger performed strongly, increasing by 21% to NOK119 (EUR14).

Norwegian estimates that the pilot strike adversely affected revenue by NOK240 million (EUR28.4 million) in 1Q2015 and Apr-2015 combined.

Norwegian Air Shuttle 1Q2015 revenue by activity (NOK million)

	1Q2014	1Q2015	Change	% of 1Q2015 total
Passenger	2,900	3,221	11.1%	80%
Ancillary	523	676	29.4%	17%
Other	128	137	7.1%	3%
Total	3,551	4,034	13.6%	100%

By network, revenue growth was concentrated entirely on international routes (up 21%), while domestic revenue fell by 5%. Domestic revenue's share of the total fell to 24% in 1Q2015 from 29% a year earlier.

Norwegian Air Shuttle 1Q2015 revenue by region (NOK million)

	1Q2014	1Q2015	Change	% of 1Q2015 total
Domestic	1,032	981	-4.9%	24%
International	2,519	3,053	21.2%	76%
Total	3,551	4,034	13.6%	100%

Total RASK up 6%

Passenger revenue per ASK (PRASK) grew by 4%, with a 3% fall in yield per RPK more than offset by the increase in load factor. The strength of ancillary revenue helped to push growth in total RASK even higher (up 6%).

The increase in RASK is a welcome reversal of the falling trend of 2013 and 2014, when annual figures dropped by 8% and 7% respectively. However, much of the increase in 1Q2015 was due to the weaker NOK against EUR and other currencies.

Norwegian Air Shuttle unit revenue development (NOK) 1Q2015 versus 1Q2013

	1Q2014	1Q2015	Change
PRASK*	0.31	0.32	4%
RASK**	0.38	0.40	6%

Operating costs up 7.4%

Total operating costs excluding other gains/losses increased by 7.4%, slightly faster than ASK growth. However, non-fuel costs grew by 18.4%, considerably faster than capacity growth, while fuel costs fell by 19.6% thanks to lower jet prices. According to CAPA calculations, Norwegian's costs would have been NOK336 million (EUR40 million) higher in 1Q2015 if fuel cost per ASK had remained at the same level as 1Q2014. This accounts for considerably more than the improvement in operating profit year-on-year.

Labour costs, the biggest category after fuel, increased by 4.8%, less than ASK growth and also less than the 6% growth in average man-labour years. Increased costs from additional staff at new bases were offset by productivity gains and the increased mix of long haul in the ASK growth.

Handling costs leaped by 36%, adversely affected by the higher number of larger aircraft (Boeing 787-8), NOK weakness and strike related costs. Maintenance costs also rose sharply, up 34%, for similar reasons. Leasing costs jumped by 43%, reflecting the use wet lease aircraft during the strike and NOK weakness. Norwegian estimates that the pilot strike adversely affected costs by NOK110 million (EUR13 million) in 1Q2015.

Norwegian Air Shuttle 1Q2015 operating costs (NOK million)

NOK million	1Q2014	1Q2015	Change
Personnel	760	797	4.8%
Sales/distribution	121	136	12.3%
Fuel	1,275	1,025	-19.6%
Airport & ATC	577	571	-1.2%
Handling	376	512	36.0%
Maintenance	272	365	34.0%
Other expenses	487	564	15.8%
Other losses/(gains)	-103	-3	-97.5%
Leasing	400	570	42.6%
Depreciation	162	220	36.4%
Total operating costs	4,327	4,757	9.9%
Total costs excl other losses/gains	4,430	4,759	7.4%
Total costs excl other losses/gains ex fuel	3,155	3,735	18.4%

Total CASK up less than 1%, but ex fuel CASK up 11%

CAPA calculates that Norwegian's operating cost (excluding other gains/losses) per available seat kilometre (CASK) increased by just under 1% year-on-year in 1Q2015, less than the 6% increase in RASK noted above.

However, this was entirely due to lower fuel costs and ex fuel CASK grew by 11%. If we subtract the NOK110 million (EUR13 million) of extra costs associated with the strike in 1Q2015 and NOK19 million (EUR2.2 million) of extra costs related to long haul wet leases, ex fuel CASK was up almost 10% (also adjusting the prior year figures for one-off long haul disruption costs). The weakness of NOK also contributed to higher CASK in the quarter.

Norwegian Air Shuttle unit cost development (NOK) 1Q2015 versus 1Q2013

NOK	1Q2014	1Q2015	Change
CASK*	0.47	0.47	1%
ex fuel CASK	0.33	0.37	11%

1Q2015 profit improvement breaks the pattern of 2014, but mainly thanks to lower fuel costs

Looking at the quarterly performance of RASK and CASK since 1Q2014, we can see that 1Q2015 is the first quarter in this period when RASK growth has outpaced CASK growth. However, as noted, this was largely thanks to lower fuel costs

Norwegian Air Shuttle year on year development of unit revenue (RASK) and unit cost (CASK) by quarter 1Q2014 to 1Q2015

The following chart plots Norwegian's 1Q2015 RASK, CASK and ex fuel CASK against average trip length over recent years and also shows the trend lines for annual RASK and CASK.

Typically RASK and CASK both fall as average trip length increases. The chart highlights the seasonal weakness of the first quarter, when RASK is below its annual trend line and CASK is above its trend line. RASK weakness in 1Q2015 reflects seasonally weaker demand than in the rest of the year. The higher CASK of 1Q2015 reflects lower levels of capacity than in the peak season, while fixed costs are not very different from peak season. The chart also illustrates that it is normal for CASK to be higher than RASK in 1Q2015.

The encouraging aspect of the chart is that RASK in 1Q2015 returned almost to its trend line after a very weak performance in 1Q2014. However, CASK remained almost at the same level as 1Q2014, whereas the increased average trip length might have been expected to lead to lower CASK. Moreover, the chart highlights the sharp increase in ex fuel CASK and its large divergence from its annual trend line.

Norwegian Air Shuttle 1Q unit cost (operating cost per available seat km) and unit revenue (total revenue per available seat km) versus average trip length 1Q2009 to 1Q2015

2015 should benefit from lower fuel costs

Norwegian still plans 5% ASK growth for 2015, with long haul driving this growth. It has not changed its target for FY2015 unit cost to be down by 5% to 7% year-on-year, in spite of the strike impact in 1Q2015, but (as CAPA observed previously) this will be due to lower fuel costs.

The narrower loss in 1Q2015 is encouraging. Lower fuel costs, and the greater maturity of long haul routes and the new European bases should see it return to FY2015 operating profit. Nevertheless, Norwegian still needs to make significant progress in lowering ex fuel unit costs if it is to generate sustainable profits in the long term.

Norwegian is considering its long haul options as US application process stalls

Norwegian is still awaiting a definitive decision regarding Norwegian Air International's US foreign carrier permit application. This would be positive for labour productivity on its long haul network as it would allow greater flexibility in the use of crew.

Norwegian has been frustrated by the lack of progress with processing its application and faces a deadline on the duration of the current temporary arrangements, under which NAI effectively wet leases 787 aircraft to the parent company with approval from Norway's authorities.

Norwegian is filing for a UK AOC under which it could restart the US application. This might be seen as more acceptable to the US, since Norwegian has significant UK-based operations, whereas it does not fly out of Ireland. A UK AOC would also give preferential traffic rights to countries such as India. It is also thought to be considering registering a Spanish AOC.

The time for excuses is over

Long haul start up problems have weighed on Norwegian's profitability over the past couple of years and the pilot strike in 1Q2015 was a further drag on its route to better results. For these reasons, perhaps it is still not possible to gain a clear view of how Norwegian's business is performing. Nevertheless, as CAPA said in our analysis of the airline's FY2014 results, the time for excuses is over.