Friday, September 29, 2017

Norwegian Airlines: Are They Built to Last?

Travelers in my area have been enjoying incredibly low fare trips to Europe on Norwegian Airlines. Right now, you can book a one-way flight for next week from Providence, Rhode Island to Shannon, Ireland for $169. With these low fares, Norwegian has been growing rapidly here in the northeast. The question is: Can they succeed in this highly competitive space? Have they replicated the Southwest and Ryanair low-cost operating models and applied it successfully to intercontinental travel? The Wall Street Journal's Heard on the Street column has some doubts:

The airline operates a very different growth model to tried and tested low-cost carriers such as Southwest Airlines Co. in the U.S. and Ryanair in Europe. These combine a disruptive approach to operations with a conservative one to finances. Crucially, strong balance sheets and fat margins have given them the muscle to expand through downturns, when rivals are in retreat and customers hungry for bargains.

With its slim margins and leveraged balance sheet, taking advantage of a downturn will be much harder for Norwegian. Frequent fliers may hope its ambitious project to disrupt the North Atlantic oligopoly thrives. History suggests they shouldn’t get their hopes up.

The Wall Street Journal has expressed skepticism about the airline in the past as well.  In July, the Heard on the Street column noted that Norwegian's costs have been rising over the past four years. Columnist Stephen Wilmot wrote, "You can’t build a low-cost airline without low costs."

The combination of slim or negative profit margins and high debt does indeed pose a serious challenge.  A cyclical downturn will occur at some time in the not-so-distant future.  At that point, the company may struggle to service its debt.   Even if they can make their interest payments, the high debt load relative to rivals may put Norwegian at a serious strategic disadvantage.  Traditional low cost carriers have maintained low debt loads as a competitive weapon, using the flexibility that a conservative capital structure provides to bludgeon higher-cost rivals.   Will competitors take advantage of Norwegian's debt load and launch a price war at a very inopportune time, during a cyclical downturn perhaps?  

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