OSLO/LONDONOSLO/LONDON (Reuters) - Norwegian Air (NWC.OL), the fast-growing budget airline trying to crack the transatlantic market by undercutting established rivals, faces mounting pressure to control costs and shore up its balance sheet to weather fierce competition.
The airline has embarked on an ambitious expansion plan buying more than 200 new fuel-efficient jets yet investors worry its drive to put more passengers on more planes is pushing up costs quickly without producing higher returns.
Doubts are creeping in because Norwegian's fate rests on the still unproven strategy of adapting the success of low-cost short-haul travel to long-haul routes, as well as making a parallel bet on leasing out jets to rival carriers pay off.
Its shares have dropped 38 percent in 2017 bucking the industry trend and, according to Norway's Financial Supervisory Authority, investors have taken out bets on price falls with 5.35 million of its shares, or 14.9 percent of its capital.
The so-called short-selling increased after Norwegian said the outlook for both its revenue and costs was worse than expected, its chief financial officer of 15 years abruptly quit and operational glitches left it short of pilots at the start of the peak summer season.
"The company's ambitious growth plan is putting pressure on costs due to training of personnel and new bases," said Jomar Kilnes, a portfolio manager at Forte Fondsforvaltning, a Norwegian Air shareholder.
"It is a great logistical challenge to make this run smoothly and we believe the recent high costs reflect that," Kilnes told Reuters. "Operational improvements are important in order to maintain shareholders' confidence."
Norwegian Air, which began operating as a low-cost carrier in 2002, has led the charge for low-cost long-haul flights, especially across the Atlantic, forcing rivals to take action to protect profits and encouraging others to try their hand.
Carriers such as Lufthansa (LHAG.DE) and British Airways parent IAG (ICAG.L) have set up low-cost brands Eurowings and Level for long-haul routes and U.S. carriers have introduced fares stripping out extras.
"They have been opportunistic and in some ways it's worked out. They've definitely had an impact on the market, people have followed where they've led, as we've seen with Eurowings and Level," Jonathan Wober, an analyst at CAPA-Centre for Aviation, said of Norwegian Air.
New airlines are also taking on the transatlantic market such as Nordic budget carrier Primera Air and Iceland's Wow air which has grabbed headlines with cut-price tickets. Others are wary, though, with doubts over whether the low-cost long-haul model can produce reliable profits in all regions.
While airlines can copy some short-haul tricks such as sticking to one aircraft type and charging for extras, there are challenges around keeping long-haul planes in use and staff costs - because overnight crew stops cannot be avoided.
Ryanair (RYA.I), Europe's largest low-cost airline, has shunned transatlantic routes because it says it can't get planes at a price to make it work. AirAsia X (AIRX.KL), which flies long-haul mostly within Asia, is not introducing European routes because of fierce competition from Gulf carriers.
To serve its ambitions, Norwegian has led a procession of blockbuster orders from budget airlines in Europe and Asia. In the last five years, it has ordered more than 200 efficient new jets including 110 Boeing 737 MAXs, with options for another 90.
But it doubled up by ordering 100 of the similar Airbus (AIR.PA) A320neo jets to support its foray into the plane leasing business, as well as more than 20 wide-body Boeing 787 Dreamliners for its transatlantic routes.
In the second quarter, Norwegian's operating expenses jumped 45 percent with increases across the board, a rise it put down to new routes and hubs. The airline also said the roughly 2,000 staff it is recruiting in 2017 was, "a significant cost driver but also a necessary investment for future growth".
Its costs for every seat per kilometer flown rose 9 percent to 0.43 of a crown. The commonly used measure of airline costs is now expected to be about 0.42 this year, up from a previous estimate of 0.39-0.40 crown. However, revenue for each seat offered fell 3 percent to 0.41 crown.
The carrier ended up with a second-quarter operating loss of 863 million crowns. That translated into a net profit of 1 billion thanks only to its 17.5 percent stake in Norwegian Finans Holding (NOFI.OL), a bank it launched to offer customers credit and to run its loyalty program.
One banker who declined to be named said the performance was the result of "increased interest expenses, huge capital expenditure, yields under pressure and aggressive commercial growth based only on market share versus profitability".
The banker said he stopped looking at potential financial exposure to Norwegian Air one to two years ago, partly because the airline did not have enough capital backing its expansion.
Norwegian's ability to meet its short-term debt obligations is ranked second-worst among European carriers after Croatia Airlines HRAR.ZA, according to Thomson Reuters Eikon data.
Norwegian's so-called quick ratio, a commonly used indicator of short-term liquidity, is 0.42, less than half the average of regional rivals. Its interest coverage ratio, a measure of how easily it can service outstanding debt, is just 3.2 while the ratio for Ryanair is 25.2. "What gets me with Norwegian ... is the balance sheet could be better. It is so low on equity, so high on debt, it would be safer if they had a bit more equity behind it," said James Halstead, a managing partner at consultancy Aviation Strategy.
"This is a cyclical industry and if something goes wrong it can go drastically wrong," he said.
Norwegian Air Chief Executive Bjoern Kjos defended the airline's capital levels, saying it relied more on national export-import banks.
"Our financing is a little different from the usual bank financing. We use these state institutions and we have always fulfilled their requirements," he told Reuters.
Norwegian Air has also been hit by operational glitches as it launches more transatlantic routes.
It did not book enough pilots for its summer schedule this year and had to cancel flights for the second time in two years. It also leased more planes, which can be more costly, to ensure it had enough capacity after Boeing delayed deliveries of its upgraded 737 MAX planes.
"They should improve their back-up plans to avoid the enormous extra costs when they experience delays on new planes and technical or personnel problems," said Leif Eriksroed, head of Norwegian equities at asset manager Alfred Berg, the 11th largest investor in the airline with a 0.91 percent stake.
Norwegian Air said a pilot shortage at the start of the summer was due to the training of pilots for the new Boeing 737s taking longer than expected. It said Boeing 737 MAX delays also affected its plans.
"The operational hiccups hardly affected our intercontinental service but rather our intra-European routes," it said, adding that operations had been running "fairly smoothly" in recent weeks with very limited cancellations.
Norwegian has also said it would control some costs better from the fourth quarter by ending so-called wet lease deals in which it rents planes with crews from other airlines, and by getting more fuel-efficient engines for its Dreamliners.
"There is a lot that we can do. We will end the wet lease arrangements and the Dreamliners that will burn 3 percent less fuel ... Fuel is 40 percent of our costs. The new engines will help a lot," Norwegian's Kjos told Reuters.
The 787 Dreamliner is a new-generation jet that was seen slashing fuel bills by some 20 percent. But Norwegian is under pressure to squeeze even more from its fleet.
"The balance sheet of Norwegian Air is admittedly stretched, but considering its valuable and sought-after assets consisting of the most modern airplanes, the company has a lot of financial flexibility," Kilnes, the portfolio manager, said.
"It is also very important that the company continues to find and close the best financing sources for its new aircraft orders," Kilnes said.
Eriksroed at Alfred Berg agreed on the importance of controlling costs. "It is important to open new routes at a pace that doesn't dilute the overall margins too much," he said.
Karl-Johan Molnes, head of research at Norne Securities, said Norwegian Air's best option would be to join the SkyTeam alliance with Air France-KLM (AIRF.PA) and Delta (DAL.N).
However, low-cost airlines generally shun such alliances as they can eat into their efficient standalone business models, adding scheduling constraints and costly bag transfers.
Still, Norwegian is pondering cooperation with European short-haul budget airlines, in which they would fly passengers to feed Norwegian's long-haul routes.
"This industry needs innovators like this," said Halstead at Aviation Strategy. "Not always the first one survives, and we hope this one will."
(Additional reporting by Ole Petter Skonnord in Oslo, Vikram Subhedar and Tom Pfeiffer in London, Victoria Bryan in Berlin and Tim Hepher in Paris; editing by David Clarke)