Norwegian Air’s Paradox: Strong COVID-19 Recovery, If It Avoids Bankruptcy

For once Norwegian Air Shuttle stands out for a good reason.

As Europe recovers from COVID-19, most airlines will confront a new problem: fuel hedging losses. They are locked into contracts expecting fuel to cost $65/barrel. Instead it is $28 but they will have to pay their higher hedged amount, creating hedging losses upwards of $1 billion.

Norwegian Air? It’s the least hedged of European airlines by a wide margin, according to Bloomberg Intelligence.

Norwegian could win passengers with cheaper tickets and still come out ahead of competitors since its fuel bill will be lower. Fuel is often around one-third of costs for airlines, making it the largest variable expense.

But first Norwegian needs to survive, a matter more serious and less guaranteed than at its over-hedged peers.

Norwegian’s latest rekonstruktion is asking creditors to convert debt to equity. The mere concept stokes worries. Norwegian’s shares dropped 63% after announcing the plan. But it’s more intricate for Norwegian.

If creditors convert debt and Norwegian can raise equity to 8%, Norwegian can access further state loans – all up, NOK3 billion (US$291 million). That would leave Norwegian fragile but still in business.

Flying post-COVID brings Norwegian advantages. It is hedged 25% for the year at $571 per metric ton, well below peers. Home market competitor SAS is 65% hedged at $642. Besides fuel, Norwegian has overall lower costs than SAS – 76% cheaper, it calculates.

Fuel savings will offset the first 14% of revenue contraction at U.S. airlines, JP Morgan estimates. But they are unhedged. The more European airlines are hedged, the less buffer they will have to quickly rebuild finances. Norwegian comes out ahead, albeit comparatively.

As Norwegian restructures, it may rely on its original markets where it is better known and financial performance is strong. Norwegian gained wider attention for its global that did not come close to Norway or anywhere in Scandinavia: London to Rio de Janeiro, Rome to Los Angeles. Beyond Scandinavia, Norwegian still has favorable fuel costs.

Normally Ryanair’s unit costs are around a fifth cheaper than Norwegian. But that advantage will be offset since Ryanair is hedged around 90% at $600. Ryanair is taking an initial hedging loss of €300 million. Before the recent small recovery in oil price, Bloomberg did not rule out Ryanair having a €1 billion hedging loss for the year.

EasyJet will report a £175-185m fuel and foreign exchange loss in the six months to March 31, a period that captures little of fuel’s rapid fall. An annual loss could be around £600m, Bloomberg estimates.

If Norwegian did hedge extensively, liquidity could be further depleted. Financial institutions could request cash collateral against expected hedging losses at weaker airlines, Moody’s
MCO
says.

European full-service airlines are also strongly hedged while U.S. airlines are not, giving a mixed environment if Norwegian strongly pursues trans-atlantic flying in the COVID-19 recovery period.

Long-haul is the question mark many hang over Norwegian. Its expansion with new – and costly – widebody 787s was fast and diverse, adding city-pairs previously unlinked or little served. Norwegian spread itself out, operating from multiple bases across Scandinavia and the rest of Europe.

Some dismiss Norwegian entirely, and point to numerous route reductions as evidence of a failed model. But it is not all-or-nothing. Some long-haul flight work, while others (and a brief foray in Argentina’s domestic market) do not. Norwegian’s operational and financial restructuring started exceeding market forecasts.

Norwegian may still have an unofficial vote of confidence from when IAG, the owner of airlines including British Airways and Iberia, made takeover bids of Norwegian at the height of its expansion.

Respected IAG and its astute CEO Willie Walsh would not chase a bad investment, one theory goes.  

As for being a worthy investment now, the financial market reckons creditors are giving serious consideration to the debt-to-equity plan, which shareholders will discuss at a May 4 meeting.

Banks and lessors top Norwegian’s creditors. The Irish Times could not get Aercap, which leases 11 aircraft to Norwegian, to comment on the plan.

Lessors could forgo debt-to-equity and repossess their aircraft, one argument goes. But that nearly guarantees they write-off any late lease payments. They will be stuck with an asset that will not be in high demand as aviation suffers from over-capacity in the near future.

The counter-argument might be that they have little to lose. They can hope lower fuel hedging lets Norwegian out-perform peers during recovery.