A VALUATION OF NORWEGIAN ASA

Master thesis

MSc Accounting, Strategy and Control

Copenhagen Business School

Author: Line Marie Kjellstad Johansen CPR: XX XX Concentration: Accounting, Strategy and Control Supervisor: Thomas Ryttersgaard Number of standard pages: 80 (174 592 Characters) Executive summary The main objective of this thesis has been to determine the theoretical value of the share of ASA per 04.12.2013. The valuation was performed through a strategic and financial analysis that formed the foundation for a forecasted budget of the company’s future financial performance. This budget was then used as the basis for the valuation of NAS’ share.

The analyses showed that the industry is heavily influenced by the development in the global economy and is marginal in terms of profitability. The industry is also characterized as highly competitive and many players targets the same customers. This implies a need for a sustainable competitive advantage to survive the fierce competition. The analyses revealed that Norwegian Air Shuttle has a higher cost and lower load factor than the international that apply the same business model. This was especially significant in terms of labor costs.

Norwegian Air Shuttle has recently changed the organizational structure of the company and established a new subsidiary in the EU. These actions has been undertaken so the company can gain the necessary traffic rights abroad and ensure growth in the future. With this restructuring, the company hopes to use foreign labor on the newly launched long-haul routes. The ultimate objective is to compete on an equal ground as the international competitors with regards to cost level.

The valuation was conducted through a present value approach, more precisely the Discounted Cash Flow model, and was evaluated through a sensitivity analysis. Additionally a relative valuation approach and liquidation approach was conducted.

The theoretical value of Norwegian Air Shuttles share was found to be NOK 290 per 04.12.2013. The share was traded at NOK 232 on Stock Exchange the same date which indicates that the share is undervalued by the market compared to the finding in this thesis.

Table of Content CHAPTER 1 - Introduction ...... 6 1.2 Methodology ...... 6 1.2.1 Data Collection ...... 6 1.2.2 Research design ...... 7 1.3 Limitations ...... 7 CHAPTER 2 – Presentation of the company and airline industry ...... 8 2.1 The history of Norwegian Air Shuttle ASA ...... 8 2.2 The airline industry ...... 9 2.3 Vision, business idea and strategic framework ...... 11 2.3.1 Mission and strategic framework ...... 11 2.3.2 Business model ...... 12 2.3.3 Core activities...... 12 2.4 Organization and Ownership ...... 13 2.4.1 Organization ...... 13 2.4.2 Ownership structure ...... 14 2.5 Peer group ...... 14 2.5.1 ...... 14 5.2.2 EasyJet ...... 15 5.2.3 SAS ...... 15 5.2.4 ...... 16 CHAPTER 3 – Strategic Analysis ...... 17 3.1 External analysis ...... 17 3.2 PET-analysis ...... 17 3.2.1 Political and legal factors ...... 17 3.2.2 Economic factors ...... 18 3.2.2 Technological ...... 21 3.3 Analysis of NAS’ competitive environment ...... 22 3.3.1 Bargaining power of suppliers ...... 22 3.3.2 Bargaining power of buyers ...... 24 3.3.3 The threat of new entrants ...... 25 3.3.4 The threat of substitutes ...... 27 3.3.5 Rivalry among existing firms ...... 29 3.3.6 Summary of Porters 5 forces ...... 29 3.4 Internal analysis ...... 30 3.5 Key industry measures analysis ...... 30 3.5.1 Load factor ...... 30

3.5.2 Yield ...... 31 3.5.3 Unit cost ...... 33 3.5.4 Operating costs ...... 34 3.5.5 Labor costs ...... 35 3.5.6 Fuel costs ...... 37 3.5.7 Other costs ...... 38 3.6 Internal level analysis ...... 39 3.6.1 Cost leadership ...... 39 3.6.2 Differentiation ...... 39 3.6.3 Focus...... 40 3.7 SWOT analysis ...... 40 3.7.1 Strengths and weaknesses ...... 40 3.7.2 Opportunities and threats ...... 41 CHAPTER 4 – Financial analysis ...... 42 4.1 Quality of the financial statements ...... 42 4.2 Reformulation of the income statement and balance sheet ...... 42 42.2 Revenues ...... 43 4.2.3 Operating expenses ...... 43 4.2.4 Other losses (gains) – net ...... 43 4.2.5 Other income ...... 43 4.2.6 Leasing ...... 43 4.3 Reformulated balance sheet ...... 45 4.3.1 Operating assets and liabilities ...... 45 4.4 Profitability analysis ...... 47 4.4.1 Return on invested capital ...... 47 4.4.2 Profit margin ...... 49 4.4.3 Asset turnover ...... 50 4.4.4 Return on equity ...... 50 4.5 Items of significance in the income statement ...... 52 5.5.1 Fuel costs and exchange rates ...... 52 4.6 Partial conclusion ...... 53 CHAPTER 5 – FOREASTING AND VALUATION ...... 55 5.1 The discounted cash flow model ...... 55 5.2 The weighted average cost of capital ...... 56 5.2.1 Capital structure ...... 56 5.2.2 Cost of debt ...... 58 5.2.3 Shareholders’ required rate of return – CAPM ...... 59

5.3 Assumptions for the forecasted free cash flow ...... 62 5.4 Revenues...... 63 5.4.1 Number of aircrafts ...... 63 5.4.2 ASK per aircraft ...... 63 5.4.3 Yield and load factor ...... 64 5.4.4 Total passenger revenue ...... 65 5.4.5 Ancillary revenues ...... 65 5.4.5 Other revenues ...... 65 5.5 Operating expenses ...... 66 5.5.1 Jet fuel costs ...... 66 5.5.3 Labor costs ...... 67 5.5.4 Airport charges and Handling charges ...... 68 5.5.5 Technical maintenance ...... 68 5.5.6 Sales and distribution expenses, Other aircraft expenses and Other operating expenses ..... 68 5.5.7 Leasing costs ...... 68 5.5.8 Depreciation ...... 69 5.5.9 Financial expenses ...... 69 5.6 Balance sheet ...... 69 5.6.1 Tangible assets ...... 69 5.6.2 Intangible assets and non-current operating liabilities...... 70 5.6.3 Current assets and current liabilities ...... 70 5.6.4 Free cash flow statement ...... 70 5.7 Present value approach - DCF ...... 70 5.8 Sensitivity analysis ...... 71 5.9 Scenario analysis ...... 72 5.9.1 Worst-case scenario ...... 73 5.9.2 Best-case scenario ...... 74 5.9.3 Labor scenario ...... 74 5.10 The relative valuation approach ...... 75 5.11 Liquidation approach ...... 77 5.11.1 Liquidation value of assets ...... 77 5.11.2 Liquidation value of liabilities ...... 78 5.12 Partial conclusion ...... 78 CHAPTER 6 – CONCLUSION ...... 79 7. References ...... 81 8. Appendix ...... 88

CHAPTER 1 - Introduction The aviation industry is characterized by intense competition, pressure on prices and high fuel costs but the Norwegian low-cost airline, Norwegian Air Shuttle ASA (NAS) has seen outstanding growth the recent years.

The company is now ready to expand its operations to international markets and is the first European low-cost carrier to operate long-haul flights. The competition from the international airlines is fierce, and Norwegian legislative issues regarding labor makes it difficult for NAS to compete on the same cost level as the international competitors. With the establishment of a new subsidiary outside of , NAS hopes to compete on an equal playing field to the international competitors. It is thus interesting to see how this affects the value of the company. This leads to the following problem statement:

“What is the fair value of Norwegian Air Shuttle ASA’s shares per 04.12.2013”?

To answer the problem statement, a throughout examination of the industry is necessary. Different analyses of the airline industry and NAS’ competitive environment, as well as the financial value drivers will be carried out. The following sub-questions will be answered to support the findings.

 What is the main external factors that affect NAS’ value creation?  How has NAS’ key industry measures developed compared to its peers?  What is NAS’ competitive advantages?  How does NAS’ key financial ratios compare to the peers?  How sensitive are the valuation estimates to changes in underlying assumptions?

1.2 Methodology This section describes the overall nature of this paper and presents the models used to answer the overall problem statement.

1.2.1 Data Collection This paper is aimed at people interested in the airline industry and NAS particularly, including investors, employees and shareholders. The paper is written from an investor’s point of view, only publicly available information is applied and the thesis is based solely on secondary data. This secures that the thesis is written with an objective perspective and that the information used is not biased due to interaction with the company. The thesis will consist of a strategic and financial part and both qualitative and quantitative information will be used. The main information source is NAS and its peer-group’s annual report’s but also relevant literature on the subject. To support the findings and get an in-depth understanding of NAS and the airline industry, relevant webpages, industry rapports and newspaper articles is also used.

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1.2.2 Research design To give the reader a satisfactory background information the second chapter of the thesis will give a throughout introduction to the company and the airline industry and describe NAS’ core activities, current strategy and organizational- and ownership structure. In the third chapter the strategic analysis will be carried out. The external factors will be analyzed through a PET-analysis and the competitive environment in the airline industry is examined through Porter’s five forces. The non-financial value drivers will be assessed through an analysis of the key industry performance measures and the result of the strategic analysis will be summed up in a SWOT analysis. The forth chapter will consist of a financial analysis. Here the historic profitability and financial aspects of the company and its peers will be analyzed. This will be done through reformulating the income statement and balance sheet. In addition, a description of significant posts in the income statement that is relevant for the forthcoming forecasting and valuation will be presented. In the fifth chapter the information found in the strategic and financial analysis will be combined to predict a 10-year forecasted budget for NAS. This forecasted budget will be used to perform the valuation of the company. The main framework for the valuation will be the Discounted Cash Flow model. This model will be supplemented by the relative valuation approach and liquidation value of the company. The final chapter will consist of conclusive remarks.

1.3 Limitations This paper is written from an external point of view and is based solely on public information. Since the objective with this thesis is to find the theoretical value of the stock per 04.12 2013, information distributed past this date will not be considered.

The models used is this thesis is widely accepted and therefore no further introduction or proof of their validity will be offered. As the focus of this thesis is NAS and its core operations, all other operations are excluded from the analysis. This include charter, cargo and other minority interest.

It is chosen to not include possible future Asian competitors in the peer-group as the author possess no knowledge about accounting practice in the respective countries. In addition, no adjustments has been done to make up for the differences of fiscal year in the peer-group. It though believed that this will not have a significant impact on the result.

As the members of the peer-group have different nationalities all values used in the paper has been calculated in Norwegian Kroner (NOK). The following exchange rates collected on the 3rd of September 2013, are applied for the whole paper: 100 SEK = 92,29 NOK , 1 EUR = 8,0677 and 1 GBP = 9,3282 NOK.1

1 DNB (2012) 7

CHAPTER 2 – Presentation of the company and airline industry

2.1 The history of Norwegian Air Shuttle ASA Norwegian Air Shuttle ASA was established in January 1993 when Svein Klev and Bjørn and Tore Kjos took over the aircraft fleet of a recently bankrupt airline. Until 2002 NAS’s main operations were domestic flights on the west coast of Norway in cooperation with Braatens S.A.F.E. This collaboration ended in 2002 when Braatens S.A.F.E was acquired by SAS.

After the termination of the domestic routes in western Norway, NAS repositioned themselves as a low-cost carrier, and it soon challenged SAS’ monopoly in the Norwegian market. NAS’ strategy was to have an business model which main focus was to reduce costs compared to traditional airlines. This should be achieved by flying the passengers point-to-point without further responsibility and with no service onboard. This led to shorter turnaround time, a more efficient utilization of the fleet and a reduction of operating costs per seat.2 NAS also based its route portfolio on several key factors which included serving point-to-point markets where flights either had been underserved or overpriced, and being the first low-cost airline to offer routes that only established airlines had offered previously. A key factor was also to constantly adjust products and services to match occasional and permanent fluxes of demand.

From 2002 to 2003 NAS has a passenger growth of 82%, and its operations expanded to foreign destinations. In December 2003 the shares in NAS were listed on with good response from investors. In 2005 the number of routes had increased from 18 in 2003 to 54, and NAS could for the first time show their shareholders a positive result. In 2007 NAS was the largest low-cost carrier in the Nordic region3 and by 2008 they had international bases set up in , and Denmark4.

Today NAS is the second largest airline in and the third largest low-cost carrier in Europe5. In 2012 they placed the largest aircraft order in European history, ordering 222 aircrafts which included 8 787-8 Dreamliner aircrafts for long-haul operations6. The Dremliner is the fastest and most cost efficient aircraft of its type and is described by CEO, Bjørn Kjos as a “game changer” for NAS7. They now operate with a route portfolio that includes flights to North-Africa, the

2 Norwegian (2002) 3 Gram (2007) 4 Norwegian (2006) 5 Norwegian (2013) 6 Norwegian (2012a) 7 Matre (2013) 8

Middle-East, North-America and Southeast- and has experienced significant growth in recent years8.

The long distance revolution

In 2013, NAS started its first long-haul operations through its wholly owned subsidiary . The first long-haul flights flew from Oslo to , and New York, USA in May 2013. The operations where later expanded to several destinations in the US. This launch was a part of NAS’ so called ‘Long distance revolution’. The new Boeing 787-8 Dreamliner aircrafts are the company’s key to succeeding in its expansion and was the first step to revolutionize its operations. The next steps are to establish bases in the different potential markets and expand its destination portfolio. NAS’ long term goal is to have long-haul operations on a global scale, also operating routes that do not involve Scandinavia and domestic routes outside its home market, specifically on the Asian continent.9 In October, 2013 it was announced that NAS will establish two new subsidiaries, one in Norway and one registered in the EU. In addition they launched new routes, from to several destinations in the US. This is its first long-haul routes departing from outside of Scandinavia and this launch will put NAS in direct competition with the most established players in the industry.

2.2 The airline industry

Figure 1: Global Economic Growth and Airline Profit

6 7 6 4 5 2 4 3 0 2 1

-2 0 Global GDP growth GDP Global

-4 -1 tax profit magin as % % revenues as magin profit tax

- -2 -6 -3

1970 1975 1980 1985 1990 1995 2000 2005 2010 Net post Net

Net post-tax profit as & of revenues Global GDP growth

Source: Own creation based on information from IATA Global commercial industry outlook June 2012

The airline industry has existed for decades and is by many characterized as risky and volatile. This section of the paper will look deeper into the development of profitability in the airline industry and what affects it.

8 Norwegian (2012a) 9 Mikalsen (2013) 9

When looking at Figure 1 it is apparent that growth in the global economy is essential for growth in the airline industry as the profit level has been closely linked to the development in the global economy the past three decades. 10 11 Cyclical patterns are characteristic for the airline industry and four to six years of profit followed by three of four years of losses seems to be the global pattern12. This is illustrated by the red line in the figure above. In the following section the industry’s profitability and cyclical nature will be described.

The development in airline profitability since the mid-1990’s.

In the start of the 1990’s the first Figure 2: Global commercial airline profitability big crisis hit the airline industry. 1995-2013 The fuel prices rose and the 20 economic climate were getting 0 colder and demand was sinking. -20 Cost cutting programs were 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013F implemented and by the mid- Source: Own creation based on IATA Financial Forecast Briefing note June 1990 the effect started showing 2011 and March 2013 and as demand perked the airline industry returned to profit13. This positive trend lasted until the start of the 21st century when yields fell and costs increased. In addition, the international airlines at this point appeared to be supply-led which suggested that a new cyclical downturn was emerging.14 In addition to this the dot.com-bubble burst in March, 2000 which caused an economic downturn that led to a decrease in demand for air travels especially. Also, at this point many low-cost carriers entered the industry which put a pressure on ticket prices and lowered the profitability of existing firms. The terrorist attack on September 11, 2001 turned the emerging crisis into a disaster for the airline industry. The attack led to a closed airspace over the US for security reasons and non-American carriers adjusted their number of flights from and within the US and extra costs incurred because of new security regulations. Furthermore, it led to a fear of flying amongst some of the population which further reduced demand. Another consequence of the attack was a general downturn in the global economy and as a result the relevant market indicator Revenue Passenger Kilometer (RPK) dropped significantly. For European carriers the effect had a time lag and the RPK which had zero growth before the attack, hit its lowest point of -26% in January 2002. In 2003 the SARS epidemic hit and an official advice to avoid non-essential traveling led to a drop in the flight demand. At the same time the Iraqi war was announced which led to negative expectations of travel security. 15

10 IATA (a) 11 IATA (2012) 12 Doganis (2001) p.2 13 Doganis (2001) p. 2 14 Doganis (2001) p. 5 15 Cento (2008) p. 50-50 10

As you can see on the graph in Figure 2, the airline industry did not experience profit again until 2006. Unfortunately the financial crisis hit in 2008 and the industry experienced its worst downturn yet. Demand plunged due to the struggling global economy and record high oil prices led to fuel costs getting sky high before dropping16. Although the industry saw profit again in 2010 the financial crisis in the Eurozone again turned the situation around especially for European carriers. Decrease in demand particularly in the business and cargo segment, increased fuel prices and volatility of prices and difficulty to get funding were problems the industry faced. However, during 2012 many low-cost carriers, NAS included, saw growth compared to other network airlines.17 In 2013 this trend is expected to continue although fluctuating fuel prices and a higher profit margin from the refineries add to the cost for airlines.18

2.3 Vision, business idea and strategic framework The vision and strategy of NAS is important to get an understanding of where the company sees itself in the future. NAS vision is “everyone should afford to fly” and to achieve this they have developed a business idea which is “to give everyone the opportunity to travel by air, attracting customers by offering competitive, low fares and a high- quality travel experience based on operational excellence and helpful, friendly service”.19

2.3.1 Mission and strategic framework NAS intends to become the preferred supplier of air travel in its selected markets and to generate excellent profitability and return to their shareholders. To achieve this mission NAS have formed several strategic principles which include focus on customer orientation where “freedom to choose” is one of the core points. The freedom to choose gives the customer the opportunity to pay for only the services desired, and it is offered a low-cost option for price-sensitive customers. This ensures NAS a broad market reach. Another core point is to continuously focus on revenue maximization and improvement of the cost base and at the same time offer a mix of destinations for both business and leisure travelers. NAS focuses on being a positive and entrepreneurial organization which has an “out- of-the-box” approach to doing business and a flat and lean organizational structure to make decision- making simple. This is to ensure quick and easy adaption to changes in the market situation. The last core point of NAS, is to continuously focus on developing high-quality, cost-efficient products and services through extensive use of industry-leading technology to make NAS a convenient travel partner.20

16 Wharton (2009) 17 ECA (2013) 18 PWC (2013) 19 Norwegian (2013b) 20 Norwegian (2012) 11

2.3.2 Business model In the airline industry there are two different types of business models, the low-cost carriers (LCC) and the full-service network carriers. What characterizes a network carrier is that the airline focuses on providing different on-board and pre-flight services like airport lounges, connecting flights, drinks and snacks on board and different service classes. The network carriers are also often members of airline alliances which gives the customers extra benefits. A low-cost carrier on the other hand focuses on cost reducing to establish a price leadership strategy in the markets they serve.21 The low-cost model also strives to reduce fixed and variable unit costs by increasing aircraft capacity and having high load factors.22 Typical for LCC’s are fees for bringing luggage, self-service check in and an elimination of free in-flight services like newspapers and snacks. LCC’s also typically sell heavily discounted tickets if you book long in advance and thereby address price-sensitive customers contrary to network airlines which typically have business and time-sensitive customers as its main segment. Even though NAS is a typical low-cost carrier they are not as aggressive on cost savings as other LCC’s. They also offer two different service classes - low-fare and flex, and a reward program. This way NAS also target business travelers and time-sensitive customers as well as the price-sensitive ones. Contrary to some other LCC’s NAS generally operate on the main airports in the cities it serve. Operators in the low- cost business model have a tendency to choose secondary airports to cut costs on airport fees. All in all NAS have characteristics from both the network-carrier and low-cost carrier business model, but is still to be considered as a typical low-cost carrier.

2.3.3 Core activities NAS primary focus is to provide Figure 3: Market Share Per Airport 2012 point-to-point flights at competitive 40 prices and with customer-friendly 30 solutions and service23. In 2012 they 20 10 36 flew 17.7 million passengers to 121 19 14 9 0 4 4 destinations. NAS’ largest hub is located in Oslo, Norway and the seat capacity from Oslo Airport is twice as high as from the second largest Source: Own creation based on Annual report 2012 hub at Arlanda Airport, .24 NAS has in the recent years established bases outside Scandinavia to reach new markets and in 2013 it opens its first base outside of . NAS’s flight operations are the second largest in the Nordic region in terms of number of passengers and revenue, and it is the largest low-cost carrier

21 Reichmuth et al (2008) 22 Norwegian (2012) 23Norwegian (2012) 24 CAPA (2013a) 12

in the region.25 In 2012, NAS held 36% of the market share in the home market26, only beaten by the System group (SAS and Widerøe).27 In the Nordic region, NAS has a market share of 17%28. NAS currently holds a fleet of 81 aircrafts, and has placed an order of 222 additional aircrafts. These aircrafts are scheduled to be delivered from 2016 and onwards.29

2.4 Organization and Ownership

2.4.1 Organization NAS is a part of the Norwegian Group where Norwegian Air Shuttle ASA is the parent company. As seen in Figure 3 the group consists of Norwegian Air Shuttle ASA and the fully owned subsidiaries Norwegian Air Shuttle Sweden AB, Norwegian Long-Haul AS, AB Norwegian Air Shuttle Ltd and NAS Asset Management Norway AS. Through Norwegian Finans Holding ASA, NAS owns 20% of which NAS’s loyalty program is run in cooperation with.30 The parent company is responsible for all flight operations except the long-haul operations which are operated by Norwegian Long-Haul AS

Figure 3- Organizational structure

Norwegian Air Shuttle ASA (Parent company)

Nas Asset Norwegian Long- Norwegian Finans Call Norwegian AS Management AB Norwegian Air Holding ASA Haul AS Norway AS Shuttle Finland Ltd (20%)

Bank Norwegian

Source: Own creation based on Annual Report 2012

In October 2013 NAS issued a press release stating they would alter the corporate structure of NAS. This new structure is part of a strategy to secure international growth and necessary traffic rights. Two fully owned subsidiaries with its own permission for operations will be established, one based in

25 Norwegian (2012) 26 Norwegian (2012) 27 Osloairports (2013) 28 CAPA (2013b) 29 Norwegian (2013c) 30 Norwegian (2012) 13

Norway and one in the EU (most likely Ireland). NAS’ states that another reason for the restructuring is that NAS is in a process of becoming an international company rather than a Scandinavian, which demands a modernized organizational structure. The objective with the restructuring is to secure NAS with a position as a competitive and global airline in the future.31

2.4.2 Ownership structure Figure 4: Main Shareholders in percentage In the end of 2012 NAS had 5333 different 2011 HBK Invest shareholders divided between private and institutional investors. The largest Finnair PLC 27 % shareholder with 26,99% of the shares is Skagen Kon- HBK Invest which is owned by NAS’ CEO 55 % Tiki 5 % Skagen Vekst Bjørn Kjos (84,13%), NAS’ board 5 % JP Morgan chairman Bjørn Halvor Kise (8,23%) and Chase Bank 2 % 4 % Tokjo Invest (7,63%). Finnair PLC became 2 % Danske Invest Norske shareholders after NAS purchased Source: Own creation based on Annual Report 2012 FlyNordic in 2007.32 The 20 largest shareholders hold 60,38% of total shares. At the end of 2012, NAS did not own any of its own shares and international shareholders controlled 23% of the shares. This shows a growth of 4% since 2011. 33

2.5 Peer group It is important to determine a peer group that can serve as a benchmark for the strategic and financial analysis of NAS. The companies included in an ideal peer group should be of the same size and operate in the same market as NAS. However, in terms of geographical market area and size, there are no highly comparable companies. The airlines chosen for the peer group has its main market within Europe and some operate in the long-haul market. Both business models are also represented in the Peer-group market share in the Nordic Region 2012 peer group. The peer-group found suitable for the purpose of this paper consists of Ryanair, EasyJet, SAS and Finnair. Other SAS 32 % 28 % 2.5.1 Ryanair EasyJet 1 % Ryanair is an Irish ultra-low cost carrier NAS established in 1985. Ryanair serves over 1600 22 % Finnair Ryanair 9 % short-haul routes in Europe from 57 bases across 8 % Source: Own creation based on SAS annual report 2012

31 Norwegian (2013d) 32 Yle (2013) 33 Norwegian (2012) 14 the continent. Ryanair started its low-cost business model in 1990, and became Europe’s first low-cost carrier.34 Their business strategy is to offer the lowest fares in every market, high frequency flights and optional fees, and its objective is to become the Europe’s largest scheduled passenger airline, through continued improvements and expanded offerings of its low-fares service. 35 Today Ryanair is the largest low-cost carrier in Europe and the most profitable airline in Europe in terms of operating margin. In 2012 they served close to 80 million passengers, making them the second largest airline in Europe by passenger number, only beaten by . 36 Ryanair currently has three bases in Scandinavia where as one is located in Oslo, Norway. As the Northern European countries have been successful in handling the European economic crisis, Ryanair sees potential growth in these markets and then specially Scandinavia. The company has a plan to increase traffic in Northern Europe by 25% over the next five years, which may lead to a fiercer competitive environment for NAS.37

5.2.2 EasyJet EasyJet is a British low-cost carrier airline established in 1995 by Sir Stelios Haji-loannou to offer low-cost flights within Europe. EasyJet currently have 23 bases across Europe, none of them located in the Nordic region. It currently operate on over 600 routes in 33 countries which are mainly located in Europe.38 In June 2013 they opened its first route to Norway, and they now serve all the Scandinavian countries.39 In February 2013 EasyJet for the first time flew over 60 million passengers over a 12 month period. EasyJet’s strategic intent is to leverage its cost advantage, leading market positions and brand to deliver point-to-point low fares with operational efficiency and friendly service for its customers. Its ambition is to be the preferred short-haul airline, delivering market leading return.40 EasyJet is similar to NAS in both business model, where both are focused on keeping unit costs and the operational costs at the lowest possible level, and strategic framework.

5.2.3 SAS Scandinavian Airlines System (SAS) was founded in 1946 as a merger of three Scandinavian national airlines. The consortium had mutual interests in intercontinental flight operations and the first SAS flight left from Stockholm to New York in 1946. For several years SAS had a monopoly situation in the Scandinavian air travel market, and economic upturns led to minimized focus on costs. In the late 1970’s recession and high fuel prices hit the airline industry and SAS shifted its focus to become more customer oriented and focus more on business travelers than leisure travelers.41 Today SAS is the largest airline in the Nordic region in terms of revenue, passengers and flights. In 2012, SAS

34 Ryanair (2013a) 35 Ryanair (2013b) 36 CAPA (2013c) 37 WSJ (2013) 38 Easyjet (2013) 39 Routesonline (2013) 40 Easyjet (2012) 41 SAS (2013) 15 transported 21,7 passengers to 101 destinations and they have 781 daily flights. Its mission is to “provide the best value for time and money to Nordic travelers whatever purpose of their journey”, but its focus has been on being the no.1 choice for Nordic business travelers.42 The past years SAS has experienced financial issues and was on the verge of bankruptcy in late 2012. The company managed to pull around but is going through a major restructuring process to cut its costs and increase profitability.43

5.2.4 Finnair Finnair was founded in 1923 as Aero O/Y and is thereby one of the oldest continually operating airlines in the world. Today Finnair is the largest airline in Finland and offer flights to Scandinavia, Europe and Asia. As their home base is located in Helsinki, Finnair has a beneficial location when it comes to flights to Asia. Hence, Finnair has focused on strengthening its position in the Asian market and expand the traffic between Europe and Asia in the recent years. Finnair’s vision is “to be the number one airline in the Nordic countries and the most desired option in Asian traffic”.44 In 2012 Finnair flew 8,8 million passengers to 70 destinations45 and had a market share in the Nordic region of approximately 9%.46

42 SAS (2012) 43 SAS (2012) 44 Finnair (2012) 45 Finnair (2013) 46 SAS (2012) 16

CHAPTER 3 – Strategic Analysis The strategic analyses is performed to get an understanding of the internal and external factors that affect NAS’ operations. These findings will serve as a foundation for the forecasting of future performance that will be performed later in the paper.

3.1 External analysis The external analyses will examine the external factors in NAS’ environment that affect value creation.

3.2 PET-analysis The PEST-analysis is a tool to detect the macro factors that may affect NAS’ cash flow in the future. The PEST-analysis indicate that the impact of Political and legal, Economic, Sociocultural and Technological factors should be examined.47 For the purpose of this paper it is decided to perform a PET-analysis, which include the factors concluded to have the most impact on NAS’ value creation in the future, Political and legal, Economic and Technological.

3.2.1 Political and legal factors The most relevant political issue that concerns NAS is the legislative rules regarding foreign labor.

NAS’s labor costs has been a subject frequently discussed by NAS and other involved parts in the media. Norwegian labor legislation states that the crew working on an aircraft registered in Norway must have a Norwegian residency and work permit, and get paid according to Norwegian salary terms.48 This prohibits NAS from hiring foreign personnel at its international bases and give them wages according to the local pay and working conditions in the base country. NAS states that it has no chance to compete against other LCC’s, especially the new Asian low-cost companies, on Scandinavian salary terms.

In January, 2013 NAS applied for a permission from the Norwegian government to use foreign labor with according labor and salary agreements on their flights, which was turned down by the Ministry of Labor.49 As a result, in June, 2013, NAS registered its new 787 Dreamliner aircrafts in Ireland, a solution that makes it possible to hire foreign personnel and pay them accordingly.50 As the aircrafts are registered in Ireland, NAS currently operates on a temporary permission to fly the Irish-registered aircrafts on a Norwegian flight license. This permission ends in December, 2013.51 One of the reasons that NAS established a new subsidiary in Ireland in October 2013 is to acquire the necessary traffic rights. This license is time consuming to obtain, and NAS has already been denied the license twice

47 Petersen and Plenborg (2012) p. 188 48 Hvamstad (2013) 49 Larsen, H.L and Skei, L (2013) 50 Skille, Ø.B and Lilleeng,S (2013) 51 NTB (2013) 17 due to insufficient information in the applications.52 If NAS does not get the approval in time, the company must apply for a new temporary permission from the Norwegian Ministry of Aviation. This approval is not certain and NAS risk being without a license for the Irish-registered aircrafts. This scenario it would hurt NAS’s long haul operations.

These actions is a step on the way to compete on a level playing field as the other European airlines when it comes to cost level.53 These actions is cost reducing measure, especially when it concerns labor costs.

When on the subject of labor costs, another Figure 5: Wages and Salaries per issue is the level of real wages in Norway. Employee in NOK thousands 2008-2012 NAS Figure 5 shows the development of the 700 SAS wages and salaries for each airline in the 600 Ryanair peer-group. As seen, NAS’ employees earn 500 EasyJet more than its LCC peers. This comes as no 400 surprise as Norway has one of the highest Finnair 300 54 Peer-group wage levels in Europe. 2008 2009 2010 2011 2012 Average Source: Own creation based on Annual reports 2008-2012 Figure 6 illustrates the difference in real wages per hour in the home markets of the Figure 6: Real wages per hour in EUR in peer group. The hourly rate in Norway Peer group home countries 2012 averages at EUR 48,3 compared to EUR 60 21,6 in the UK. These differences offer an 40 explanation to why NAS’ labor costs are at a 20 higher level than Ryanair and EasyJet, even 0 though the airlines follow the same business Norway Sweden Finland Ireland UK model. The fact that Norwegian labor costs Source: Own creation based on information from European 124% more per hour than in the UK commission, 2013 underline NAS’ petition to pay foreign personnel at local conditions to compete with airlines operating in these markets.

3.2.2 Economic factors The economic factors that has the largest impact on NAS’ value creation is the price of jet fuel and growth in GDP. These factors will be discussed in the following subsections.

52 Dagens Næringsliv (2013) 53Skille, Ø.B and Lilleeng,S (2013) 54 Storeng, O (2013) 18

3.2.2. 1 Jet fuel price Jet fuel is one of the largest external cost drivers for an airline company. Jet fuel is distilled petroleum and naturally, the price of jet fuel tends to follow the price of crude oil.

Figure 7: Jet Fuel vs Crude oil 1993-2013 0,3 0,2 0,1 0 -0,1 -0,2 -0,3

-0,4

feb.94 feb.95 feb.96 feb.97 feb.98 feb.99 feb.00 feb.01 feb.02 feb.03 feb.04 feb.05 feb.06 feb.07 feb.08 feb.09 feb.10 feb.11 feb.12 feb.13

aug.93 aug.94 aug.95 aug.96 aug.97 aug.98 aug.99 aug.00 aug.01 aug.02 aug.03 aug.04 aug.05 aug.06 aug.07 aug.08 aug.09 aug.10 aug.11 aug.12 aug.13

Jet fuel Crude Oil

Source: Index mundi 2013

Figure 7 shows the development of jet fuel price vs. crude oil the past two decades. The correlation coefficient is 0,84 which implies a strong correlation. This indicates that the projected future growth in the oil price can be used to predict the future jet fuel price.

Figure 8 shows the development of the price of jet fuel per gallon in US dollars the past ten years.

Figure 8: Jet Fuel per gallon in US dollars 2003-2013

4,5 4 3,5 3 2,5 2 1,5 1 0,5

0

apr.04 apr.05 apr.06 apr.07 apr.08 apr.09 apr.10 apr.11 apr.12 apr.13

aug.06 aug.07 aug.03 aug.04 aug.05 aug.08 aug.09 aug.10 aug.11 aug.12 aug.13

Dec 2011 Dec Dec 2003 Dec 2004 Dec 2005 Dec 2006 Dec 2007 Dec 2008 Dec 2009 Dec 2010 Dec 2012 Dec

Source: Index mundi 2013

The figure shows that the price of jet fuel has gradually increased since the beginning of the century. In 2008 there was a steep drop in the price per gallon. In July 2008 the price per galleon was US$ 3,89

19 and by February 2009 it had dropped 209% to US$ 1,26. This steep decline can be explained by the financial crisis, which indicates that the fuel price is influenced by the global economic situation. During 2012 the fuel price fluctuated from US$ 2,68 to US$ 3,25 per gallon, a change of nearly 21,5%. So far in 2013 the price has peaked at US$ 3,21 in February and had a low-point of US$ 2,72 in May. The price in August 2013 was US$ 3 per gallon.

The demand for oil has increased steadily since its introduction, and 3/5 of all oil supply is turned into fuel, as the use of car, planes and ships is rising. British oil company BP predicts that the demand for oil will increase from 89 million barrels a day in 2013 to 104 million per day in 2030.55 This fact combined with oil being a limited resource, it is indicated that an increase in the future might be unavoidable. However, the oil price is affected by a lot more than just plain supply and demand, but also global economic alterations, political imbalances and the notions of investors and speculators.

To avoid the effects of a sudden change in the fuel prices hedging is common in the airline industry. NAS uses their risk management to avoid the effects of sudden increases in price, whilst at the same time being able to utilize decreases in the price. NAS states in its annual report (2012) that a 1% change in jet fuel price will affect the post-tax profit by NOK 100 000. As a comparison SAS states in its annual report that a 1 % change will have an effect of NOK 73,8 million

To manage the risk NAS uses fuel derivatives and hedges against the risk by using forward commodity contracts. NAS does not state how much of their anticipated fuel consumption they hedge in its annual report, but state that “while they do hedge jet fuel to increase predictability and reduce volatility in earnings, they do so modestly and at a lower relative volume compared to their primary competitors”56. As a comparison SAS has hedged 50% of their anticipated consumption until October 2013. Finnair has hedged 75% of the expected consumption for the first half of 2013, EasyJet 86% for the same time period and Ryanair is hedged for 90% of consumption in 2013. NAS’ approach to hedging may indicate that they are more exposed to fuel price volatility than its competitors. The predicted development in jet fuel price is important for an airline when estimating future costs. It is thus natural to look at the prospects of the future development. As the price of jet fuel is highly correlated to the price of crude oil, this price can be used as a substitute for the jet fuel price. Figure 9 shows the forecasted price of crude oil 2013-2025.

55 Economist (2013) 56 Norwegian (2012) 20

It is seen that the price of Figure 9: Forecasted price of crude oil 2013-2025 crude oil is estimated to 110 have a marginally 105 decreasing growth rate from 100 95 2012 to 2013 and then 90 increase in 2014 before the price diminishes for the rest Source: Own creation based on numbers from World Bank, 2013 of the period. It is though important to remember the price is affected by external factors and unforeseen happenings may disturb the forecast.

3.2.2..2 Growth in GDP As previously illustrated, the development in the airline industry is closely correlated to the development in the global economy. Thus, the development in the gross domestic product (GDP) can be used as an indicator of economic growth. Figure 1 illustrates that an increasing growth in GDP implies an increasing growth in revenues for an airline. The forecasted growth in GDP will thus affect the projected future earning for NAS. The average forecasted growth in GDP is estimated to be 1,6 % in the Eurozone the next two years while it is estimated to be 2,4% in Norway and the US.57 In a 20 year perspective the world GDP growth is forecasted to grow on average 3,1% per year. 58 On another note, predicts the average growth in air travel to be 4,7% for the next 20-year. 59

3.2.2 Technological An airlines success is dependent on high tech aircrafts that maximize comfort for the customers while minimizing costs for the airline. The recent years the focus on building aircrafts that is fuel and cost efficient had increased. NAS has stated that they expect the new aircraft fleet to have 30% less fuel consumption than the current which underlines the importance of innovation. In addition the aircrafts are more environmental friendly as measures have been taken to reduce the CO2-emmisions. This has given NAS the opportunity to pride itself with the slogan “one of the youngest and greenest fleet in Europe”, a slogan that might be brand-enhancing. These factors show that the innovation in aircraft technology is an important factor for the future cost level of an airline.

However, the airlines are just as dependent on reliable and functioning airlines. After all, an aircraft that does not serve its purpose has the opposite of a cost reducing effect. After the delivery of the first in 2013, several technical problems has occurred. These problems has caused a number of delays and cancellations of flights. This has not only led to unsatisfied customers, but a media frenzy with allegations of NAS being unfit to fly long-haul routes and stories of horrible customer service. Even though the technical issues is out of NAS’ control, this is the aircraft

57Word Bank (2013b) 58 Airbus (2013) 59 Airbus (2013) 21 manufacturer responsibility, NAS’ reputation is being damaged. In addition to this, extra costs incurs as NAS has to wet-lease replacing aircrafts and reimburse customers. NAS has estimated this cost to be NOK 100 million just in 2013.60 This issue is a critical concern for NAS as the company is dependent on a reputation as a reliable airline to increase its competitive power. This is especially important when expanding into new markets.

3.3 Analysis of NAS’ competitive environment To understand the competition and profitability in an industry it is necessary to analyze the industry’s underlying structure. This will be done using the recognized framework created by Michael E. Porter known as “Porter’s five competitive forces that shape strategy”. The five forces are bargaining power of suppliers, bargaining power of buyers, threat of new entrants, threat of substitutes and the rivalry among existing firms. If the forces are intense, it is difficult to earn attractive returns on investments. It is important to understand the forces and its underlying causes to understand what cause the profitability and provide a framework for how to influence anticipated competition and profitability over time.61

3.3.1 Bargaining power of suppliers Powerful suppliers can squeeze profitability out of an industry that is unable to pass on the cost increase to its customers. A supplier is powerful if it is more concentrated than the industry it sells to, does not rely heavily on the industry it sells to for its revenues, the companies face switching costs by changing supplier and there is no substitute for what the supplier provides.62

There are four suppliers which are significant for NAS: Airports, employees, technical maintenance providers and jet fuel suppliers.

Airports

The airports are essential for the conduct of an airline. They supply the gates that are necessary for NAS to operate. In many of the cities NAS serve in Scandinavia there is only one airport. This means NAS have no options to choose from is they want to continue to serve the particular city. In other cities, there are alternative airports, but they are often much smaller which makes it difficult to continue operations at the same level. This indicates that the airports possess some bargaining power. However, the airports are as dependent on the airlines as the airlines are dependent on them. So if NAS’ main airport, Oslo Airport, decide to raise its fees, NAS could decide to move its operations to the somewhat close by airports Torp or Rygge, but this would be unfortunate for both parts.

60 NTB (2013b) 61 Porter,M.E (2008)p. 80 62 Porter,M.E (2008) p. 83 22

Even though there is a mutual dependency between the airports and the airlines, the competition between airlines has increased the past years and as a result the airlines capacity has increased. As the number of players with high capacity has gotten bigger it makes the dependency of each airline smaller and this increases the airport’s bargaining power.

Aircraft manufacturers

The number of aircraft producers is not inundating. There are two aircraft manufacturer that are substantially larger than the others, Airbus and Boeing. This put them in a duopolistic situation which gives them high bargaining power and it is hard for the airline to negotiate on price.

NAS has previously had a fleet consisting of only Boeing aircrafts, but recently ordered 100 Airbus A320neo. When the supplier side is so scarce and NAS only has two suppliers of aircrafts, it makes them dependent on these manufacturers. On the other hand, the manufacturers are dependent on the airlines as customers but with NAS being relatively small compared to other global airlines, this is not likely to make a huge impact on the bargaining power. However, the recent large order NAS placed might increase its bargaining power to some extent.

The cost of changing supplier is high and often long-term contracts are agreed upon. Also specific training might be required for an aircraft and changing supplier will induce costs further. Purchasing of aircrafts also require high capital investments and have a long delivery time. Since NAS previously were bound to only one supplier Boeing, but now has opted for two, it might reduce the bargaining power of the aircraft manufacturers to some extent. The two manufacturers see that NAS is willing to change supplier if they are not satisfied and since NAS’ crew already is trained for both aircraft types this reduces NAS’ changing costs. However, the lack of suppliers and NAS’ company size still gives the aircraft manufacturers relatively high bargaining power.

Employees

The personnel are important for NAS because they are the public face of the company and their job is important for NAS’ market value and customer retention. NAS currently has 3036 (2012) employees, including all different types of personnel. These are looked upon as suppliers because they supply NAS with the necessary workforce to continue their services. Parts of NAS’s employees are organized in a labor union which has led to negotiations where it has been threatened with strike several times. Strikes have been avoided so far, but as NAS has employed more foreign personnel the threat of strike is again on the horizon. The Norwegian labor organization Parat, which is a part of NAS’ labor union, states that NAS does not comply with the previously entered agreement concerning the use of foreign workforce. Parat accuse NAS of ‘social dumping’ based on accusations that NAS is bending the rules and use foreign personnel on domestic routes while not paying them at the Norwegian scale of tariff. NAS says in response that they have no intentions of letting the labor unions control its operations.

23

They also state that all employees have competitive salary compared to their home country.63 This is not the first time these issues have caused a threat of strike for NAS. In 2013 similar negotiations caused NAS employees to be on the verge of strike, but the parts came to an agreement in the final hours of the negotiations.64

The result of a strike is significant economic loss, stop in traffic, public attention and pressure on NAS to give in to the union’s demands. This shows that airline employees have strong bargaining power and that they are not reluctant of using it to improve their rights.

Fuel suppliers

The airline industry is fuel-intensive and the price of oil is determined by supply and demand. As previously mentioned the price of oil and jet fuel is highly correlated. Hence, the airlines have little power to influence the jet fuel prices. This indicates that the jet fuel suppliers have a strong bargaining power. The only way NAS can reduce its fuel cost is by hedging and as previously mentioned NAS does this to some extent, but at a lower level than its competitors. Nevertheless, the jet fuel suppliers still have high bargaining power as fuel is a necessity for an airline and the price of fuel is determined by external factors.

3.3.2 Bargaining power of buyers The buyers are NAS’ customers. They are the opposite of the suppliers and powerful customers can negotiate lower airfares, higher quality and better service by playing the different airlines against each other. Customers are considered powerful if they are price sensitive and use their power primarily to pressure prices, if there are few buyers, the industry’s products are standardized or undifferentiated and the switching costs are low.65

In the airline industry the customers are divided into two groups, business travelers and leisure travelers. The leisure traveler can be described as anyone whose travel is not related to any business or work. This is a broad description and includes several individuals with different preferences. However, to narrow it down, a leisure traveler is considered a person who is price-sensitive, flexible on time and date and whose switching costs are low. 76% of all air travels are made by leisure travelers.66

The technological development has made it easy to compare prices from different airlines through search engines and the increasing number of competitors has made the selection range wider. This increases the customer’s negotiation strength and intensifies the competition between the airlines. This development can also indicate that the leisure travelers are prone to choose LCCs over network

63Mikalsen, K.E (2013b) 64 NTB (2012) 65 Porter, M.E (2008) HBR p.83 66 Airbus (2013 24 carriers regardless of airline brand, due to the prices generally being lower. This shows that as long as the products are standardized, price is the most important variable for the leisure traveler.

Generally speaking each leisure traveler has little bargaining power, but as the group has a significant sixe, combined they possess power to some extent because of their low switching costs.

The business traveler can be defined as a person who travels on behalf of a company or in work related matters and this group represents 24% of all travelers.67 The typical business traveler is dependent on frequent time slots, flexibility and a no-hassle travel. The business travelers are often frequent flyers and might take advantage of volume discounts or corporate agreements. This can provide the airline with steady earnings from business travelers and also raise the business travelers switching costs. Due to this the business traveler’s bargaining power is considered stronger than the leisure travelers.

NAS main customers are the leisure travelers but their focus on business travelers are increasing. Examples of measures undertaken to attract business travelers are fast-track security checks and Wi-Fi on board on their aircrafts. However NAS don’t offer lounges or alliance frequent flyer points which might make the business travelers prefer an airline which does. Findings in the market rapport “Nordic Business and Travel Forecast and Challenges 2014” supports these arguments as 52% of Nordic business travelers state that they would never use a low-cost carrier on long-haul flights. 68

All in all the bargaining power of the customers are considered to be moderate as the substantial group of leisure travelers have low switching costs and the business travelers provide the airline with steady income.

3.3.3 The threat of new entrants New entrants to the airline industry would bring new capacity and have a desire to gain market shares that will put pressure on prices, costs and the rate of investments necessary to compete. 69 The airline industry is a capital and labor intensive industry and has entry barriers that make it less attractive and difficult to enter. The main barriers of entry in the airline industry are capital investments, airport capacity, governmental interaction and airline alliances.

Capital investments

To start an airline capital investments are needed. The most significant investment is aircrafts and the stated price range of NAS’ latest aircraft order is from USD $90,5 million for the 737-800 to USD

67 Airbus(2013) 68 Kaspersen, L (2013) 69 Porter, M.E p.80 25

$211,8 million for the Dreamliner70. An airline needs several aircrafts in its fleet to be competitive. Also other costs as personnel, maintenance, fuel etc. will incur.

It is also possible to buy used aircrafts or lease but older aircrafts are less cost efficient. Also, when leasing aircrafts the airline does not have the possibility to sell the aircraft if profits are down. If a contract is entered it might be difficult to end the contract prematurely. However, over a third of the world’s airlines fleets are now being leased71, and this indicates that there are benefits with leasing that exceed the disadvantages. Nevertheless, leasing aircrafts still requires a substantial capital investment as renting a costs around NOK 2 million a month.72

Getting financing from investors is a possibility but as the airline industry is volatile and the chance of loss is relatively high, investors might be hesitant73.

Airport capacity

To be able to operate its business, the airline must be allocated take-off and landing slots. The increased growth in air travel has increased the pressure on the available capacity at airports. To regulate the slots at an airport a coordinator gives permission to an airline to use the full range of airport infrastructure necessary to operate an airline on a specific time and date. The slot allocation is regulated by rules governed by IATA. The most basic principle of slot allocation is that if an airline has operated at least 80% of a slot during the summer/winter period they are entitled to the same slot the following year. This is called the “grandfather rights” and secure established airlines to continuously operate their profitable routes.74 How easy it is to gain slots is dependent on the airport and the spare capacity, as well as how the established airlines utilize their slots. As the capacity of the already established airlines is increasing, it puts pressure on the airports in Europe. This gives an obvious advantage for established airlines as it is difficult for new entrants to gain slots and challenge the established airlines. At some of the major airports, the large airlines might have their own terminals at the airports where they control the gates.75 This makes it even harder for new entrants to gain slots.

Governmental intervention

In Europe several airlines are fully or partially owned by the government. These airlines are called flag-carriers. In the Nordic region SAS and Finnair can be characterized as flag carriers as the governments are the major shareholders. The issue with government-owned airlines is the possibility

70 Boeing (2013) 71 Economist (2012) 72 Norwegian (2012). 73 Mouawad, J. (2012) 74 European commission (n/a) 75 Mouawad, J. (2012) 26 of financial support from the government. In 2009 and 2010 SAS received financial support to stop them from going bankrupt. This was highly criticized as it can distort competition and lower the competition criteria for other airlines. These benefits are hard for new entrants to compete with although flag carriers are not the norm anymore. There are plenty of examples of airlines which have made it without governmental support, NAS being one of them.

Also, to run a commercial airline an approval from the Civil Aviation Authority is necessary. Getting this approval is comprehensive process which demands substantial resources from the applicant.76 This process can also impact the barrier of entry.

Airline alliance

A frequent flyer program gives the customer a certain number of bonus points to use at future travels or at merchandise. The airlines which offer these programs are often members of an airline alliance which allows the customer to earn and use bonus points at any of the member airlines or at different partners of the alliance. Traveling with an alliance-airline (network carriers) also gives the passengers other benefits like more flexibility when flights are delayed or cancelled because of so called code sharing which is when two airlines share the same flight77. The airlines enjoy the benefits of mutual marketing and traffic feed, and thereby more passengers.

The airline alliances and their frequent flyer programs create a customer loyalty where members of the programs are more likely to choose airlines where they earn bonus points rather than one where it doesn’t. To become a member of an alliance the airline needs to fulfill a number of criteria which include complying with the highest industry standards of customer service, security and technical infrastructure78. As of October, 2013 no LCCs are members of any of the global airline alliances79.

As seen the high capital requirements, the “grandfather rights” and the benefits of the flag- and network-carriers make the entry barriers high in the industry. Even though there are examples of new airlines which have been successful in the past decade, the threat of new entrants are considered to be relatively low.

3.3.4 The threat of substitutes A substitute is defined as something that performs the same way or has a similar function as the industry’s products, and when the threat of substitutes is high the profitability suffers.80 The threat is considered high if the substitute offers an attractive price-performance trade-off to the industry’s product and the buyers switching cost is low. In the airline industry the most intuitive substitutes are

76 Luftfartstilsynet (2012) 77 Princeton (n/a) 78 Statalliance (2013) 79 CAPA(2012) 80 Porter, M.E (2008) p.84 27 boats, trains and busses/cars as they fulfill the need for transportation. However, over long distances these methods of transportation are time consuming. In Scandinavia distances can be long81, and with Norway being one of the most sparsely populated countries in Europe82, this indicates a need for air travel. In Denmark on the other hand, high speed trains make the travel time between some destinations almost as quick as air travel because of the travel- and waiting time to and at the airport. In addition, a new plan, “Timemodellen”, for transportation has been approved in Denmark. This is a plan to shorten the travel time between the major cities in Denmark by one hour.83 The highways have also been developed in the past decade but the travel time is still considered to be significantly longer than flying.

One matter that has gotten increased attention the recent years is the green movement. It is a common belief that air travel cause air pollution. Whether this belief is merited or not has been discussed with several different viewpoints, but this might cause some customers to prefer other means of transportation when traveling to reduce the emission and be more environmental friendly. This is however likely to only regard a small percentage of the passengers.

Another substitute that has become more relevant in the recent years is video conferencing. This substitute is mostly relevant for the business travelers as this provides them with the opportunity to hold meetings and personally interact with business companions without travelling. This method of communication holds several benefits. In addition to being environment friendly, a business could save a substantial amount of money by eliminating travel expenses, and at the same time have a faster decision making process as the video conference provides a faster and more flexible way of communication. Despite these advantages, it is likely that many business travelers prefer to meet with their clients face-to-face, especially if there are large and important decisions to be made.

The threat of substitutes is linked to time and money. Leisure travelers have the option of choosing a different type of transportation if the cost of flying is too high, but for business travelers which are time-conscious air travel might be the only option. Though, this is dependent on the travel distance. On the other hand, the technological developments have made it possible for business travelers to conduct their business without travelling.

The threat of substitutes is depended on the travel distance and the group of customers. NAS has a benefit because the travel distances in the home market are long which indicates that air travel is the preferred method of transportation. This combined with the fact that the average price level of flying is relatively low in the home market, and air travel being the quicker option gives the factors that

81 SAS(2004) 82 OECD (n/a) 83 Bane Danmark (2013) 28 encourage the use of substitutes less significance. The threat of substitutes is therefore considered to be low/moderate.

3.3.5 Rivalry among existing firms A high level of rivalry limits the profitability of an industry. The level which rivalry drives down and industry’s profits depends on which intensity they compete and the basis on which they compete. The intensity is considered high if there are numerous competitors, especially in equal size and power range, the industry growth is slow or the exit barriers are high. 84

The Nordic market consists of few, but dominant airlines. The completive environment is fierce as several airlines offer the same routes which create direct competition and rivalry.

In the home market SAS is NAS’ biggest competitor. Combined they account for 80% of the Norwegian market shares, 61% of the shares in the Danish market, 51% in the Swedish and 22% in the Finnish market.85 Previously, SAS as a network carrier has focused mainly on business travelers but with its most recent strategic plan 4ExellenceNXG they state that they will focus more on the leisure travelers to reach a larger part of the market.86 This increases the rivalry with NAS as they now target the same segments. Internationally, Ryanair and EasyJet is the largest competitors.87 Ryanair and EasyJet are direct competitors with NAS as they target the same segment of customers, the price- sensitive. In addition, the launch of long-haul routes between London and the US will put NAS in fierce competition with the established network carriers , Virgin Atlantic and American Airlines amongst some.

In the airline industry the switching costs for the passengers are low, as air travel is considered to be a standardized service. The only significant factor that differentiates between the airlines is price, making customers somewhat indifferent to which airline they choose. This makes the competition fierce and prone to price wars which can become unprofitable for the airlines.

The airline industry is characterized by fierce competition and pressure on prices. There is intense competition between both the LCCs and the network companies and the service and products are similar which makes it hard for the customer to differentiate between airlines. The rivalry between the competitors are strong, especially in NAS home market where NAS and SAS are the two dominating players.

3.3.6 Summary of Porters 5 forces The intensity of the different forces is summarized in the table below.

84 Porter, M.E (2008) p. 85. 85 Osloairports (2013) 86SAS (2012) 87 SAS (2012) 29

Table 1: Threat level

Threat level Low Moderate High Barganing power of suppliers X Barganing power of buyers X Threath from new entrants X Threat from substitutes X X Rivalry among existing firms X

As seen in the table there is high barriers for entry and a low threat of substitute services for air travel, and the power of the customers are moderate. However, the threat of substitutes has the potential to grow as the infrastructure is improved and the benefits of alternative ways of travel are getting closer to the advantage of air travel. This combined with the high bargaining power of the suppliers and the high level of rivalry among the existing firms makes the forces in the airline industry intense. The power of the forces combined with the volatile nature of the airline industry makes the industry less attractive.

3.4 Internal analysis

3.5 Key industry measures analysis The key industry measures analysis will analyze the main drivers for profitability in the airline industry. In addition to this, NAS’ operational expenses will be separated and examined. The measures will be compared to the peer-group and the historical development will be illustrated graphically. This analysis is carried out to get a general understanding of the industry and NAS profitability compared to the peer-group.

Load factor, yield and unit costs are three ratios which is suitable to examine NAS’s internal cost and value drivers and compare them to the peer-group. These measurements will be described below.

3.5.1 Load factor The load factor shows Figure 10: Global Airline Yields and Load Factor 1974-2010 30 80 how much of the total 20 70 capacity that is used to 10 0 60 ASK % generate earnings. A -10 50

100% load factor 1974 1980 1986 1992 1998 2004 2010 Change over year % year over Change means that all seats on Yield Load Factor all flights are filled. Source: Own creation based on IATA economic briefing December 2008 The load factor is calculated by dividing Revenue Passenger Kilometer (RPK) by Available Seat Kilometer (ASK). The

30 load factor is a poor indicator of profit as the price of the seats is important for the earnings88. If all remaining available seats are sold at a reduced price this will affect the earnings negatively, compared to if all tickets were sold to regular fees.89 To avoid this distortion the load factor must be seen in context with the yield of each passenger. As seen in Figure 10 there is a somewhat negative correlation between yield and load factor. The higher the load factor gets the lower the yield. The gap between load factor and yield is larger in the recent years than in the 70’s and 80’s. This could be a result of the increasing competition between airlines which has led to airlines dumping prices on tickets which has led to a higher load factor but decreasing revenues. This is why it is not possible to only look at the load factor when reviewing airlines profitability.

Figure 11 illustrate NAS’ load factor Figure 11: Load factor compared to the peer-group. As seen NAS’ 90 load factor is the lowest between the low- 85 cost carriers during the whole period. NAS 80 75 had a load factor of 79% in 2012 while 70 EasyJet had a load factor of 88,7%. NAS’s 2008 2009 2010 2011 2012 load factor is on average 4,24 percentage SAS Ryanair NAS points below the LCC peer-group average Easyjet Finnair Average in the period 2008-2012. A possible Source: Own creation based on Annual reports 2008-2012 explanation for this is the high number of routes NAS operates which can make it hard to fill up the aircrafts to the less attractive destinations. There is a clear relationship between capacity and load factor, and if the growth in capacity exceeds the growth in passengers, the result is a declining load factor. Not surprisingly NAS has the highest load factor in relation to the network carriers. This is due to the network carriers’ focus on time- sensitive customers rather than price-sensitive customers which implies a lower load factor. This indicates that low-cost carriers are more likely to dump ticket prices to boost their load factor. An interesting point is that in their latest annual report SAS states that 1% increase in the load factor would increase earnings by SEK250 million. This shows that improving the load factor could make a significant difference on revenues, but as earlier pointed out it must be looked upon in relation to the yield.

3.5.2 Yield The increased competition in the airline industry has put a pressure on the different carriers. To capture market shares, airlines reduce flight fares only to be matched by its competitors. As a result the ticket prices needs to be lowered even more to fill up the seats. The result is that a large proportion of

88 CAPA (2013d) 89 American airlines (n/a) 31 the passengers are flying on discounted fares. A result of this trend may be a decline in the real value of airline yields.90

Yield is a measure of the average revenue produced per passenger kilometer. 91 The yield is the most common measure of revenue and is calculated by dividing the revenues by the Revenue Passenger Kilometer (RPK)92 which is the number of occupied seats multiplied with the distance flown93. As the capacity of an airplane is not flexible the airline wants to fill up the seats to improve the yield. To do this the airlines often has to sell tickets to a reduced price which will increase the load factor but not necessarily return a high yield level. An approach that is used to maintain the highest possible yield is yield management, where the airline sells high priced tickets to time-sensitive customers who are willing to pay a higher fare to have a flexible ticket. The cheap tickets are sold to price-sensitive customers where flights are non-changeable and at unattractive slots. This way the airlines find a tradeoff between a high load factor and high yield.94 Hence, the yield measurement is a method to see if an airline is selling discounted tickets to improve the load factor. Factors that affect the yield other than ticket prices is distance flown, cost efficiency and economic climate.

When analyzing the yield level of the Figure 12: Yield level peer-group it is clear that SAS has the highest level with NOK 1,09 in 2012 1,2 SAS compared to Ryanair which had 0,48. 1 Ryanair NAS yield level has decreased over the 0,8 NAS period from 0,645 in 2008 to 0,545 in 0,6 Average 0,4 EasyJet 2012. This level is marginally above the 0,2 Finnair yield level of EasyJet. It is not surprising 2008 2009 2010 2011 2012 that Ryanair’s yield is at a lower level Source: Own creation based on Annual reports 2008-2013 than the rest of the peer-group as the negative correlation between a high load factor and yield is shown in Figure 10. It is however interesting to note that EasyJet has the highest load factor in the peer-group but a yield level close to NAS and Finnair.

90 Doganis,R (2001) p. 9 91 Doganis,R (2001) p. 9 92 American airlines (n/a) 93 Norwegian (2012) 94 Voneche, F (2005) 32

To analyze the combined effects of load Figure 13: RASK factor and yield, the measurement Ticket 1,00 revenue per unit produced (RASK) is NAS 0,80 used. This ratio expresses the revenue SAS 0,60 generated per ASK and is found by Ryanair multiplying load factor with yield. The 0,40 Easyjet development in RASK is seen in Figure 0,20 Finnair 2008 2009 2010 2011 2012 13. As seen the development in RASK is Source: Own creation based on Annual reports 2008-2012 similar to the development in yield.

A part of the LCC’s strategy is low ticket prices and they are therefore a natural choice for price- sensitive customers while network carriers tend to target time-sensitive customers and is thus able to generate a higher ticket revenue. Hence, the fact that NAS’ yield is on the same level as Finnair shows that NAS as a LCC also manage to target the more rewarding customers. The black line in Figure 12 represents the average of the peer group show a trend of declined yield between 2008 and 2010. A natural explanation for this is the financial crisis that outburst in 2008 and this further underlines the point made that yield in the airline industry correlates with the development in the global economy. Another important factor that is likely to influence NAS’ yield level in the future is the expanded long- haul operations. Typically an airline is not able to raise the ticket prices so much that it compensates for the increased stage length. The result is a lower RASK level.

3.5.3 Unit cost The unit cost is used to measure the cost Figure: 14 Unit Cost level of an airline. It is the Cost per 1 Available Seat Kilometer (CASK) and 0,8 NAS is presented as operating expenses over SAS 95 0,6 produced seat kilometers. The unit Ryanair cost is a good measurement to compare 0,4 EasyJet the cost level of different airlines. The Finnair 0,2 unit costs for the peer group is 2008 2009 2010 2011 2012 illustrated in Figure 14. In the figure it is Source: Own creation based on annual reports 2008-2012 apparent that Ryanair has the lowest unit cost amongst the peer group. Ryanair’s unit cost in 2012 was NOK 0,26 which is 0,189 lower than NAS’ unit cost of 0,45. The airline with the highest unit cost is SAS with 0,89. These numbers indicate that the network carriers tend to have a higher unit cost than the LCCs, something that is in accordance with the business models.

95 Norwegian (2012) 33

NAS states in its annual report (2012) that its fleet renewal and an investment in advanced IT infrastructure will reduce its unit costs in the future. Up until now, NAS’ IT systems has been a driver for cost saving. When NAS first started its operations, it was the first airline to offer self-service check-in, something that kept both labor costs and boarding time down. Additionally, NAS has taken into consideration that its customers are price-sensitive and are more likely to book flights if there is cheap tickets available. To utilize this NAS created a “low-price calendar”, where the customers can see when there is cheap flights and plan their travels according to this. This way they keep the transaction and provision costs from booking agencies down in addition to saved labor, and have the possibility to generate new customers.96 In addition to IT, large scale operations and high asset utilization are powerful cost reducing measurements. The investment in a larger fleet will help NAS to exploit the economies of scale and increase the bargaining power with suppliers. NAS’ cost focus has showed results as its unit cost has decreased from NOK 0,56 in 2008 to NOK 0,45 in 2012. When the international expansion proceeds and the subsidiary in the EU is fully operating, NAS will have the possibility to compete with the other established airlines in the same market. As labor costs are reduced as a result of internationally hired labor, NAS states in its annual report (2012) that they anticipate their unit cost to surpass its relevant European competitors. 97 To continue the trend NAS must continuously exercise a tight cost control policy throughout the company.

3.5.4 Operating costs As the airline industry is a capital Figure 15: Operating expenses in % divided intensive industry, the management is into fuel, labor and other costs for peer group 2012 always trying to find a way to minimize 80% the costs. However some costs drivers are 60% company specific and if managed right 40% they can increase NAS’s competitive 20% advantage. To minimize the costs NAS 0% Fuel Labor Other take advantage of economies of scale, NAS Ryanair SAS EasyJet Finnair bargaining power and discounts from Source: Own creation based on annual reports 2012 external parties. All these cost reducing actions are easier to exploit as the airline increases in size. NAS also tries to increase the capacity per aircraft and have high load factors to reduce the fixed and variable unit costs. 98

96 Andersen, E. (2010) 97 Norwegian (2012) 98 Norwegian (2012) 34

To explain the operating expenses the costs are divided into fuel cost, labor cost and other costs as the first two are the largest single expenses for an airline. Figure 15 shows the different costs groups in percent of total operating expenses.

3.5.5 Labor costs Labor cost is the largest single cost that is Figure: 16 Labor Costs in % of operating not affected by external factors and it is expenses Peer-group 2008-2012 NAS thus a cost that differentiates between 40% SAS different airline companies’ cost level. 30% Ryanair NAS focuses on effective staff utilization 20% EasyJet and put effort in route and crew planning Finnair 10% to increase the optimization. In Figure 16 2008 2009 2010 2011 2012 Average the labor expenses of NAS and the peer- Source: Own creation based on annual reports 2008-2012 group is illustrated. As seen in the figure NAS’s labor costs were 18% of total operating expenses in 2012 which is one percent lower than the peer-group average. NAS’s labor costs are still higher than its LCC competitors Ryanair and EasyJet at respectively 11% and 13%, and the high average is dragged up by SAS who has an average labor cost of 35%.

Revenues and labor costs often correlates. Figure: 17 Labor cost in % of Operating An increase in revenue is either (or Revenue Peer-group 2008-2012 NAS simultaneously) caused by an increase in SAS ticket prices or higher demand of air 35% Ryanair travels. It is fair to assume that an increase 25% EasyJet in revenue is caused by higher demand 15% more often than an increase in ticket price Finnair 5% due to the intense competition in the airline 2008 2009 2010 2011 2012 Peer-group Average industry. Higher demand leads to higher Source: Own creation based on annual reports 2008-2012 demand for personnel which again leads to higher labor costs. Figure 17 shows the labor costs in percentage of the operating revenues. When comparing Figure 16 and 17 there is a strong similarity of the graphs. SAS’s personnel costs in percentage of operating revenue is still the highest among the group with an average of 33,5%. NAS’ personnel costs is on average 17,3%, 1,6 percent point below the average of the peer-group. However, the LCC competitors Ryanair and EasyJet still has a significantly lower personnel cost than NAS with Ryanair having an average cost of 10,9%.

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In Figure 18 NAS’ revenue growth compared with Figure 18: Growth in Labor and labor cost growth is looked at. As seen there is a Operating Revenue % 2008-2012 positive trend as the change in revenues from 0,25 2009-2010 and onward is increasing whilst the 0,20 labor costs are decreasing. This shows that NAS is 0,15 able to increase its revenues at a higher pace than 0,10 2008-20092009-20102010-20112011-2012 the labor costs. However NAS’ labor costs are still Change Labor % Change Revenue % 4% higher than its LCC competitors. Source: Own creation based on annual report 2008-2012 On the other hand, productivity of the employee is also essential. How much output the employee creates is important for both productivity and cost level. To measure the productivity a relevant measurement is number of passengers per employee. As there is evidence that there exists a positive correlation between passengers per employee and profitability99 this is an important measure. Figure 19 shows available seat kilometers per employee while Figure 20 shows number of passengers per employee.

Figure 19: ASKs per Employee (million) Figure 20: Passengers per employee 2008-2012 2008-2012 12000 14 10000 12 NAS 8000 10 SAS 6000 8 Ryanair 4000 6 2000 4 EasyJet 0 2 Finnair NAS SAS Ryanair EasyJet Finnair 0 2008 2009 2010 2011 2012 2008 2009 2010 2011 2012 Source: Own creation based on annual reports 2008-2012

The LCC’s scores the highest in both number of ASKs per employee and passengers per employee. As seen in Figure 19 and 20 Ryanair excel in both measures. Ryanair’s employees fly on average 12,6 million ASK’s per year and has 9274 passengers per employee compared to a SAS employee who fly 2,14 ASKs with 1534 passengers per employee. NAS scores lowest amongst the LCCs but still has a significantly higher productivity level than the network carriers. An average NAS employee fly 8,24 million ASKs per year - 52,9% less than LCC competitor Ryanair. NAS also has 51,8% less passengers per employee than Ryanair.

99 Norwegian (2012) 36

The past year there has been a negative trend in both ASKs per employee and passengers per employee for NAS. Number of ASKs has seen a negative growth of -1,6% since 2011 while number of passengers has had a negative growth of -6,4%. This might just be a one-off happening but if this trend continues it is necessary to look into the cause as cost cutting with regard to labor costs is one of the company’s main focus. It is evident that even though NAS outdistance the network carriers, it still need to focus on increasing it productivity should it be able to fully compete with the international low-cost carriers.

3.5.6 Fuel costs Jet fuel is the biggest external cost driver for Figure 21: Average Fleet age for Peer- an airline. The only way NAS can minimize group 2012 20 these costs is by effective risk management and effective fleet utilization. As previously 10 mentioned NAS put in an order of 222 new 12,6 9,8 aircrafts both short- and long-haul in 2012. 4,6 3,9 4 0 This renewal of the fleet is in order with its NAS SAS Ryanair* EasyJet* Finnair objective to have the most cost-efficient and Source: Own creation based on annual reports 2008-2012 environment progressive fleet available100. This large order was made so NAS can replace short-haul aircrafts after 7-9 years of service and hence have a continuous and long-term supply of both replacement and net growth aircrafts101. The newer the fleet is, the lower the fuel costs are. NAS’ fleet is on average 4,6 years old which indicates lower fuel costs than airlines with an older fleet. Figure 21 shows the average fleet age for the peer group in 2012. As seen Ryanair has the youngest fleet while SAS hold the oldest. To compare the oldest and youngest fleet with NAS’ fleet fuel costs per ASK and fuel cost per RPK is examined.

Table 2: Fuel cost per ASK and RPK

NAS SAS Ryanair Fleet age 4,6 yr 12,6 yr 3,9 yr Fuel cost per ASK 0,14 0,22 0,11 Fuel cost per RPK 0,18 0,27 0,14

NAS pays NOK 0,14 in fuel per ASK while Ryanair pays 0,11. Network carrier SAS pays almost 50% more at NOK 0,22. Further, while Ryanair pays only NOK 0,14 in fuel pr RPK, NAS pays 0,18 and SAS as much as NOK 0,27. These findings supports what is previously stated, that a young fleet is much more cost efficient than older fleets as they utilize the fuel better.

100 Norwegian (2012) 101Norwegian (2012) 37

How much fuel each airline consume per Figure 22: Fuel per ASK NAS production unit, ASK, is illustrated in 0,25 SAS Figure 22. NAS has the highest average cost 0,20 of fuel per ASK amongst the LCC’s with an Rya 0,15 nair average of 0,14 compared to Ryanair’s 0,10 0,10 Eas and EasyJet’s 0,13. It is evident that NAS yJet 0,05 Fin needs to even more cost efficient when it 2008 2009 2010 2011 2012 nair comes to fuel. As the average fleet age and Source: Own creation based on annual reports 2008-2012 average distance flown are somewhat similar, this is not an explanation to why NAS’ levels are higher than the other LCC’s. A possible explanation for Ryanair’s low cost level could be the accusations against Ryanair’s fuel consumption. The accusations were raised after two unfortunate happenings where the crew on Ryanair flights was forced to issue mayday warnings due to low fuel reserves. The incidents made people question whether Ryanair put pressure on its crew to fly with a minimum level of extra fuel to reduce the fuel cost. These allegations were denied, but the Civil Aviation Accident and Incident Investigation Commission (CIAIAC) concluded that Ryanair “comply with the minimum legal requirements, but tend to minimize the amount of fuel…and leave none for contingencies” and that its fuel policy is “based specifically on minimizing the fuel load at the start of the flight…As a result, Ryanair aircraft generally land with the minimum required fuel”. Further the CIAIAC stated that “this policy…gives Ryanair a competitive advantage over other airlines that tend to fly with larger amounts of reserve fuel and therefore use more fuel. Market competition is forcing other airlines to reduce their costs by adopting fuel policies similar to Ryanair’s”. 102 These findings were denied by Ryanair. Whether this is the case or not it is important that NAS don’t follow this policy to meet the market competition. A policy like this can contribute to a weakening of the brand and any unfortunate happening might ruin NAS’ reputation.

3.5.7 Other costs The last post in the operating costs is “other costs”. Other costs consists of costs like aircraft leases, sales and distribution expenses, airport charges, handling charges, technical maintenance expenses and other aircraft expenses. Most of these costs are externally given and thereby not an area of improvement. These will thus not be analyzed.

The key measures analysis has revealed that NAS’ costs are generally at a higher level than the low- cost carriers in the peer-group. This can to some extent be explained by factors discussed in the external analysis. With regards to the findings in the external analysis, it is important to focus on the fact that in 2012, NAS has a unit cost and yield level marginally different from EasyJet’s. This shows

102Smith, O (2013) 38 that if operating on an equal playing field, NAS has the potential to drastically lower its cost level, especially in relation to labor costs.

3.6 Internal level analysis It is important to understand NAS’ competitive advantages and disadvantages and why they have grained their success. This will be analyzed within the frameworks of Michael E. Porter’s Generic Strategies which describes strategies to achieve and maintain competitive advantage. This framework will position NAS in relation to cost leadership, differentiation and focus.

3.6.1 Cost leadership The cost leadership strategy is a strategy where the company tries to achieve competitive advantage by reducing costs to become the cost leader in the industry. As described in the key industry measures analysis NAS’ cost level is higher than the international low-cost carrier’s.. Amongst to the netwrok carriers in the peer-group, NAS is the definite cost leader and close to LCC competitor EasyJet. Ryanair however is the definite cost leader in the peer-group. The fact that NAS is moving closer to EasyJet in terms of unit cost and yield indicates that NAS has a potential to lower the costs significantly when the new subsidiary in the EU is established. The altering of the organizational structure gives NAS the opportunity to recruit locally at local conditions and thus reduce the labor costs which will result in a lower unit cost. The recently purchased aircraft fleet which is more cost efficient than the older fleet will also impact the unit costs. Still, NAS must continue its strict cost control and strive for optimal utilization and cost efficiency if they shall be able to increase their international competitiveness.

3.6.2 Differentiation Differentiation strategy is when a company seek do stand out from their competitors. It has been argued earlier that air travel is a standardized service which indicates that differentiation is difficult. However, offering unique services in addition to the actual transportation is a way of differentiation in the airline industry. The network carriers offer a different level of service, which is reflected in their price level. This strategy differentiates the two airline groups from each other. A fact that differentiates NAS from the LCC competitors is that their routes mainly depart from the main airport in the area they serve. This is untypical for the LCC business model and might be experienced as an advantage for the customers, depending on their final destination. NAS in general have a higher service level than other LCCs and their slogan “only pay for what you need” gives the passengers the opportunity to pay for additional services with no hidden fees for fundamental necessities. In addition, NAS is the only airline in the peer-group which offers free Wi-Fi to all of its passengers in 80% of its air crafts. This service awarded them the “Passengers Choice award” for best inflight connectivity and communications in 2012. An award for “Best low-cost airline” in Europe in 2013 indicates that NAS has succeeded with differentiating themselves from the other LCCs in a positive way.

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3.6.3 Focus This strategy aims for the company to concentrate at a particular niche in the market to either differentiate themselves or become the cost leader. As previously mentioned there are two main niche groups in the airline industry, the business travelers and the leisure travelers. Through their two different service classes, low-fare and flex NAS serve both leisure and business travelers. However, regarding their long-haul operations it can be argued that they focus more on the leisure group due to the current destinations. Yet, in general NAS can be said to focus equally on both groups.

When analyzing the different generic strategies it seems like NAS is trying to find their position amongst the number of competitors. In the home market where its biggest competitor is SAS, NAS is the absolute cost leader and differentiate themselves from SAS with cheaper tickets and an “only pay for what you need” strategy. In an international context, NAS is more difficult to position. They don’t offer unique services that cannot easily be imitated, nor are they the cost leader. An explanation might be that NAS is a young international airline, it is still expanding into new markets and has yet to fit all the pieces in the puzzle. Nevertheless, the competition in these markets are fiercer and for NAS to acquire a sustainable competitive advantage the company needs to follow a unique strategy. A sustainable competitive is something that is rare and hard to imitate. Since the concept of the LCC business model is “no frills”, it is hard for a LCC to differentiate itself without offering increased service or unique attributes which will lead to a higher cost level. As for now, NAS’ biggest opportunity to get a competitive advantage is to become the cost leader. When the new subsidiary is established NAS compete on equal ground as the other LCCs, and time will tell if NAS possess the abilities needed to become the cost leader amongst its international competitors.

3.7 SWOT analysis The SWOT analysis sums up the strengts, weaknesses, opportunities and threats discovered in the strategic analysis.

3.7.1 Strengths and weaknesses NAS most prominent strength is its cost efficient fleet and effective cost structure. This is fundamental for a successful airline. The cost structure has led to a decreasing unit cost, and high yield compared to other low-cost carriers. This gives NAS the potential to become cost leader if operating on the right premises, but the company still has the lowest load factor amongst the low-cost carriers which can be affect the RASK. The company does not have any sustainable competitive advantages, and the services they offer are easy to imitate. Though, it’s innovative and “out of the box” approach to doing business still gives NAS a certain edge which attracts customers. NAS approach to hedging makes them more exposed to fuel price volatility than its competitors, and their focus on long-haul operations makes them vulnerable to a decrease in yield.

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3.7.2 Opportunities and threats NAS biggest opportunity is the potential to decrease its labor unit cost. This will give the company a necessary competitive advantage for further growth. Higher fuel prices is a threat for NAS as they do not hedge to the same extent as other airlines and a sudden and an unforeseen increase can be costly. The same accounts for the strong labor unions which have high bargaining power. NAS must also sort out the technical difficulties with the Dreamliner before it launches its routes from London, as trouble when entering a new market might disrupt its reputation. This is because its brand name is not as strong in the new markets as in Scandinavia and potential new customers is likely to choose another airline if NAS shows to be unreliable. The most significant threat for NAS is the possibility that it will not obtain an Irish flight license. This makes the company dependent on an extended temporary permission from the Norwegian Ministry of Aviation and due to the governmental and public opposition towards NAS’ “flagging out” it is not certain that this will be permitted.

Table 3: SWOT-analysis

INTERNAL Strenghts Weakness Strong brand name No evident competitive advantage Advanced IT infrastructure Easily imitated services Decreasing unit cost Lowest load factor among LCC's Effective cost structure - cost leader in home market Labor cost level Cost efficient fleet Small scale fuel hedging Innovative Chance of decreasing yield Routes appeal to a broad market Restructuring of the organizational structure Potential to become cost leader High current yield level Opportunities Threats Decreasing labor unit cost Higher labor unit cost in home market Market shares in new markets Established competitors Growth in passengers Increasing fuel prices Forecasted decrease in oil price High speed trains in Scandinavia High barganing power for labor unions Videoconferencing Norwegian labor legislation Denied Irish flight license Further technical issues with aircrafts EXTERNAL

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CHAPTER 4 – Financial analysis After analyzing the airline industry and NAS’ strategy and business environment, the focus will now be directed to the financial aspects. When performing a valuation the stock price relies on the expected future performance of the company. It is therefore natural to analyze the historical financial performance of NAS in order to understand the underlying cost drivers and what drives the value of the company. To do this is it necessary to reform the financial income statement and balance sheet. By doing this the operational drivers of value will be visible. In the last part of this chapter items of significance in the income statement will be discussed.

The basis of the financial analysis will be the annual reports from the past five years.

4.1 Quality of the financial statements It is important to assess the validity of the financial statement as companies may have reasons for altering numbers. Good accounting quality is characterized as a financial statement that provide an objective picture of the company’s financial position and is free of manipulation103. NAS follow the International Financial Reporting Standards (IFRS) and the group’s auditor is PricewaterhouseCoopers AS. It is stated in the auditor’s report that “in our opinion, the financial statements of the parent company are prepared in accordance with the law and regulations and presents fairly, in all material respects, the financial position for Norwegian Air Shuttle ASA as at December 31, 2012 and its financial performance and its cash flows for the year then ended in accordance with the Norwegian Accounting Act and accounting standards and practices generally accepted in Norway”104. These findings makes it safe to assume that NAS’ annual reports are in accordance with the prevailing rules and legislations and give an objective picture of the group’s financial position.

4.2 Reformulation of the income statement and balance sheet When reforming the income statement, the operational posts are separated from the financial posts. This way it is easier to see the true value drivers and the separation is also beneficial when the financial ratios are to be calculated. The definition of what is operational and financial posts is not always obvious because the definition is not clear cut. Also the classification of items in the income statement and balance sheet does not clearly distinguish between the two items.105 It is therefore important to do an arbitrary decision on what should be included in the operational items. The reformed income statement provides us with NOPAT, net operating profit after taxes and the reformed balance sheet shows the invested capital. The full reformulated income statement and balance sheet can be seen in appendix 1-3.

103 Petersen og Plenborg (2012) p. 334 104 Norwegian (2012) 105 Petersen og Plenborg (2012) p. 68-70

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In the following section a few selected posts are discussed as it is not clear whether they are classified as operating or financial items.

42.2 Revenues NAS’ revenues are generated from passenger transport, ancillary revenue and other revenues. The passenger transport and ancillary revenues stems directly from the operational activities but the other revenues must be looked into further. NAS states in its annual report that other revenues comprise revenues from third parties including wet-lease, cargo and revenue from business activities from subsidiaries that are not airlines. The revenues from the other subsidiaries are revenues from Bank Norwegian. This activity is considered to be an indirect part of NAS’ core business due to the reward program that is run in cooperation with Bank Norwegian and is therefore classified as an operating item.106 This reasoning also include the item Share of profit (loss) from associated companies.

4.2.3 Operating expenses The majority of NAS’ costs are directly linked to NAS’ core operations. Some items however need to be discussed further. In 2008 (and the previous years) there is a cost item named Blocked Space. This is an item that does not occur in the later years. This cost is not prominent and is therefore treated like a nonrecurring item and not included in the reformulated balance sheet.

4.2.4 Other losses (gains) – net NAS states in their annual report that the item Other losses (gains) – net is related to losses and gains on financial assets and financial liabilities. The size of this post has been fluctuating each year included in the analysis and no information regarding the performance of NAS is given. This post is therefore treated as a special item and removed from the operating activities in the reformulated income statement.

4.2.5 Other income In 2010 NAS received compensation from SAS regarding a law suit. This income is classified as other income in the income statement. This is something that is not likely to happen in the future and is treated as a special item. In 2010, 2011 and 2012 NAS has also had other income from sale of assets. These are considered transitory of nature and is not considered to have any effect on NAS’ future operations and are subtracted from operating income in the reformulated income statement.

4.2.6 Leasing NAS’ fleet consists of a mix between leased and owned aircrafts, where the larger part is leased. Leasing is used to avoid the large capital investments connected with aircraft purchases and in addition it makes the airline flexible with regards to capacity in the high/low season. There are two types of leasing - financial and operational. Financial leases are classified as a lease agreement where

106 Petersen og Plenborg (2010) p. 76 43 all material risks and rewards of the asset is transferred to the lessee at the end of the lease term. This type of lease is stated in the balance sheet as an asset and liability. In an operational lease agreement most of the risk lies with the contracting party.107 Contrary to a financial lease, the operational lease is not shown on the balance sheet. Due to this a company which lease its assets tend to have an artificially low operating profit, and artificially high capital productivity. Therefore it is necessary to find the asset value and include in the reformulated balance sheet to avoid that the financial ratios calculated at a later stage are biased. 108

There are several ways to find the asset value of an operating lease. Koller et al (2010) explains a method where the following formula is used.

푅푒푛푡푎푙 푒푥푝푒푛푠푒 퐴푠푠푒푡 푣푎푙푢푒 = 푡 푡−1 1 푘푑 + 퐴푠푠푒푡 푙𝑖푓푒 where kd = cost of debt

In this method the asset value is estimated based on rental expenses, cost of debt and asset life.

A second method is constructive capitalization, also called the ILW-method. The ILW-method estimates the amount of debt and assets that would be reported on the balance sheet if the operational leases had been treated as financial leases. The liability is calculated as the present value of the future minimum lease payments. To estimate the present value an interest rate is required and this would ideally be the average of the historical marginal secured borrowing rates of NAS, at the inception of the operating leases, weighted by the relative size of each lease in comparison to all operating leases. An estimate could be the historical interest rate for reported secured long-term debt. The present value is then treated as the off-balance sheet debt of the non-cancelable obligations under operating leases. The value of the off-balance sheet asset is estimated by examining the relation between assets and debt. The ILW is based on three assumptions, first that straight line depreciation is used for all assets, secondly that both the liability and asset of the operating lease equal the present value of future minimum lease payments in the beginning of each lease term and finally that the value of both the asset and liability is zero after the last payment. Further assumptions regarding asset life, tax rate, interest rate and remaining lease period are required. 109

NAS’ reports that it lease cars and properties in addition to aircrafts. It is fair to assume that these different items have different asset lives. However, no satisfactory information regarding asset life nor depreciation plan for the leased items is provided in the annual report. An inaccurate assumption on

107 Norwegian (2012) 108 Koller et all (2010) p. 559

109 Imhoff et al, (1991) p. 51-63 44 asset life could have a large impact on the asset value and this combined with other tricky assumptions necessary for the ILW method makes both this and Koller et al’s method inappropriate for the purpose of this paper.

A third method to find the asset value is a method that is applied by many in the banking community. In this method the lease payments are multiplied by a capitalization rate to find the approximate asset value. The capitalization rate is found by using the following formula:

1

1 푐표푠푡 표푓 푑푒푏푡 + 푎푠푠푒푡 푙𝑖푓푒

SAS and EasyJet states in their annual rapport that they use a capitalization rate of 7. This method is found the most suitable for the purpose of this paper and the rate stated by SAS and Easyjet is used as a benchmark since no satisfactory information is reported from NAS.

The lease interest expenses are then found by multiplying the calculated asset value by the cost of debt110. These expenses are then subtracted from the operating profit in the reformulated income statement while the remaining lease expenses are treated as depreciation expenses and are thereby included in the operational expenses. 111 The capitalized leasing cost is added to tangible assets and correspondingly to financial liabilities in the reformulated balance sheet.

4.3 Reformulated balance sheet In the reformulated balance sheet the operating assets and liabilities must be separated from the financial. This is done to analyze the company’s ability to generate profits. The classification of the items are discussed in the following.

4.3.1 Operating assets and liabilities The operating assets and liabilities must be identified so invested capital and net working capital can be calculated. The invested capital is found by subtracting total operating liabilities from total operating assets. The invested capital represents the amount a company has invested in its operating activities and which requires a return. 112

Non-current assets and liabilities  Intangible assets consists of NAS’ software and goodwill. These assets are associated with the operational side of NAS.  Deferred tax assets and liabilities most commonly arise from differences when accounting for taxes. It is not stated in the annual report whether the deferred tax assets and liabilities are

110 See section zzz 111 Koller et al (2010) p. 568. 112 Petersen og Plenborg (2012) p. 74. 45

connected to its financial or operating activities and is therefore included on the operational side as tax assets in most cases are related to operations.113 Consequently, the deferred tax liabilities will be attributed to the operational side.  Investment in associated companies can be argued that should not be a part of the core operations. The investment is a 20% share in Bank Norwegian. Bank Norwegian operates NAS’ cash point system and as these points can be used to purchase different services from NAS. Bank Norwegian can thereby be looked upon as a sales unit that sells the company’s products and this item is classified as operating. 114

Current assets and liabilities  Cash and cash equivalents often consists of operating cash and excess cash. It is not distinguished in the annual report between the two and as Petersen and Plenborg (2012) argues that in most cases the consequences of reclassifying operational cash as excess cash is modest, this item is chosen to be treated as a financial activity.  Derivative financial instruments are related to the gains and losses on NAS’ forward foreign exchange contracts and forward commodity contracts. These contracts are used to minimize risk related to fuel, and other operating costs denominated in USD. These financial activities are clearly related to NAS’ operating activities and thereby included in the operational current assets and liabilities.  Air traffic settlement liabilities, trade and other receivables and trade and other payables are items related to NAS’ customer and suppliers and hence operating activities and is included in the current assets and liabilities.

Financial assets and liabilities The financial side of the balance sheet consists of equity, net interest-bearing debt and minority interests.

 NAS’ borrowings are divided into short-term and long-term borrowings. Both types of borrowings are interest bearing and thereby a part of NAS’ financial liabilities.  Pension liabilities are interest bearing according to Petersen and Plenborg (2012) and is thus treated as a financial liability.  As previously mentioned cash and cash equivalents and capitalized operational leases are attributed to the financial assets and liabilities.

113 Petersen og Plenborg (2012) p. 88 114 Petersen og Plenborg (2012) p.76 46

4.4 Profitability analysis The profitability analysis examines NAS’ financial performance by using information found in the reformulated income statement and balance sheet. Sound profitability is important for NAS’ future survival and to ensure a satisfactory return to shareholders and the historical profitability is an important element in defining the future expectations from the company.115

Figure 23: Du Pont-model When performing a profitability analysis the Return on equity (ROE) is found. ROE measures the profitability taking both Return on operating and financial leverage into account. The equity (ROE) structure of the profitability analysis is also called the

Du Pont model and can be seen in a simplified version Return on Financial invested leverage below. captial (ROIC)

Asset Profit margin turnover

Source: Own creation based on Petersen and Plenborg, 2012

4.4.1 Return on invested capital The return on invested capital (ROIC) is a measure for the overall profitability of operations. The measure expresses the return on capital invested in NAS’ net operating assets and is important when analyzing the company’s historical performance. The formula for estimating the ROIC is:

푁푒푡 표푝푒푟푎푡𝑖푛푔 푝푟표푓𝑖푡 푎푓푡푒푟 푡푎푥 (푁푂푃퐴푇) 푅푂퐼퐶 = 퐴푣푒푟푎푔푒 𝑖푛푣푒푠푡푒푑 푐푎푝𝑖푡푎푙

The calculations of ROIC are based on average invested capital as this way of calculation is the most accurate if there is a steady development of invested capital over the years which is the case with NAS. 116 The development on NAS’s return on invested capital the past five years compared to the industry average is shown in Figure 24. NAS’ ROIC in 2012 was 7,64%. This indicates that the company in 2012 was able to generate 7,64 øre for each NOK invested. The ROIC has been variable the recent years with as low as 1,96% in 2010 and 10,48 % in 2009 as the highest level.

115 Petersen and Penborg (2012) p. 93 116 Petersen og Plenborg (2012) p. 96 47

NAS’ average ROIC of the period is FIGURE 24: RETURN ON 5,62 % which is a little higher than the INVESTED CAPITAL 2009 -2012 117 industry average 2004-2012 of 4,1%. 15,00%

This shows that the average profitability 10,00% 10,48% 7,64% of the company has been better than of 5,00% the industry the past four years. 2,41% 0,00% 1,96% 2009 2010 2011 2012 With regard to these findings it is NAS Industry average interesting to see how NAS’ ROIC Source: Own creation based on annual reports 2008-2012 performs compared to its main competitors. In the following graph the development of Ryanair and EasyJet’s ROIC is illustrated. These two airlines are chosen as a benchmark as they follow the same business model as NAS and thereby the accounting data and financial ratios are regarded as comparable.

To perform a cross-sectional analysis the data used in the analysis must be comparable.118 Hence, a reformulation of the income statement and balance sheet following the same premises as for NAS, is conducted for Ryanair and EasyJet. These can be seen in appendix 8-14.

In the cross-sectional analysis it can be FIGURE 25: CROSS -S ECT IO NA L seen that NAS’ ROIC in general have been ANALYSIS 2009 -2012 lower than Ryanair and EasyJet’s. 15,00% Ryanair’s average ROIC the past five 10,00% years have been 10,54% and this level can 5,00% be categorized as outstanding compared to 0,00% the industry standards. NAS reached a 2009 2010 2011 2012

ROIC higher than its competitors in 2009 NAS Industry average Ryanair Easyjet due to the reduced fuel cost level and Source: Own creation based on annual reports 2008-2012 increased production but on average NAS’ return on the invested capital is significantly lower than its competitors.

As the ROIC is not able to measure and explain whether the profitability is driven by a better revenue and expense relation or an improved capital utilization119, the ratio will in the following be

117 IATA (2013) 118 Petersen and Plenborg (2012) p.65

119 Petersen and Plenborg (2012) p. 107

48 decomposed into Profit Margin and Turnover rate of invested capital to better understand what drives NAS profitability.

The relationship between these ratios can be explained by:

푅푂퐼퐶 = 푃푟표푓𝑖푡 푀푎푟푔𝑖푛 (푃푀) 푥 퐴푠푠푒푡 푡푢푟푛표푣푒푟 푟푎푡𝑖표 (퐴푇푂)

The two variables will be analyzed in the subsequent sections.

4.4.2 Profit margin The profit margin describes the relationship between revenues and expenses and expresses operating income as a percentage of net revenue. The profit margin is defined as:

푁푂푃퐴푇 푃푟표푓𝑖푡 푀푎푟푔𝑖푛 = 푁푒푡 푅푒푣푒푢푒푠

The airlines operate in an industry where FIGURE 26: PROFIT MARGIN the competition is high and it is highly 2008-2012 affected by economic cycles. It is 20,00% consequently a hard industry to maintain 15,00% high profit margins. In the recent years the 10,00% airline industry has been characterized by 5,00% very low profit margins and the average 0,00% expected profit margin in the airline 2008 2009 2010 2011 2012 120 industry for 2012 was 0,6%. This means NAS Ryanair Easyjet that the average airline only is able to Source: Own creation based on annual reports 2008-2012 generate a net income of 0,6 øre for each NOK of sales. Figure 26 shows the development in NAS and its peers’ profit margin the past five years.

It is evident that NAS’ profit margin fluctuated with the same pattern as it’s ROIC. The reason for this stems from NAS’ costs as the revenues has been steadily increasing during the entire period. Looking at the profit margin of Ryanair and EasyJet, Ryanair again has a formidable level of the ratio. This means that Ryanair has a clear competitive cost advantage over the other airlines. This comes as no surprise as Ryanair has been the clear cost leader in the previous analyses done in Chapter 3. NAS’ profit margin is on average lower than the competitors with NAS’ average being 3,75% compared to Ryanair’s 12,51% and EasyJet’s 5,96%. On a positive note, in 2012 NAS and EasyJet are developing towards the same level.

120 CAPA (2012b) 49

4.4.3 Asset turnover The turnover rate expresses a company’s ability to utilize invested capital. The asset turnover rate is defined as:

푁푒푡 푅푒푣푒푛푢푒 퐴푠푠푒푡 푡푢푟푛표푣푒푟 = 퐼푛푣푒푠푡푒푑 푐푎푝𝑖푡푎푙

An asset turnover rate of 1,06 conveys that for each NOK invested in operation, 1,06 NOK is generated. This implies that a high asset turnover rate is preferable as this shows that the company effectively uses its assets to generate revenue.

The asset turnover rate of NAS decreased from FIGURE: 27 ASSET 1,44 in 2009 to 1,06 in 2012. This is opposite of TURNOVER RATE 2009 - 2012 EasyJet which had levels almost equal to NAS in 2,10

2009 but has seen an increase from 1,40 in 2009 1,60 to 1,68 in 2012. On the other hand Ryanair has 1,10 had the lowest asset turnover rate during the 0,60 whole period. This indicates that Ryanair’s ability 2009 2010 2011 2012 to utilize its assets is worse than the other airlines. NAS Ryanair Easyjet NAS has also seen a reduction in this ability the Source: Own creation based on annual reports 2008-2012 past years and this results in inefficiency. An explanation for NAS’ decreasing asset turnover may be its investments in a new fleet which has led to a higher increase in investments than in revenue.

FIGURE 28: ROIC, PROFIT When examining Figure 28 it is observed that the MARGIN AND TURNOVER NAS’ ROIC fluctuations are caused mainly by RATIO 12,00% 2,00 the fluctuations in the profit margin and thus a 10,00% 1,50 varying revenue and expense relation. As seen 8,00% 6,00% 1,00 the ROIC and profit margin are almost identical 4,00% 0,50 over the period while the asset turnover rate are 2,00% 0,00% - more stable. This strengthens the indication of it 2009 2010 2011 2012 being the revenue and expense relation that is the ROIC Profit Margin main driver of the return on invested capital. ATO - Right scale

Source: Own creation based on annual reports 2008-2012 4.4.4 Return on equity The return on equity (ROE) measures the profitability taking into account both operating and financial leverage contrary to the previous section where only operating profitability where addressed. The ROE

50 measures the owners of NAS’ return on their investments. The trends and level of ROE is affected by the following three factors:121

 Operating profitability (ROIC)  Net borrowing interest rate after tax  Financial leverage

Return on equity is found by applying the following relationship:

푁푒푡 𝑖푛푡푒푟푒푠푡 푏푒푎푟𝑖푛푔 푑푒푏푡 푅푂퐸 = 푅푂퐼퐶 + (푅푂퐼퐶 − 푁푒푡 푏표푟푟표푤𝑖푛푔 푐표푠푡 푎푓푡푒푟 푡푎푥) 푥 퐵표표푘 푣푎푙푢푒 표푓 푒푞푢𝑖푡푦

푁푒푡 푖푛푡푒푟푒푠푡 푏푒푎푟푖푛푔 푑푒푏푡 푤ℎ푒푟푒 = 퐹𝑖푛푎푛푐𝑖푎푙 푙푒푣푒푟푎푔푒 퐵표표푘 푣푎푙푢푒 표푓 푒푞푢푖푡푦

The net borrowing costs is found by dividing net financial expenses after tax by net interest bearing debt. Petersen and Plenborg states that the rate found using this formula rarely matches the true borrowing rate of a firm as there is a difference between deposit and lending rates and currency gains and losses are included in the financial income and expenses. Due to this the average of the effective interest rate on borrowings stated in the annual report the respective years will be used as an estimate. The borrowing cost found will be adjusted for the corporate tax rate which is 28% in Norway.

The financial leverage gives information about the Figure 29: Financial leverage relationship between debt and equity. It is calculated 5,00 4,62 4,49 as previously mentioned by dividing net interest 4,50 3,80 bearing debt by book value of equity. The 4,00 3,46 3,50 development of the financial leverage the past five 2,86 3,00 years can be seen in Figure 29. As observed the 2,50 financial leverage ratio has been high the past years 2008 2009 2010 2011 2012 something that indicates a high debt level compared Source: Own creation based on annual reports 2008-2012 to equity.

121 Petersen and Plenborg (2012) p. 117 51

The return on equity for NAS and the competitors is FIGURE 30: RETURN ON illustrated in Figure 30. The level of ROE has EQUITY fluctuated a substantial amount from 25% in 2009 to 30,00% being negative in 2010 and 2011 and again 20,00% increasing to 24% in 2012. The negative levels in 10,00% 2010 and 2011 is explained by the drop in ROIC due 0,00% -10,00% to the low levels on the profit margin which again 2009 2010 2011 2012 were caused by an higher increase in costs compared NAS Easyjet Ryanair the increase in revenue. Even though the negative Source: Own creation based on annual reports 2008-2012 levels in ROE can to some extent be explained by economic cycles and other external factors it still means that NAS was not able to generate any profit with the shareholders’ investments these years. EasyJet and Ryanair had a more promising development in the ROE with an average of respectively 10,65% and 13,09%. This is marginally higher than NAS’ average of 10,37%. This shows that except from in 2010 and 2011 NAS’ ROE has been substantially higher than the two other airlines.

4.5 Items of significance in the income statement The following item is included in this section because a change in the fuel costs and exchange rate will impact the expectations for the future and thus have special significance to the following chapters of forecasting and budgeting.

5.5.1 Fuel costs and exchange rates The fuel costs have been discussed previously in the paper but this section will focus more on the impact of change in the fuel price.

Table 4: Fuel costs in percent of operating costs

2008 2009 2010 2011 2012 NAS 31 % 21 % 33 % 40 % 41 % Ryanair 36 % 45 % 35 % 39 % 43 % Easyjet 34 % 33 % 28 % 31 % 44 %

Table 4 shows the development of the fuel costs in percent of operating costs for NAS, Ryanair and EasyJet. The table shows that the fuel cost is a large part of an airlines total costs and as these costs are affected by external factors and risk management is important. As previously mentioned NAS’ hedges to some extent but less than its competitors. As jet fuel are denominated in USD and NAS’ functional currency is NOK, there are two external factors that affect NAS’ fuel costs – the jet fuel price and the exchange rate.

52

Table 5: Fuel cost with varying fuel price and exchange rate

Fuel price/exchange rate 5NOK/USD 5,5NOK/USD 6NOK/USD 6,5NOK/USD 7NOK/USD 600 USD/ton 1 708 893 1 879 782 2 050 672 2 221 561 2 392 450 800 USD/ton 2 278 524 2 506 376 2 050 672 2 962 081 3 189 934 1000 USD/ton 2 848 155 3 132 971 3 417 786 3 702 602 3 987 417 1200 USD/ton 3 417 786 3 759 565 4 101 343 4 443 122 4 784 900 1400 USD/ton 3 987 417 4 386 159 4 784 900 5 183 642 5 582 384

Table 5 shows how the fuel cost would have varied at different levels of jet fuel price per ton and exchange rate. It is evident that a small change in the exchange rate and jet fuel price could have a huge impact on NAS’ costs if no risk management is undertaken. It must be remembered that NAS is not exposed to US dollar just through jet fuel, but also through aircraft borrowings and leasing contracts etc. To minimize the risk of fluctuations NAS had in December, 2012, forward foreign currency contracts worth MUSD 761 to secure its debt, and secured 8090 tons of jet fuel through derivative contracts.

Hedging is important to avoid a sudden increase in exchange rates or jet fuel price, but also to have a better indication of what future costs will be. A sudden increase in cost level might reflect in higher ticket prices for the customers, which may result in the price sensitive customers choosing another airline. The fact that NAS hedges its jet fuel to a less extent than its competitors is difficult to asset whether is the correct strategy or not. Though, when looking at NAS’ fuel cost in percent of operating costs compared to Ryanair and EasyJet the numbers does not differ significantly which indicates a right path. Hedging is mentioned in this section to give an indication of the company’s risk exposure. The hedging strategies have no or little long-term effect on the valuation.

4.6 Partial conclusion In the financial analysis it was found that NAS’ profitability ratios has been fluctuating the past years. The ROIC has been fluctuating more than the peer-group due to a varying profit margin. This indicates that the ROIC is driven by the revenue and expense relation rather than capital utilization. The asset turnover rate has been decreasing in the analyzed period, most likely due to the investments in a new fleet which has led the invested capital to increase at a higher pace than the revenues. The low level of ROIC in 2010 and 2011 led to a negative ROE in these years which means NAS was not able to generate any profit with the shareholders investments these years.

When analyzing the chosen peer-group for the financial analysis, Ryanair’s low unit cost is reflected in its financial ratios and this is the airline with the strongest development in ROIC and profit margin over the analyzed period. NAS had the highest level of ROE in 2009 and 2012, and Ryanair had the lowest asset turnover rate of the peer-group throughout the whole measured period. EasyJet can be considered as NAS’ closest peer and in 2012 the two airline’s ratios are somewhat similar. This is a 53 positive sign for NAS as NAS to this date still is a minor player internationally and EasyJet is considered a large and important airline in the international market.

The low levels on the ratios in 2010 and 2011 can be explained by new investments, but it shows that revenue growth is not high enough to out weight the negative effect the new investments have on the financial ratios. However in 2012 the ratios are higher which can indicate that this was a temporary situation. All in all, the business model can be regarded as sustainable on a long-term perspective because it is the core business that generates the earnings.

54

CHAPTER 5 – Forecasting and valuation In the previous chapters a foundation for the subsequent chapter has been build. The strategic analysis has provided useful information regarding the airline industry and what characterizes it. The strategic analyses has identified the external factors that affect NAS’ value creation and placed NAS in relation to its competitors in terms of important industry measures like load factor, yield and unit costs. With regards to this NAS’ competitive advantages was found. The financial analysis has provided an understanding of the financial and operational historic performance and given information about the value drivers. The information collected in these two analyses create the basis of the forecasted budget that will be projected in this chapter. The forecasting is done to create an indicator of how the company’s financial performance will develop which is important when estimating the share price.

5.1 The discounted cash flow model Present value approaches estimate the intrinsic value of a company based on analysts’ projections of the cash flows of a company and the discount factor that reflects risk in the cash flows and the time value of money. 122

The most popular of the present value approaches is the discounted cash flow model (DCF). This model discounts the free cash flow available to all investors at the weighted average cost of capital (WACC). The model is two staged where the first stage is the forecast period and the second the terminal period. In this model only the free cash flow to the firm, the growth rate and the WACC affect the market value of the company. The model can be explained by the following equation:123

퐵푢푑푔푒푡 푃푒푟푖표푑 푇푒푟푚푖푛푎푙 푝푒푟푖표푑 ⏞푛 퐹퐶퐹퐹 퐹퐶퐹퐹 ⏞ 1 퐸푛푡푒푟푝푟𝑖푠푒 푣푎푙푢푒 = ∑ 푡 + 푡 푥 0 (1 + 푊퐴퐶퐶)푡 (푊퐴퐶퐶 − 푔) (1 + 푊퐴퐶퐶)푛 푡=1

where FCFF = Free cash flow to the firm WACC = Weighted average cost of capital g = growth in the terminal period n = years in budget period

The DCF method is popular valuation method because of its forward looking approach. It use future expectations in estimating value rather than historical performance. This is beneficial as the future will never be exactly the same as the past. The model is also flexible with regards to not being influenced by the applied accounting practice and it relies on the fundamental expectations of the company and allows strategic activities to be accounted for.

122 Petersen and Plenborg (2012) p. 212 123 Koller et al (2010) p. 103 55

The model is based on assumptions. The most fundamental one is that it assumes that all cash surpluses will be paid out as dividends or reinvested in projects with a net present value equal to zero.

The negative sides of this model is that it relies solely on the assumed expectations of the future performance found in the forecasted budget. This implies that even small errors in assumptions and in the forecasting measures can lead to large mistakes when estimating the value of the company.124 This is why a sensitivity analysis is performed after the valuation to see how changes in the assumptions alter the share price and the value of the company.

In the following sections of the paper the different variables included in the DCF-model will be estimated and discussed.

5.2 The weighted average cost of capital As the WACC is one of the key elements in the DCF model this is an important factor. The WACC is used to discount the future cash flow to find a present value. It is important to use great care when estimating the WACC as small alterations in can have a great impact on the final value of NAS. The WACC represents the weighted average cost of equity and net interest bearing debt. The relationship is expressed in the following:

푁퐼퐵퐷 푀푉퐸 푊퐴퐶퐶 = x 푟 x (1 − 푡) + x 푟 푁퐼퐵퐷 + 푀푉퐸 푑 푁퐼퐵퐷 + 푀푉퐸 푒 where NIBD = net interest bearing debt MVE = market value of equity 푟푑 = interest rate on net interest bearing debt 푟푒 = shareholder’s required rate of return t = the company’s marginal tax rate

In the following sections the capital structure, cost of debt and shareholders return will be discussed.

5.2.1 Capital structure The calculation of WACC is dependent on the capital structure as this indicates the weights of cost of debt and cost of equity. The debt-to-equity ratio should reflect the target level rather than the current weights as the current capital structure don’t necessarily reflect the levels that is expected to prevail in the future.125

NAS states in their annual report that their policy is to have a capital structure that meets the demands of operations, reduces cost of capital, complies with financial covenants and future investments planned by the group and that they will constantly adjust debt and equity to maintain and secure an optimal capital structure. Hence, there is no information about the explicit target level.

124 Petersen and Plenborg (2012) p. 218 125 Koller et al (2010) p. 262 56

To estimate the target capital structure of a company a combination of three approaches can be used. 126

1. Estimate the company’s current market-value-based capital structure.

To find the target debt-to-equity ratio one must use market values as these values is the numbers that reflect the true opportunity cost of investors.127 The market value of equity is found by multiplying the number of shares outstanding with the current market price the same date.128 By 31.12.2012 NAS had 35 162 139 shares outstanding and the market price the same date was NOK 143,9. Yet, the share price has risen substantially since that time and using the market share price per 21.11.2013 would have increased NAS’ equity by NOK 2,6 billion. With regards to this, Koller et al (2006) states that this current share price might only reflect a short-term upswing in the market that the management has yet to rebalance. The share price of 31.12.2012 is thus used in this paper. As no observable market value of the net-interest bearing debt is available the book-value of the debt is used as an estimate129. With respect to these findings the debt-to-equity ratio is estimated to be respectively 78% and 22% per 31.12.2012.

2. Review the capital structure of comparable companies.

In Figure 31 the equity ratio for NAS and its FIGURE 31: EQUITY RATIO peer-group is illustrated for the past five years. 2008-2012 In addition to this the peer-group average and 100,00% the industry average130 is added. As seen there is no obvious coherence between equity ratio 50,00% and industry when looking at the selected 0,00% variables. NAS equity ratio is by far lower 2008 2009 2010 2011 2012 than its competitors and the ratio in the peer- NAS Ryanair Easyjet Average group varies from 11,61% to 84%. As a result INDUSTRY AVERAGE of this it is problematic to identify a reliable Source: Own creation based on annual reports 2008-2012 industry standard.

3. Review business management’s implicit or explicit approach to financing the business and its implications for the target capital structure.

126 Koller et al (2010) p. 263 127 Petersen and Plenborg (2012) p. 246 128 Koller et al (2010) p. 264 129 Koller et al (2010) p. 263 130 Petersen and Plenborg (2012) p. 248 57

Other than the statement mentioned above there are no statements regarding the target capital structure.

Given the results of the three approaches above it is concluded that the best estimate for the debt-to- equity ratio is an average of the past five years. This seems to be the best estimate of a target capital structure. By using the average historical capital structure changes in share price and externally influenced cyclical changes has been taken into account. As NAS states that it constantly adjust debt and equity ratio to maintain and secure an optimal capital structure it is assumed that this has been done in the past years and the average thus is a good estimate for the future. The equity and debt ratio used in further calculations is 21% and 79% respectively.

5.2.2 Cost of debt The interest rate of debt after tax is calculated as:

푟푑 = (푟푓 + 푟푠) 푥 (1 − 푡) where 푟푑 = required rate of return on net interest-bearing debt 푟푓 = risk-free interest rate 푟푠 = risk premium on debt (credit spread) t = corporate rate on tax

The corporate tax in Norway is per 2012 and 2013 28%.

In the following sections the risk-free interest rate and NAS’ company specific risk will be estimated.

5.2.2.1 Risk-free interest rate The risk-free interest rate expresses how much an investor can earn without incurring any risk. A proxy for this rate is usually local government bonds as the underlying assumption is that these bonds are risk-free. For valuation purposes a government bond with a time horizon of 10 or 30 years are often used. The 30-year bond may suffer from illiquidity which will affect the yields while the 10-year bond is less sensitive to changes in inflation and matches the underlying cash flow better than the 30- year bond. 131 Hence, for the purpose of this paper the rate for Norwegian 10-year government bonds are used as an estimate for the risk-free interest rate. The average rate for this bond was 2,1% in 2012. 132

131 Petersen and Plenborg, 2012. p 249 132 Norges Bank (2012) 58

5.2.2.2 Risk premium on debt The risk premium on debt is also known as the credit spread. This is the difference between corporate bonds and credit risk-free bonds.133 For this paper it is calculated as the difference between the issued bonds and the risk-free interest rate.

The cost of debt after tax for NAS is thus estimated to be:

푟푑 = (0,021 + (0,075 − 0,021) 푥 (1 − 0,28) = ퟓ, ퟒퟕ %

5.2.3 Shareholders’ required rate of return – CAPM The most common method of estimating the shareholders’ required rate of return is the Capital Asset Pricing Model (CAPM). The basic idea behind the CAPM is that by holding a sufficiently broad portfolio of shares, investors will only pay for the risk that cannot be diversified away. Hence, it is only the systematic risk which is priced. The systematic risk is expressed by the beta (β). 134

According to the CAPM the shareholder’s required rate of return is defined as:

푟푒 = 푟푓 + 훽푒 (푟푚 − 푟푓) where 푟푓 = risk-free interest rate 푟푚 = return on market portfolio 훽푒 = Systematic risk on equity (levered beta)

The CAPM model is based on the assumptions that all investors are risk-averse, can sell and buy at competitive prices and face no transaction cost, can borrow and lend at the risk-free interest rate and that all investors have homogenous expectations. These assumptions are regarded as unrealistic but it is stated that the model works as well as the next best alternative. 135

5.2.3.1 Systematic risk – Beta Beta is the relative risk the company is facing in relation to the market portfolio. An explanation of how the different levels of beta is interpreted is illustrated in Table 6.

Table 6: Interpretation of Beta

β=0 Risk-free investment β<1 Investment is less risky than the market portfolio β=1 Investment has the same risk as the market portfolio β>1 Investment har greater risk than the market portfolio

133 Koller et al (2012) p. 488 134 Petersen and Plenborg (2012) p. 249 135 Damodaran (n/a) 59

The beta cannot be observed and must thus be estimated. The most common method to estimate the raw beta is by performing a regression analysis. In this method the returns of NAS’ shares for a selected time interval, is regressed with the return on a market portfolio to find the estimated beta. The most common regression model used to estimate beta is the market model. 136 This model is defined as:

푟푖 = ∝ + 훽푟푚 + 휀

When applying the market model several factors must be taken into consideration. The first factor is measurement period. Koller et al (2006) recommends using at least five years of data to get enough data for the analysis. The time horizon is therefore chosen to be from 1.1.2008 – 22.11.2013.

The next factor to take into consideration is the return interval. Return interval refers to whether daily, weekly or monthly returns should be used in the regression analysis. Daily returns will give the highest number of observations but will also expose the data set to systematic biases related to non- trading days. This may also be the case with weekly returns.137 Monthly returns are thus recommended as this return interval will give the most precise estimate of beta. For this paper a regression analysis with both monthly and weekly returns are performed to illustrate the difference in beta.

The final factor to take into consideration is the choice of market index. Ideally the beta should be estimated against the index of which the stock is traded. In NAS’ case this would be Oslo Stock exchange (OSEBX). However, as this index is heavily weighted in only a few industries (the energy sector) this index is not applicable for this purpose. With regards to this two international well- diversified market portfolios are chosen instead. The chosen market indices are Standard & Poor’s 500 index (S&P500) and Morgan Stanley Capital International Index Europe, Australia and Far East (MSCI EAFE). These indices are recognized as good estimates for the market index as they both contains a well-diversified market portfolio.

Table 7 illustrates the market index and the two different return intervals. As seen in the table the different return intervals and market indices lead to different beta estimations.

Table 7: Estimated beta using regression Weekly Monthly

NAS/SP500 NAS/MSCI EAFE NAS/SP500 NAS/MSCI EAFE Beta 1,02 0,95 1,55 1,23

Average 0,985 1,39 Source: Yahoo Finance, retrieved 22.11.2013

136 Koller et al (2010) p. 245 137 Koller et al (2010). p.246 60

The beta values found when using the regression analysis differ to such an extent that it is found necessary to take a look at the beta for the airline industry. Damodaran (2013) has analyzed 44 airlines in Europe and found that the unlevered beta value for the European airline industry is 0,602.138 The formula for levered beta is:

퐷 훽 = 훽 푥 (1 + ) 푙푒푣푒푟푒푑 푢푛푙푒푣푒푟푒푑 퐸

When applying the industry beta in this formula a beta level of 2,85 is found. This estimation proves that the underlying assumptions made when calculation the beta largely affect the value. The reason for this beta estimate being so high is the debt-to-equity ratio found in section 5.2.1. A lower ratio would have resulted in a lower beta value.

As the airline industry is volatile and sensitive to external factors it is reasonable to assume that NAS’ systematic risk should be higher than for the market portfolio. A beta of 2,85 is though considered to be too high. It is thus considered that the average of the beta estimation found in the regression analysis using monthly return intervals is a reasonable estimate for NAS’s systematic risk. A beta of 1,39 is used as an estimate of beta in the CAPM model.

5.2.3.2 Market risk premium The market risk premium is the difference between market returns and returns from risk-free investments and indicates what an investor requires in order to be willing to invest in the market portfolio rather than in a risk-free portfolio. There are two commonly used ways to determine the risk premium, ex-post and ex-ante. The ex-post approach examines the difference between historical returns on the stock market and returns on risk-free investments tracing 50 to 100 years back in time. A drawback with this approach is that it is backward looking and thus might not be a good indicator for the future market portfolio’s risk premium. In this paper the latter approach is used. The ex-ante method attempts on the basis of analyst’ consensus on Table 8: Market Risk Premiums future earnings to infer the market portfolios implicit Pwc 5 % risk premium. 139 As there is no such consensus, a Deloitte 5,80 % selection of assorted financial companies’ and analyst’s Bloomberg 11,90 % Damodaran 5,80 % estimate of the risk premium in Norway in 2012 is Average 7 % presented in Table 8. As seen the estimates vary from Source: PWC(2013b),Deloitte(2013), 5% to 11,9%. As 11,9% is considered too high, this rate Damodaran(2013b) is disregarded and the average of the remaining risk

138 Damodaran (2013) 139 Petersen and Plenborg (2012) p. 263 61 premiums is used as an estimate for the risk premium. Thus, for the purpose of this paper a risk premium of 5,5% is used.

Based on the analyses provided in the above sections, the CAPM is calculated on the basis of a risk- free interest rate of 2,1%, a beta of 1,39 and a market risk premium of 5,5%. The return on equity is thus found to be:

풓풆 = ퟎ, ퟎퟐퟏ + (ퟏ, ퟑퟗ 풙 ퟎ, ퟎퟓퟓ) = ퟎ, ퟎퟗퟕퟓ = ퟗ, ퟕퟓ%

The weighted average cost of capital is hence calculated as:

푾푨푪푪 = ퟎ, ퟕퟗ 풙 ퟎ, ퟎퟓퟒퟕ + ퟎ, ퟐퟏ 풙 ퟎ, ퟎퟗퟕퟓ = ퟔ, ퟑퟕ%

The average WACC for European LCC’s between 2004-2012 has been 8,3% according to IATA. 140 In addition, NAS states that they apply a discount rate of 7,9% for 2012. A reason for the cost of capital differing from the one stated in the annual report and the airline industry average might be the assumptions chosen when estimating the WACC. The capital structure has an impact on the WACC and as previously mentioned, NAS has a very high debt ratio. A reason for this might be because the capitalized leases are included in the net-interest bearing debt in the reformulated balance sheet, contrary to in the original. When a calculation of the debt-to-equity ratio without capitalized leases is performed the estimated WACC is 6,84 %. This is not a significant difference. It is thus assumed that the underlying assumptions used when calculating the WACC is accurate and the WACC of 6,37 % is used for the purpose of this paper.

5.3 Assumptions for the forecasted free cash flow In order to perform the valuation of NAS, an estimate of the future cash flows must be provided. This is done by combining the findings in the strategic and financial analysis to create a forecast of the future financial performance. In addition, the financial outlook for the industry is taken into consideration when establishing the forecasts.

When choosing the budget period, one must be aware that a too short period may undervalue the company and on the other side, it is hard to forecast specific items a long time into the future.141 To intercept the long-term effects of the changes NAS is going through, a budget period of 10 years is chosen.

Even though forecasting is a good way to estimate future performance, there are factors that must be remembered. The first factor is that the forecasted numbers will always be subject to the analyst’s individual opinion and thus not truly objective. The second factor is that even though the forecasted

140 IATA (2013) 141 Koller et al (2012) p. 186 62 numbers are a result of thorough analyses, the fact that the numbers are based on historical performance causes an uncertainty. With regards to this it is important to state that no matter how thorough and objective the analyses are, it is not possible to predict the future. The forecasting is thus a result of the individual opinion but is supported by in-depth and well-argued analyses and it is assumed that the chosen predictions will lead to a qualified and reliable estimate of NAS’ share price.

In the table below the estimated forecast assumptions are showed. The next sections will provide a discussion on which basis these assumptions are made.

5.4 Revenues When estimating NAS’ future revenues it is natural to look at the capacity increase NAS is expecting in the future. This is as discussed in the strategic analysis, measured in number of Available seat kilometers (ASK). The planned increase of the fleet has been briefly discussed previously in the paper, but a more thorough analysis is required to estimate the effect with regards to revenues. NAS states that they anticipate a growth rate in the fleet of 11% from 2016-2023. Combined with the detailed information the company provides regarding the fleet until 2015 this allows us to calculate an estimate of future capacity.

5.4.1 Number of aircrafts The first step is to calculate the average Figure 32: Number of aircrafts number of aircrafts in the fleet in the 250 forecast period. This is done by 194 200 167 179 139 154 analyzing the fleet plan that is provided 150 126 102 114 84 95 until 2015 and estimating an average 100 62 68 growth of 11% annually for the rest of 50 0 the forecast period. The result can be seen in Figure 32. As no information regarding additional long-haul aircrafts Source: Own creation based on annual report 2012 in the future is provided, it is assumed that the level of long-haul aircrafts will stay at the 2015-level the remaining period. This year the number is 8. This estimated total number of aircrafts will be used to estimate ASK per aircraft.

5.4.2 ASK per aircraft When estimating the ASKs per aircraft it is Table 9: ASK’s per Aircraft necessary to look at the historical levels. As 2011 2012 illustrated in Table 9 ASK’s per aircraft in 2011 Number of aircrafts 62 68 was 354,2 and 381,2 in 2012. This implies that Total ASK 21958 25920 ASK per aircraft 354,2 381,2 the newer aircrafts implemented in the fleet has a bigger capacity than the older ones. When estimating ASK’s per short-haul aircraft the historic ASK

63 per aircraft is multiplied with number of short haul aircrafts to find the contribution to total ASK’s. As is it proved that capacity will increase, a 4% growth in ASK per aircraft is added in 2013 and then 2% each year until 2015. After this it is assumed that ASK’s will stay at constant level.

To find the ASK contribution from long-haul aircrafts it is assumed that these aircrafts have a capacity that is twice the short-haul due to the size and stage length and that this capacity will stay constant.

Table 10: Total ASK’s in forecast period

F2013 F2014 F2015 F2016 F2017 F2018 F2019 F2020 F2021 F2022 Short-haul 81 88 94 106 118 131 146 159 171 186 Long-haul 3 7 8 8 8 8 8 8 8 8 Total fleet 84 95 102 114 126 139 154 167 179 194 ASK pr short-haul 396,4 404,4 412,4 412,4 412,4 412,4 412,4 412,4 412,4 412,4 ASK pr long-haul 762,4 762,4 762,4 762,4 762,4 762,4 762,4 762,4 762,4 762,4 Long-haul contribution 32 110 35 583 38 769 43 705 48 685 54 164 60 190 65 493 70 504 76 632 Short-haul contribution 2 287 5 336 6 099 6 099 6 099 6 099 6 099 6 099 6 099 6 099 Total ASK 34 397 40 919 44 868 49 804 54 784 60 262 66 289 71 592 76 603 82 731 ASK pr aircraft 409 431 440 437 435 433 431 429 428 427

As seen the introduction of more short-haul aircrafts in the fleet lowers the total ASK per aircraft.

5.4.3 Yield and load factor When estimating the revenues it is necessary to forecast yield and load factor as we remember from the strategic analysis that these estimates are important for total revenues. In addition the released interim rapports from 2013 will serve as an indicator of performance in the first forecast year as the valuation date is set to 04.12.2013.

The load factor describes how many of the available seats that are sold. In the strategic analysis it was found that a result of increased capacity could be a diminishing load factor as the growth in capacity exceeds the growth in the market. In 2012 NAS had a load factor of 79%. As we have seen when estimating future ASK’s, the capacity will increase at high rate and this combined with fiercer competition, will make it hard to maintain this load factor. In the interim rapports (Q1-Q3) from 2013 it is stated that load factor diminished in the two first quarters and increased again in the third. This is in accordance with the findings in the strategic analysis. It is thus assumed that NAS load factor will stabilize at a lower level than the historical. A reasonable estimate for future load factor is estimated to be the average of the reported numbers for 2013 which is 78%.

The yield measures the revenue generated per passenger kilometer. NAS will see an increased stage length as a result of the introduction of long-haul operations. As discussed in the strategic analysis it is hard for airlines to rise the tickets price to a level that compensates for an increased stage length. In addition, it is likely that NAS in the introduction period to international markets will promote the company by selling its tickets at a low price to attract new customers. The modernization of the fleet is also a cost saving strategy. Lower fuel and operating costs will thus enable NAS further lower its 64 ticket prices in all markets. A final factor that impact the yield level is the previously mentioned capacity increase. Most likely this will not only affect the load factor because when supply is higher than demand, a natural consequence is a lower price level. As found in the strategic analysis the stage length and ticket prices are the two main factors that affect the yield, and an increased stage length and lower ticket prices is a combination that is very likely to cause a decline in the yield. In the available quarterly rapports for 2013, it is reported a yield development in coherence with these arguments. It is therefore estimated that the yield will diminish by a rate of 0,025 in F2013. It is found reasonable to assume that the diminishing rate will have a slower development in the coming years, and that the yield will diminish by 0,012 in 2014 and then 0,01 until 2017. The yield is then predicted that to stay constant at the 2017-level of 0,483 for the rest of the forecast period. This constant level is predicted to be a reliable estimate as it is 0,007 higher than Ryanair’s current level.

5.4.4 Total passenger revenue To estimate the total future revenues for NAS total number of ASK’s will be multiplied by RASK which is found by multiplying yield with load factor. As remembered, RASK indicates the ticket revenue per unit produced.

Table 11: Forecasted Passenger Revenue

F2013 F2014 F2015 F2016 F2017 F2018 F2019 F2020 F2021 F2022 Load factor 78 % 78 % 78 % 78 % 78 % 78 % 78 % 78 % 78 % 78 % Yield 0,525 0,513 0,503 0,493 0,483 0,483 0,483 0,483 0,483 0,483 RASK 0,410 0,400 0,392 0,385 0,377 0,377 0,377 0,377 0,377 0,377 Total ASK 34 397 40 919 44 868 49 804 54 784 60 262 66 289 71 592 76 603 82 731 Revenues 14 086 16 377 17 607 19 155 20 644 22 708 24 979 26 977 28 865 31 175

When looking at the latest market forecast of aircraft manufacturer Airbus, they predicts the 20-year world air traffic growth rate to be 4,7% and as discussed in the PET-analysis, the forecasted world GDP growth is predicted to be 3,1% over the next 20 years. With regards to this the estimate of future revenues seems reliable.

5.4.5 Ancillary revenues Ancillary revenue is revenue generated from sale of additional services. The past years this item has been 8% and 14,5% of the revenue from passenger transport, but has seen a decreasing trend the past two years. It is thus predicted to stay at the 2012-level of 12,5% of passenger revenue for the entire forecast period.

5.4.5 Other revenues Other revenues is difficult to forecast as they consist of non-foreseeable items like sale of assets and other compensations. In the past other revenues has on average been 2,16% of passenger transport and due to this it is projected that other revenues will be 2,16% of passenger revenues throughout the forecast period

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As the revenues are projected with regards to growth in production the remaining part of the forecast are estimated in relation to revenue.

Table 12: Forecast assumptions for operating expenses

FORECAST ASSUMPTIONS HISTORICAL FORECAST 2008 2009 2010 2011 2012 Average F2013 F2014 F2015 F2016 F2017 F2018 F2019 F2020 F2021 F2022 Jet fuel 32,2 % 19,5 % 24,9 % 29,4 % 29,1 % 27,0 % 28 % 27 % 26 % 25 % 23 % 22 % 22 % 22 % 22 % 22 % Airport charges 13,5 % 14,2 % 15,4 % 14,8 % 13,5 % 14,3 % 14 % 14 % 14 % 14 % 14 % 14 % 14 % 14 % 14 % 14 % Labor costs 17,3 % 17,8 % 18,2 % 17,4 % 16,1 % 17,4 % 16,5 % 16,0 % 16,0 % 15,5 % 14,5 % 14,0 % 13,9 % 13,7 % 13,2 % 13,0 % Handling charges 9,9 % 9,9 % 10,3 % 9,3 % 8,4 % 9,6 % 10 % 10 % 10 % 10 % 10 % 10 % 10 % 10 % 10 % 10 % Technical maintenance 9,2 % 9,0 % 8,3 % 6,8 % 6,2 % 7,9 % 6 % 6 % 6 % 6 % 6 % 6 % 5 % 5 % 5 % 5 % Sales and distribution expenses 1,9 % 2,0 % 2,0 % 1,9 % 2,1 % 2,0 % 2 % 2 % 2 % 2 % 2 % 2 % 2 % 2 % 2 % 2 % Other operational expenses 5,1 % 5,4 % 4,7 % 4,5 % 4,2 % 4,8 % 5 % 5 % 4 % 4 % 4 % 4 % 4 % 4 % 4 % 4 % Other aircraft expenses 5,0 % 4,5 % 4,8 % 4,2 % 3,8 % 4,5 % 4 % 4 % 4 % 4 % 4 % 4 % 4 % 4 % 4 % 4 % Depreciation 2,1 % 2,0 % 2,2 % 2,8 % 3,0 % 2,4 % 3 % 3 % 3 % 3 % 3 % 3 % 3 % 3 % 3 % 3 % Tax rate 28,0 % 28,0 % 28,0 % 28,0 % 28,0 % 28,0 % 28 % 28 % 28 % 28 % 28 % 28 % 28 % 28 % 28 % 28 %

5.5 Operating expenses The operating expenses consists of different items. An analysis of the different costs are necessary and will be considered with regards to the findings in the strategic analysis.

5.5.1 Jet fuel costs As concluded in the PET-analysis the jet fuel price is closely linked to the oil price. It is therefore difficult to predict the future jet fuel cost as the oil price is determined by many external factors. In addition it was established that the exchange rate has an effect on the total jet fuel costs in chapter 4.

NAS has purchased a fleet which is stated to consume approximately 30% less jet fuel than the existing fleet. This factor combined with the increased focus on long distance flights is likely to affect NAS fuel costs positively. An increased number of flights with a long stage length will decrease total fuel consumption in relation to productivity because the main part of consumed fuel is related to take- off and landing.

The predicted jet fuel costs are stated as percent of revenue in the forecasted budget. This is because the jet fuel cost to some extent correlates with the growth in revenue. A growth in the revenues implies a higher demand for fuel. Historically NAS’ jet fuel costs has averaged on 27% of the operating revenue with the 2012-level being 29%. In the PET-analysis it is observed that the price of crude oil is forecasted to decrease in the budget period except from 2014. This is of course not a sure fact as it also was reviled in the strategic analysis that the oil-price and accordingly the jet fuel price is volatile and sensible to many external factors. It is however assumed in the forecasted budget that the jet fuel cost will have a diminishing development in relation to revenue as a result of the implementation of fuel efficient aircrafts and a declining jet fuel price. A significant reduction is not expected to happen immediately as the main part of the fuel efficient aircrafts are supposed to be delivered in 2016 and onwards. It is therefore predicted that the fuel costs in percent of revenues will have gradually

66 diminishing trend and then stabilize at a level of 22% in 2018. This is a 24% reduction from the current fuel cost which is assumed to be a reasonable cost save for NAS.

5.5.3 Labor costs As discussed previously in the paper, labor costs is the main focus of NAS’ cost cutting. As remembered the company has found it necessary to “flag out” parts of its operations in order to cut the labor costs and compete at an equal ground as its international competitors. In the strategic analysis it was discovered that one of the biggest threats for NAS is the risk of not receiving the necessary permission and traffic rights which will allow them to use foreign labor on the long-haul flights. For the estimated future budget it is assumed that NAS succeed in obtaining these rights and will use foreign labor on the long haul flights.

With regards to this, there are three main factors that must be taken into consideration the first being base country of employees and the wage level in the respective country, the second is the productivity of the employees and the third the bargaining power of employees. NAS has given signals that most of the crew on long-haul flights will be hired through their Asian bases as the wage level in Asia is much lower than in Scandinavia and the rest of Europe. This implies that the total labor costs will decrease as a larger share of the personnel is hired at Asian pay and working conditions. As NAS will focus more on long-haul operations, the stage length will as mentioned increase. In the strategic analysis is was found that a long stage-length result in a higher employee productivity which will further cut the labor costs. The strategic analysis also found the bargaining power of the employees to be strong. Even though NAS is likely to hire a larger share of foreign personnel, it must be remembered that they are still obliged to pay the Scandinavian employees at Scandinavian tariff. As the strategic analysis identified several occasions where the strong labor unions has threatened with strike to maintain their rights, it is found reasonable to assume that this is likely to happen again. The strong bargaining power of the employees is thus considered to be a factor that might prevent the steep decline in total labor costs.

When looking at the historical numbers the labor costs has measured been between 16 - 18% of the total revenues. Even though it is concluded that the labor costs are likely to decrease it is found reasonable to assume that the effect will not show instantly. The training of new crew and other temporary extra costs is likely occur for the first years. It is though reasonable to predict the labor costs to decrease on a medium-term perspective. With regards to this it is estimated that NAS’ labor costs will be 16,5% of revenue for the first year in the budget period. Then the costs will have a diminishing growth rate for the rest of the budget period until it reaches 13% which seems like a fair estimate of long-term labor cost in percent of operating revenue. This level is found reasonable as this is close to the current level of competitor EasyJet.

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5.5.4 Airport charges and Handling charges These costs are directly related to operations and externally set. It is therefore predicted that these two cost are directly linked to activity level and thus revenue. The historical airport and handling charge costs have had a constant development with the average being 14,3 % for the airport charges and 9,6% for the handling charges. As international operations commence, different price levels at airports, increased capacity and exchange rate must be taken into account. For these reasons the airport and handling charges are estimated to be marginally lower than the historical average and is estimated to be 14% and 9,5% of total revenues in the forecasted budget.

5.5.5 Technical maintenance The technical maintenance cost is related to maintenance of the different aircrafts. This cost is likely to decrease combined with the implementation of new aircrafts with lower maintenance cost. The historical technical maintenance cost has varied between 9 and 6% of operating revenue. In the forecasted budget the future technical maintenance cost is estimated to be 6% of revenues the first three years of the budget then decrease to 5% for the rest of the budget period. This is due to the rising share of aircrafts with low technical maintenance costs in the future years.

5.5.6 Sales and distribution expenses, Other aircraft expenses and Other operating expenses Because of the extra expenses that has incurred as a result of the Dreamliner issues, the post other operating expenses will be marginally higher than the historical level in 2013 and 2014. In the remaining period this item, other aircraft expenses and sales and distribution expenses are estimated to have a marginally lower level than the 2012-level. This is because these costs are directly linked to operations and is thus positively affected by the increased capacity.

5.5.7 Leasing costs As no detailed information regarding future leasing costs are provided, the costs will be estimated on basis of the historical leasing expenses. When estimating the number of leased aircrafts the detailed fleet plan will be laid to ground until 2015 and as no information regarding further diversification is provided, it is assumed that the 2015 levels will stay constant. The lease cost per aircraft in 2012 was NOK 25823. To find the leasing expenses the estimated number of leased aircrafts is multiplied with the estimated lease expense per aircraft. As the new fleet will consist of aircrafts that are likely to be more expensive to lease than the current, it is added 5% to the lease cost per aircraft in the future. When the present value of leasing expenses is calculated these will be treated the same way as in section 4.2.6 to find depreciation and interest.

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Table 13: Forecasted leasing costs

F2013 F2014 F2015 F2016 F2017 F2018 F2019 F2020 F2021 F2022 Leased aircrafts 48 47 43 47 53 59 66 73 82 91 Leasing cost pr plane 27114 27114 27114 27114 27114 27114 27114 27114 27114 27114 Total leasing costs 1 301 473 1 274 359 1 165 903 1 275 263 1 426 207 1 593 756 1 779 734 1 986 171 2 215 315 2 469 665 Capitalized lease 9 110 310 8 920 512 8 161 320 8 926 840 9 983 451 11 156 290 12 458 141 13 903 195 15 507 206 17 287 658 Depreciation 1 240 1 275 1 166 1 276 1 427 1 594 1 780 1 987 2 216 2 471 Lease interest -475 -488 -446 -488 -546 -610 -681 -761 -848 -946

5.5.8 Depreciation There are several methods to forecast future depreciation and the method chosen in this paper is to forecast depreciation as a percentage of revenues.142 This method is suitable as NAS’ capital expenditures are smooth. Since the deprecation of operational leases are included in the historical reformulated income statement, this is also included in the forecast. The depreciation on leases is calculated from the forecasted present value of the operational leases. When looking at historical numbers it is seen that the depreciation rate has been fairly stable relative to the revenues. The 2012 depreciation rate is thus used as an estimate of future depreciation.

5.5.9 Financial expenses The financial expenses are calculated as a percentage of Net Interest-bearing debt. The rate used to find the financial expenses is the cost of debt found in section 5.5.2. 143

5.6 Balance sheet

5.6.1 Tangible assets The tangible assets are directly related to operations and thus will be forecasted in relation to revenues.144 Tangible assets consist of operational related assets like aircrafts, prepayment to the aircraft manufacturers and other equipment. The largest item is aircrafts, parts and installations. This item has historically moved from 8,4% of revenues to 43,5% in 2012. It is thus forecasted to increase to 55% of revenues in the forecasted period. Buildings has historically contributed marginally to the assets with an average of 0,1% of revenue but as NAS is expanding the need for buildings is likely to increase so a level of 0,2% for the budget period is assumed . The other large contributor to tangible assets is prepayments to aircraft manufacturers. This post consist of prepayments to aircraft manufacturers before actual delivery. It is decided to keep this level constant at the 2012 level as no information regarding new additions to this item is provided and because it is assumed delivered assets will be transferred to aircrafts, parts and installations so the net effect will be zero.

Equipment and fixtures and financial lease assets are forecasted to stay at the historical average.

142 Koller et al (2010) p .194 143 Petersen and Plenborg (2012) p. 176 144 Koller et al (2012) p. 199 69

5.6.2 Intangible assets and non-current operating liabilities These items have had a stable level in regards to operating revenues the past years. The average level has been 2,7 % for intangible assets and 2,2% for non-current operating liabilities. As the levels has been very stable in the historical period, it is assumed that the average level is a good estimate for the future.

5.6.3 Current assets and current liabilities These items are directly related to NAS’ activity level and thus revenues. The historical level of current assets and liabilities has been stable in relation to the revenue and the average historical development is thus assumed to be a reasonable estimate for the future.

The full forecasted balance sheet can be seen in Appendix 20.

5.6.4 Free cash flow statement One of the objectives by creating a forecasted budget is to calculate a free cash flow statement which will indicate NAS’ free cash flow to the firm in the budget period. The calculated free cash flow from the forecasted budget can be seen in Table 14.

Table 14: Forecasted cash flow statement

FORECASTED CASH FLOW STATEMENT F2013 F2014 F2015 F2016 F2017 F2018 F2019 F2020 F2021 F2022 NOPAT 877 1 282 1 444 1 949 2 873 3 262 3 798 4 108 4 460 4 822 Depreciation 1 297 1 597 1 846 1 934 1 876 2 057 2 286 2 522 2 773 3 059 Gross CF 2 174 2 879 3 289 3 883 4 749 5 319 6 084 6 630 7 234 7 881

∆ in current assets -330 -308 -135 -170 -164 -227 -250 -220 -208 -254 ∆ in current liabilities 553 834 367 462 444 615 677 596 563 688 ∆ non-current liabilties 69 112 49 62 60 83 91 80 76 93 ∆ in NWC 292 638 281 353 340 471 518 456 431 527

Non-current assets beg 16 105 21 131 23 940 24 309 26 494 28 916 31 982 35 366 38 644 41 980 Non-current assets end 21 131 23 940 24 309 26 494 28 916 31 982 35 366 38 644 41 980 45 878 Depreciation 1 297 1 597 1 846 1 934 1 876 2 057 2 286 2 522 2 773 3 059 CAPEX -6 323 -4 406 -2 215 -4 119 -4 298 -5 123 -5 670 -5 800 -6 109 -6 958

FCFF -3 857 -888 1 355 117 791 667 932 1 286 1 555 1 451

As seen the forecasted cash flow to the firm is negative the first two years of the forecast period and relatively low the next years. This is a result of the large capital expenditures due to investments.

5.7 Present value approach - DCF As discussed in section 5.1 the discounted cash flow model estimates the intrinsic value of a company. The approach estimates the enterprise value of NAS by estimating the present value of the future free cash flows. The estimation of the value of NAS equity and hence share price can be seen below. 70

Table 15: Discounted cash flow approach

F2013 F2014 F2015 F2016 F2017 F2018 F2019 F2020 F2021 F2022 FCFF -3 856,51 -888,29 1 355,34 116,74 791,01 666,98 931,66 1 285,76 1 555,25 1 450,69 WACC 6,37 % 6,37 % 6,37 % 6,37 % 6,37 % 6,37 % 6,37 % 6,37 % 6,37 % 6,37 % Discount 0,940 0,884 0,831 0,781 0,734 0,690 0,649 0,610 0,574 PV -3 625,636 -785,122 1 126,211 91,196 580,942 460,524 604,765 784,657 892,300 PV FCFF 129,839 PV terminal 19 056 EV 19 186 NIBD 10 878 BV net financial assets 1 879 Equity value 10 187 Shares 35,162 Share price 290

The enterprise value is calculated by summing the present value of the free cash flows and the terminal value and then adding the book value of cash and cash equivalents and assets for sale.145 Then the net interest-bearing debt is subtracted to find the equity value. The present value of the operating leases is included in the net interest-bearing debt so no further adjustments with regards to leasing is found necessary.

With an equity value of 10 187 millNOK and 35 162 139 outstanding shares the share price is calculated to be NOK 290.

5.8 Sensitivity analysis In a sensitivity analysis different variables in the DCF-model are changed to see how sensitive the model is to the underlying assumptions. When the sensitivity analysis is performed, all the other variables are kept constant to show the true effect.

First the models sensitivity towards a change in the beta value is estimated. This is done as there is uncertainty connected to the beta value as the value differs greatly dependent on which data and method is chosen for the estimation.

Table 16: Share price sensitivity to changes in beta value

Beta 0,89 0,99 1,19 1,29 1,39 1,49 1,59 1,69 1,79 WACC 5,79 % 0,1 6,14 % 6,25 % 6,37 % 6,48 % 6,60 % 6,71 % 6,83 % Share price 407 381 333 311 290 270 252 234 217

As seen in Table 16, small changes in the beta value affect the WACC by changing the shareholders’ required rate of return. The share price varies considerably when the beta and henceforth the WACC is altered.

145 Koller et al (2010) p. 103 71

Next, the underlying assumptions for the forecasted budget are looked upon. In this analysis the variables are adjusted with 1 percentage point +/-, except from yield which is adjusted +/- 0,001.

Table 17: Share price sensitivity to underlying assumptions in the forecasted budget

Debt Jet fuel Growth Revenue Labor Load ratio costs in ASK terminal Yield costs factor + 1% 297 162 328 450 311 166 315 -1 % 283 415 250 190 269 419 277

As seen some of the assumptions have a significant impact on the estimated share price. The most sensitive variable is the growth in terminal value followed by change in labor costs and jet fuel. A change of one percentage point in the terminal growth moves the share price from 290 to 450/190. If the labor cost is increased by one percentage point the share price decrease to 166.

The result of the sensitivity analysis underlines what was stated previously, that the DCF model is highly dependent on the underlying assumptions and thus the analyst’s individual opinions. Is also shows that NAS is sensitive to changes in the labor costs. This emphasizes that NAS is dependent on cutting these costs to increase its value. The change in jet fuel cost has the same effect as the change in labor cost, but as this is an externally set cost no extreme measures besides effective risk management can be done.

5.9 Scenario analysis A scenario analysis examines how the share price is affected if the forecast assumptions are changed. In a typical valuation a best- and worst-case scenario where several variables are altered, is performed. In this paper it is chosen to focus on the labor costs, jet fuel and most importantly the yield and load factors which is the variables that determines the revenue growth of NAS. In addition a labor-scenario will be included to show what the value would be if the labor costs were kept constant. These factors are chosen as the strategic analysis revealed that the biggest threats for NAS is an increase in jet fuel price, declining yield and the legislative issues regarding labor. On the same note the opportunities is a growth in passengers which imply an increased load factor, a cut in labor costs and the potential to become cost leader.

Table 18: Original scenario

Original scenario F2013 F2014 F2015 F2016 F2017 F2018 F2019 F2020 F2021 F2022 Yield 0,525 0,513 0,503 0,493 0,483 0,483 0,483 0,483 0,483 0,483 Load factor 78 % 78 % 78 % 78 % 78 % 78 % 78 % 78 % 78 % 78 % Jet fuel 28,0 % 27,0 % 26,0 % 25,0 % 23,0 % 22,0 % 22,0 % 22,0 % 22,0 % 22,0 % Labor 16,5 % 16,0 % 16,0 % 15,5 % 14,0 % 14,5 % 13,9 % 13,7 % 13,2 % 13,0 % Share price 290

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5.9.1 Worst-case scenario In the forecasted budget it is assumed that NAS yield level will diminish at a rate of 0,025 in 2013, 0,012 in 2014 and then a set rate of 0,01 until 2017 where it stabilizes for the rest of the forecast period. In this scenario it is assumed that the diminishing rate is increased by 0,05 which leads to the yield stabilizing at 0,458 rather than 0,483. In addition the load factor will decrease by one percentage point compared to the forecasted budget.

Table 19: Worst-case scenario

Worst-case scenario F2013 F2014 F2015 F2016 F2017 F2018 F2019 F2020 F2021 F2022 Yield 0,520 0,503 0,488 0,473 0,458 0,458 0,458 0,458 0,458 0,458 Load factor 77 % 77 % 77 % 77 % 77 % 77 % 77 % 77 % 77 % 77 % Jet fuel 29 % 28 % 28 % 28 % 28 % 27 % 25 % 24 % 23 % 22,5 % Labor 16,1 % 16,1 % 16,1 % 16,1 % 16 % 15,5 % 14,5 % 14,5 % 14,5 % 14,5 % Share price -109

In this scenario the expected jet fuel price is expected to increase rather than decrease. This leads the jet fuel cost to stay at the historical level as the impact of the fuel efficiency from the new fleet will not show until 2018 when the jet fuel price will gradually diminish to a cost of 22,5% of revenues in 2022. The labor cost is as previously discussed one of the costs that NAS focus most on cutting and to do this the company is dependent on a permission to use foreign crew on the long-haul flights. In the worst-case scenario it is assumed that the needed permissions is not given so the labor costs stay at the 2012-level of 16,1% until 2017 and then gradually diminish until it reaches a level of 14,5%. It is assumed that NAS will be able to cut the labor costs to a certain extent in a long-term perspective due to the increase productivity of the long-haul flights.

In the worst-case scenario the share price drops to NOK -109. This is of course not theoretically possible, but underlines the point made that the airline industry is sensitive to external factors. This scenario is realistic if its international expansion is a failure and NAS struggles to capture market shares internationally. Then it is likely that NAS will see a decrease in load factor because of weaker passenger growth, and yield as they are forced to sell tickets cheap to capture customers. If SAS, the biggest competitor in the home market is successful in its recent restructuring and strategy to transform its customer focus from business travelers to leisure travelers there is a genuine possibility that SAS is able to capture market shares from NAS in the home market. This threat is intensified if NAS is not able to sort out the technical issues with the Boeing Dreamliner, which cause a serious threat to its reputation as a reliable and service-minded airline. The Dreamliner issue would mainly affect the long-haul operations, but these operations are a crucial factor of NAS’ success internationally. Another possibility is that Ryanair and/or EasyJet expand its operations in NAS’s home market and thus capture larger market shares. This scenario could lead to price wars amongst the competitors which will be damaging for NAS’ revenue growth.

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5.9.2 Best-case scenario In this scenario it is assumed that the yield diminishing rate will be 0,005 less than the current and stabilizes at 0,508 instead of 0,483. It is assumed that the yield will diminish even in the best-case scenario as this seems unavoidable due to the increased stage length and it would be unrealistic to assume ticket prices so high that it would compensate. In addition the load factor is expected to increase by 1 percentage point. The jet fuel price is expected to be lower than anticipated in the original scenario, and the result from the implementation of the fuel efficient fleet will show earlier in the forecast period. In addition it is assumed that NAS is successful in diminishing the labor costs at an earlier stage than in the original forecast. The result is that the assumed level of a labor cost of 13% is reached in 2017 rather than in 2022.

Table 20: Best-case scenario

Best-case scenario F2013 F2014 F2015 F2016 F2017 F2018 F2019 F2020 F2021 F2022 Yield 0,53 0,523 0,518 0,513 0,508 0,508 0,508 0,508 0,508 0,508 Load factor 79 % 79 % 79 % 79 % 79 % 79 % 79 % 79 % 79 % 79 % Jet fuel 27 % 25 % 24 % 23 % 22 % 21 % 21 % 21 % 21 % 21 % Labor 15 % 14,50 % 14 % 13,50 % 13 % 13 % 13 % 13 % 13 % 13 % Share price 600

With the assumptions made in this scenario the share price shoots up to NOK 600. The best case scenario is realistic if NAS is successful in the international expansion and manage to capture a market share so big they don’t find it necessary to charge discounted ticket prices to attract new customers. This will result in the yield decreasing at a lower rate. In addition does the high level of market shares in the international markets increase the load factor which combined with the higher yield level result in a higher revenue growth.

5.9.3 Labor scenario NAS main concern regarding labor costs is the legislative issues regarding aircraft registration and accordingly work force nationality and salary level. If the Norwegian government decides NAS is not allowed to fly with aircrafts registered in Ireland, and thus foreign crew, or they are not successful in obtaining the necessary permissions, it would be difficult for NAS to cut its labor cost to the desired level. The other concern regarding labor costs is the labor unions which are strongly protesting against the implementation of foreign crew on flights.

The two previous scenario analyses assumes that the variables change for the better or worse simultaneously and the original forecasted budget is based on the assumptions that NAS is able to lower their labor costs the intended way. It would thus be interesting to see what the theroretical share price would have been if the labor costs would stay at the 2012-level when all the other variables stay at the forecasted level.

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Table 21: Labor scenario

Labor cost scenario F2013 F2014 F2015 F2016 F2017 F2018 F2019 F2020 F2021 F2022 Labor 16,1 % 16,1 % 16,1 % 16,1 % 16,1 % 16,1 % 16,1 % 16,1 % 16,1 % 16,1 % Share price -51

As seen, if the labor cost stayed at the 2012 level and the other variables at the forecasted level, the estimated share price would have been NOK -51. This further underlines the point that NAS is dependent on cutting the labor costs gain a sustainable competitive power.

5.10 The relative valuation approach In the relative valuation approach multiples will be used to estimate the value of NAS. This method is popular amongst practitioners due to its low level of complexity and because it is less time-consuming than other valuation methods. 146In the relative valuation approach multiples based on common variables are used to find company value. One of the drawback with the relative valuation approach is that the value derived from these models often differs from the value estimated in the present value approach due to different expectation in the market compared to the analyst’s individual forecast. In addition, the underlying requirements for using multiples are hard to fulfill in practice. As an example a valuation based on the EV/EBITDA multiple requires the compared companies to have an identical expected tax rate and depreciation rate.147 As these requirements are not met, the value estimate will be biased.148 Regardless of these drawbacks, it is chosen to include a valuation based on the EV/EBITDA and EV/Revenue multiples as it is interesting to see what the value of NAS is estimated to be using consensus estimates. For the calculation the previously used peer-group consisting of SAS, Ryanair, EasyJet and Finnair will be used. These are companies that are not truly comparable, but operate in the same industry and to some extent share the same economic characteristics and outlook. 149

The data used in the analysis is derived from two different sources, Thomson One Banker150and Damodaran151. This is done as it is interesting to see whether the results will differ. In the analysis forecasted numbers for 2013 is used from both sources, and as Thomson One provides forecasted numbers for 2014 an estimation based on these numbers are included. In addition, an estimation only including multiples from LCC’s, is done to see if the different business models have any impact on the result.

146 Petersen and Plenborg (2012) p. 226 147 Petersen and Plenborg (2012) p. 227 148 Petersen and Plenborg (2012) p. 234 149 Petersen and Plenborg (2012) p. 227 150 Thomson One (2013) accessed 05.12 151Damodaran (2013) 75

Table 22: EV/EBITDA

EV/EBITDA 2013/2014 ONLY LCC's 2013 DAMODARAN THOMSON THOMSON F2014 DAMODARAN THOMSON Easyjet 7,69 7,3 7,2 7,69 7,3 Ryanair 9,23 7,8 8,3 9,23 7,8 SAS 5,7 8,1 0,8 Finnair 13,08 2,7 N/A Mean 8,925 6,475 5,433 8,460 7,550

EBITDA 2 498 2 498 3 264 2 498 2 498 EV 22 295 16 175 17 737 21 133 18 860 NIBD 10 878 10 878 14 554 10 878 10 878 Equity value 11 417 5 297 3 183 10 255 7 982 No of shares 35,162 35,162 35,162 35,162 35,162 Share price 325 151 91 292 227

When looking at the estimated share prices it is observed that the share price differs greatly between the two sources and between the accounting years. Also when using only the multiples related to LCC’s, the share price using Damodaran’s estimates decrease contrary to the share price calculated using Thomson’s. These observations imply that even though the share price found from Damodaran’s estimates for the LCC’s is close to the share price found in the DCF, the multiple is biased as it relies too heavily on the chosen source.

Table 23: EV/Revenue

EV/Revenues 2013/2014 ONLY LCC's 2013 DAMODARAN THOMSON THOMSON F2014 DAMODARAN THOMSON Easyjet 0,87 1,1 1,1 0,87 1,1 Ryanair 2,09 1,7 1,7 2,09 1,7 SAS 0,39 0,2 0,1 Finnair 0,26 0,2 N/A Mean 0,90 0,80 0,97 1,48 1,40

Revenues 16 221 16 221 19 316 16 221 16 221 EV 14 639 12 977 18 672 24 007 22 709 NIBD 10 878 10 878 14 554 10 878 10 878 Equity value 3 761 2 099 4 118 13 129 11 831 No of shares 35,162 35,162 35,162 35,162 35,162 Share price 107 60 117 373 336

This multiple analysis shows the same tendency as the latter, the estimated share price varies in relation to source and accounting year.

The above findings shows that a reliable relative valuation needs extensive work and truly comparable firms to be valid. In this analysis the differences between companies distort the result and the share price can thus not be considered as a reasonable estimate for NAS. 76

5.11 Liquidation approach The final valuation approach that will be performed is the liquidation approach. This approach estimates the amount a company could be sold for if all assets were sold and liabilities paid off. This is not a true option for NAS but the approach is included to further understand what triggers NAS’ value.

In a healthy industry with attractive growth rates and healthy returns, a company’s liquidation value is typically less than the value as a going company152. When estimating the liquidation value it is assumed that NAS would go out of business in December 2013 and the forecasted budget for 2013 is used in the calculations.

The typical steps for calculating a company’s liquidation value is as follows153:

Book value of equity +/- The difference between the liquidation value and book value of assets +/- The difference between the liquidation value and book value of liabilities +/- The liquidation value of off-balance sheet items - Fees to lawyers, auditors, etc = Liquidation value

5.11.1 Liquidation value of assets When calculating the liquidation value of assets one must look at the book value of the assets and estimate a liquidation value based on this. The main part of tangible assets consists of aircrafts, parts and installations on leased aircrafts, buildings and equipment and fixtures. As NAS owned fleet consist of fairly new and cost efficient aircrafts it is assumed that these assets will be liquidated at book value less 10%. The prepayment to aircraft manufacturers is related to the contract with Boeing and Airbus to purchase aircrafts. There are two main factors to consider when determining the liquidation value of this contract. The first being that these contracts allegedly was entered on very good terms.154 The second factor is the demand for the respective aircrafts. The contract consists of high tech, cost efficient aircrafts and the aircrafts have a long delivery time. It is thus reasonable to assume that there will be several airlines that would be interested to take over these contracts. Due to the assumed favorable terms of the contracts the liquidation value of the contracts is assumed to be equal to book value.

The remaining tangible assets are assumed to have a liquidation value of book value less 20%, while inventory and trade and other receivables is estimated to have a liquidation value of book value less

152 Petersen and Plenborg (2012) p. 235 153 Petersen and Plenborg (2012) p. 235 154 Stocklink (2012) 77 respectively 25% and 10%. The intangible assets are estimated to have liquidation value equal to zero. The financial assets are assumed to have a liquidation value equal to book value.

5.11.2 Liquidation value of liabilities The liquidation value of liabilities is assumed equal to Table 24: Liquidation value book value, except from operational leasing liabilities Equity 3 787 where there is an assumed loss of 10% of book value. Net financial expenses -462 Net financial assets 2 279 This estimated as it is assumed the leasing agreements New equity 5 604 will be acquired by other companies, but at a lesser value. The equity value is estimated as book valued Loss on tangible assets -875,03 equity – net financial assets + net financial assets and a Loss on current assets -163 liquidation cost of 10% is assumed. The calculations of Loss on leasing liabilities -1 116 Liquidation value 3 449,96 the liquidation approach can be seen in Table 24. As Cost of liquidation 345,00 expected the share price is lower that what was estimated Liquidation value 3 104,96 using the DCF-model and in the multiple analysis when No of shares 35,162 using LCC’s as a benchmark. This shows that NAS value Share price 88 is triggered by the expectations of future growth rather than its current status.

5.12 Partial conclusion When estimating the share price of NAS three different valuation approaches was carried out. It was found that the share price varies greatly based on the valuation approach and used. The DCF model returned a share price of NOK 290 whilst the relative valuation approach is concluded to be too biased towards source and accounting year to be considered as a reliable estimate for the share price. The liquidation approach returned a value of NOK 91 which is significantly lower than the result from the DCF. This was though expected and the analysis was carried out to show that the value of NAS relies on the expectations of future growth.

The DCF model relies on assumptions of the future and is hence considered to be the most reliable estimate of the value of NAS. As it is concluded that the forecasting is performed in accordance with the findings in the strategic analysis it is concluded to be a reliable estimate. For the purpose of this paper the value of NOK 290 is concluded to be the intrinsic value of NAS’ share.

With regards to this it is necessary to mention that there is great uncertainty connected to this price as the sensitivity- and scenario analysis showed that the share price is hugely sensitive to minor changes in the forecast assumptions. This underlines the point made previously that a valuation based on an analyst’s projections of the future always will be biased towards the analyst’s individual opinions, and hence not be truly objective.

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CHAPTER 6 – Conclusion The objective of this paper was to determine the theoretical value of NAS’ share per 04.12.2013. This was done through thorough strategic and financial analyses. The information found in the strategic and financial analyses was combined to form a foundation for a forecasted budget of the future. This budget served as the basis for the valuation.

The strategic analyses identified how the airline industry is influenced by the global economic situation and described the fierce competition in the industry. The analyses placed NAS as a company with a higher cost level, lower load factor and a marginally higher yield compared to the analyzed international low-cost carriers. It was particularly noticed that NAS labor costs were significantly higher than these competitors’. In the past, one could say, NAS has had an advantage as they are the only low-cost carrier with significant market shares in the home market and thus, the dependency of a sustainable competitive advantage has not been as urgent. Though, in a market where multiple players targets the same customer segment, competition is fierce and this is something NAS will particularly notice as they further expand the international operations. When they launch the long-haul routes from London to the US they will be in direct competition with some of the largest and most established airlines in the world. In the internal analysis is was found that NAS, per today, do not possess an evident and sustainable competitive advantage. It was hence concluded that the only way NAS could gain competitive power is to cut its costs, in particular, the labor costs. With regards to this, several external threats was identified with the main being the Norwegian labor legislation which prohibits NAS to use foreign labor on their flights as long as the aircrafts is registered in Norway. NAS has been forward thinking and registered its new long-haul aircrafts in Ireland but are dependent on an Irish flight license to commence operations in 2014, a license they have been denied twice per December 2013. Furthermore the strategic analyses showed that NAS is in risk of a declining yield as a direct result of capacity increase. The interim reports of 2013 supported these findings by stating a decline in yield and hence RASK. The financial analyses showed fluctuating results in the years examined, and it was discovered that NAS financial performance in general is below the LCC peers. It was identified that NAS ROIC is driven more by the revenue expense relation rather than capital utilization and that the company has a high debt-to equity ratio.

It was proved in the scenario analysis that the absolutely biggest concern for NAS it the high labor costs. The share price calculated when applying the DCF-framework with the expected development incorporated was NOK 290. In the labor scenario, where it was assumed that all variables develop as expected in the forecasted budget, except for the labor costs, the share price dropped significantly to - 51. These findings empathize NAS’ dependency on the necessary permissions to use foreign personnel as this is the company’s only chance to cut its labor costs.

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The second large concern is the declining yield and accordingly RASK level. NAS must find a way to have an attractive price level and increased stage length simultaneously, without slashing the yield level and sending the RASK to the grave.

In addition to the DCF-model the relative valuation approach and liquidation value was applied. The relative valuation approach is disregarded as it was found that the estimates was too biased towards chosen source and accounting year. The liquidation value approach returned a share price of NOK 88. As expected this number is significantly lower than the DCF, but it shows that the value of NAS is based on the expectations of future performance rather than its current assets.

With respect to all the findings in this paper, the share price of Norwegian Air Shuttle ASA is estimated to be NOK 290 per 04.12.2013. This is higher than the market price of NOK 232 which indicates that the share is undervalued by the market.

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8. Appendix

Appendix 1: NAS’ Reformulated income statement

REFORMULATED INCOME STATEMENT NORWEGIAN AIR SHUTTLE

NOK 1000 2008 2009 2010 2011 2012

Passenger transport 5 641 533 6 389 406 7 210 161 9 097 228 11 201 072 Ancillary revenue 463 609 788 655 1 034 006 1 224 744 1 405 495 Other revenues 121 271 131 129 162 172 206 688 234 624 Total revenues 6 226 413 7 309 190 8 406 339 10 528 660 12 841 191

Sales and distribution expenses -115 251 -149 415 -167 859 -198 930 -274 954 Aviation Fuel -2 006 248 -1 423 328 -2 092 859 -3 093 514 -3 740 508 Airport charges -841 999 -1 037 716 -1 295 913 -1 561 369 -1 730 217 Handling charges -615 740 -722 658 -863 551 -982 191 -1 077 334 Technical maintenance expenses -574 077 -659 796 -697 196 -711 597 -792 565 Other aircraft expenses -312 815 -325 371 -405 787 -441 657 -482 932 Personell costs -1 076 068 -1 303 299 -1 531 211 -1 836 194 -2 068 202 Other operational expenses -318 094 -396 058 -397 735 -472 908 -534 336 Share of profitt(loss) from assosiated companies -8 773 3 200 6 328 19 518 32 840 Total operating costs -5 869 065 -6 014 441 -7 445 783 -9 278 842 -10 668 208 EBITDA 357 348 1 294 749 960 556 1 249 818 2 172 983

Lease depreciation 263 193 382 586 480 248 511 871 637 267 Depreciation and amortization and impairment 129 611 148 882 186 707 293 950 385 244 EBIT -35 456 763 281 293 601 443 997 1 150 472

Tax 1 394 176 789 72 214 44 416 166 535 Tax shield 52 797 -53 075 -76 038 -164 278 -58 453 Operating tax 51 403 -229 864 -148 252 -208 694 -224 988 NOPAT 15 947 533 417 145 349 235 303 925 484

Special items Other losses (gains) - net -147 768 49 315 29 732 305 720 -336 385 Other income - - 191 328 3 471 17 851 Total special items -147 768 49 315 221 060 309 191 -318 534 Earnings before interest - after special items -131 821 582 732 366 409 544 494 606 950

Financial items 351 966 47 974 26 600 -268 911 186 888 Lease interest -163 404 -237 528 -298 163 -317 796 -395 648 Net financial items 188 562,29 -189 554,47 -271 562,55 -586 706,65 -208 759,76

Financial tax (28%) -52 797,44 53 075,25 76 037,51 164 277,86 58 452,73

Profit 3 944,00 446 253,00 170 884,00 122 065,00 456 643,00

88

Appendix 2: Reformulated Balance Sheet – Operational

REFORMULATED BALANCE SHEET - OPERATIONAL NON-CURRENT ASSETS 2008 2009 2010 2011 2012

Intangible assets 198 074 190 543 210 293 236 216 237 774 Defferred tax assets 59 759 157 270 2 069 4 293 Total intangible assets 257 833 190 700 210 563 238 285 242 067

Aircrafts, parts and installations on leased aircrafts 523 676 974 892 2 092 136 3 869 159 5 579 757 Equiptment and fixtures 31 014 30 905 26 175 31 991 58 476 Buildings 3 933 3 933 9 525 9 525 9 525 Financial lease assets - 26 092 31 203 27 882 24 562 Investments in associate 44 743 47 934 62 272 82 091 116 050 Prepayment aircraft manufacturers 705 165 1 410 992 2 002 600 2 126 954 2 844 359 Total tangible assets 1 308 531 2 494 748 4 223 911 6 147 602 8 632 729

Total operating non-current assets 1 566 364 2 685 448 4 434 474 6 385 887 8 874 796 Capitalized operating leases 2 986 179 4 340 798 5 448 877 5 807 669 7 230 405 TOTAL NON-CURRENT ASSETS ADJUSTET FOR LEASE 4 552 543 7 026 246 9 883 351 12 193 556 16 105 201

CURRENT ASSETS

Inventory 34 214 40 825 66 191 81 994 68 385 Trade and other recievables 914 379 829 893 842 143 1 072 497 1 096 558 Derivative financial intstrument 18 360 23 688 43 395 242 790 - Total current operating assets 966 953 894 406 951 729 1 397 281 1 164 943

TOTAL OPERATING ASSETS 5 519 496 7 920 652 10 835 080 13 590 837 17 270 144

OPERATING LIABILITES

Provision for periodic maintenance 114 090 70 336 94 961 81 865 175 306 Deffered tax liabilities 9 695 17 806 89 483 134 646 301 042

Total non-current operational liabilities 123 785 88 142 184 444 216 511 476 348

Trade and other payables 694 832 746 549 1 063 436 1 230 935 1 564 955 Air traffic settlement liabilities 598 162 792 713 954 232 1 208 326 1 739 681 Derivative financial intstrument 104 325 1 227 15 003 539 190 356 Tax payable 267 111 158 976 488 - Total current operating liabilities 1 397 586 1 651 647 2 033 647 2 440 288 3 494 992

TOTAL OPERATING LIABILITIES 1 521 371 1 739 789 2 218 091 2 656 799 3 971 340

INVESTED CAPITAL 3 998 125 6 180 863 8 616 989 10 934 038 13 298 804 Average invested capital 5 089 494 7 398 926 9 775 514 12 116 421

89

Appendix 3: Reformulated balance sheet – financial

REFORMULATED BALANCE SHEET - FINANCIAL LIABILITIES 2008 2009 2010 2011 2012

Capitalized operational leases 2 986 179 4 340 798 5 448 877 5 807 669 7 230 405 Net recognized pension liabilities 61 815 97 558 121 672 151 187 - Long-term borrowings 440 873 878 878 1 943 903 2 682 888 4 166 854 Short-term borrowings 257 456 675 303 520 972 1 551 918 1 349 459 Financial lease liability 28 829 20 007 15 485 10 853 Total financial liabilities 3 746 323 6 021 366 8 055 431 10 209 147 12 757 571

ASSETS

Other long-term receivables 32 404 26 391 53 242 113 061 135 562 Financial assets available for sale (non-current) 5 628 7 236 2 689 2 689 2 689 Financial assets available for sale (current) - - - - 10 172 Cash and cash equivalents 607 536 1 408 475 1 178 416 1 104 946 1 730 895 Total financial assets 645 568 1 442 102 1 234 347 1 220 696 1 879 318

EQUITY

Share capital 3 236 3 421 3 457 3 488 3 516 Share premium 789 130 1 041 894 1 055 083 1 075 463 1 093 549 Other paid-in equity 38 984 47 421 54 521 63 365 63 365 Other recievables -7 633 -11 032 -7 944 -9 639 -9 335 Retained earnings 73 650 519 902 690 785 812 910 1 269 556 Total equity 897 367 1 601 606 1 795 902 1 945 587 2 420 651

Net interest bearing debt 3 100 755 4 579 264 6 821 084 8 988 451 10 878 253 Net bearing debt + equity 3 998 122 6 180 870 8 616 986 10 934 038 13 298 904

Appendix 4: Present value of leasing expenses

Cost of debt 5,47 % Capitalization rate 7 2008 2009 2010 2011 2012 Operational lease payments 426 597 620 114 778 411 829 667 1 032 915 Capitalized operational lease 2 986 179 4 340 798 5 448 877 5 807 669 7 230 405

Interest on capitalized lease 163 403,71 237 528,47 298 162,55 317 795,65 395 647,76 Depreciations on capitalized lease 263 193,29 382 585,53 480 248,45 511 871,35 637 267,24

90

Appendix 5: Calculation of ROE

ROE 2008 2009 2010 2011 2012 ROIC 10,48 % 1,96 % 2,41 % 7,64 % Borrowing cost 5,22 % 3,70 % 3,76 % 3,90 % Financial leverage 2,86 3,80 4,62 4,49 ROE 25,52 % -4,63 % -3,84 % 24,43 % Average ROE 10,37 %

Appendix 6: Effective borrowing cost Effective interest rate 8,6 8,6 8,6 8,8 7,5 5,56 7,8 2,5 3,1 6,8 5,4 4,5 4 3,1 7,2 4,5 4,6 3,8 5,6 5,6 5,9 Average effective interest 7,08 7,25 5,14 5,22 5,42 After tax 5,10 % 5,22 % 3,70 % 3,76 % 3,90 %

Appendix 7: Credit spread / company specific risk

Average bond rate Risk free Company (issued by NAS) interest spesific risk 2008 8,52 4,47 4,05 2009 8,6 4 4,6 2010 8,6 3,52 5,08 2011 8,8 3,12 5,68 2012 7,6 2,1 5,5

91

Appendix 8: Reformulated Income statement Ryanair

REFORMULATED INCOME STATEMENT RYANAIR 2008-2012 2008 2009 2010 2011 2012

Sheduled revenues 2 226 2 343 2 325 2 828 3 504 Ancillary revenues 488 598 664 802 886 Total revenues 2 714 2 941 2 988 3 630 4 390

Staff cost 285,3 309,3 335 376,1 415 Fuel cost 791 1257,1 893,9 1227 1593,6 Maintenance 57 66,8 86 93,9 104 Marketing 17 151,9 144,8 154,6 180 Route charges 259 286,6 336,3 410,6 460,5 Handeling charges 396 443,4 459,1 491,8 554 Other 122 0 0 0 0 Total operating costs 1 928 2 515 2 255 2 754 3 307

EBITDA 786 426 733 876 1 083

Depreciation 176 256,1 235,4 277,7 309,2 Lease depreciation 44 47,16 57,60 58,62 54,70

EBIT 566 123 440 539 719

Tax 48 11,3 35,7 46,3 72,6 Tax shield 16 38 12 13 11 Operating tax 64 27 48 60 83 NOPAT 502 96 392 480 636

Net financial expenses 98 273,1 61,1 67,3 50,2 Lease interest 29 31 38 39 36 Total financial items 127 304 99 106 86

Tax on financial items 15,9 38,0 12,4 13,2 10,8

Profit 391 -170 305 387 560

92

Appendix 9: Reformulated balance sheet – operational

OPERATING 2008 2009 2010 2011 2012 Non current assets 3628,9 3751,6 4383,8 5004,4 4975,3 Current tax 1,6 0,5 9,3 Inventories 2 2,1 2,5 2,7 2,8 Other assets 169,6 91 80,6 99,4 64,9 Trade recievables 44,3 41,8 34,2 50,6 51,5 Derivative fin item 122,6 130 10,3 383,8 231,9 Capitalized lease 508,9 547,4 668,5 680,4 634,9 Current assets 849 812,3 796,1 1216,9 986

Total operating assets 4477,9 4563,9 5179,9 6221,3 5961,3

Provisions 44,8 72 102,9 89,6 103,2 Deferred tax 148,1 155,5 199,6 267,7 319,4 Derivative fin instruments 75,7 54,1 35,4 8,3 53,6

Total non-current operating liabilities 268,6 281,6 337,9 365,6 476,2

Trade and other payables 129,3 132,7 154 150,8 181,2 Accrued expenses and other liabilities 919,4 905,8 1088,2 1224,3 1237,2 Current tax 0 0,4 0,9 0 0 Derivative financial intstruments 141,7 137,4 41 125,4 28,2 Total current operating liabilities 1190,4 1176,3 1284,1 1500,5 1446,6

Total operating liabilities 1459 1457,9 1622 1866,1 1922,8

Invested capital 3018,9 3106 3557,9 4355,2 4038,5

93

Appendix 10: Reformulated balance sheet Ryanair – financial

FINANCIAL 2008 2009 2010 2011 2012 Liabilities

Capitalized lease 508,9 547,4 668,5 680,4 634,9 Current maturities of debt 366,8 202,9 265,5 336,7 368,4 non-current maturities of debt 1899,7 2195,5 2690,7 3312,7 3256,8 other creditors 99,9 106,5 136,6 126,6 146,3

Total financing liabilities 2875,3 3052,3 3761,3 4456,4 4406,4

Assets

Available for sale 311,5 93,2 116,2 114 149,7 Restricted cash 292,4 291,6 67,8 42,9 35,1 Financial assets: cash 406,3 403,4 1267,7 869,4 772,2 Cash and cash equivalents 1470,8 1583,2 1477,9 2028,3 2708,3

Total financing assets 2481 2371,4 2929,6 3054,6 3665,3

Equity 2624,6 2425,1 2726,2 2953,9 3306,7

net interes b debt 394,3 680,9 831,7 1401,8 741,1

Invested capital 3018,9 3106 3557,9 4355,7 4047,8

94

Appendix 11: Reformulated Income statement EasyJet

REFORMULATED INCOME STATEMENT EASYJET 2008 2009 2010 2011 2012 Total revenue 2362,8 2666,8 2973,1 3452 3854

Total operating costs 2114,2 2441,7 2611,8 2984 3323 EBITDA 248,6 225,1 361,3 468 531

Amortization 2,5 4,4 6,2 7 8 Deprecitation 44,4 55,4 72,5 83 97 Lease Depreciation 64,206 67,396 59,16 63,22 55,1 Loss/profit on disposal of assets for sale 11 -7 EBIT 137,494 108,904 216,44 314,78 370,9

Corporate tax 27 16,5 32,7 23 62 Tax shield 6,55056 15,17712 17,4832 16,0272 12,936 Operating tax 33,55056 -1,32288 50,1832 39,0272 74,936 NOPAT 103,94344 110,22688 166,2568 275,7528 295,964

Net financial expenses -19,2 5,4 19,6 21 14 Lease interest 46,494 48,804 42,84 45,78 39,9

Total financial expenses 27,294 54,204 62,44 66,78 53,9

Financial tax (24%) 6,55056 15,17712 17,4832 16,0272 12,936

Profit 83,2 71,2 121,3 225 255

95

Appendix 12: Reformulated balance sheet EasyJet – operational Operational 2008 2009 2010 2011 2012 Non current assets

Goodwill 359,8 365,4 365,4 365 365 Other intangible assets 80,6 81,7 86,8 86 91 Equipment 1102,6 1612,2 1928,1 2149 2395 Derivative financial items 21,3 7,8 8,2 24 21 Other non-current assets 61,1 62,7 53,5 63 57 Deferred tax assets 0,5 0,4 0 0 0 Capitalized lease 774,9 813,4 714 763 665 Total non-current assets 2400,8 2943,6 3156 3450 3594

Current assets

Assets held for sale 195,8 73,2 73,2 0 0 Trade and other recievables 236,9 241,8 194,1 165 241 Derivative financial instruments 96,5 68 52,6 83 73

Total current assets 529,2 383 319,9 248 314

Total operating assets 2930 3326,6 3475,9 3698 3908

Current liabilities

Trade and other payables 653 750,7 828,7 916 1021 Derivative financial intstruments 76 91,1 9,6 52 26 Current tax 75,1 57,7 27,5 9 29 Maintenance provisions 49 45,1 71,4 45 59

Total current liabilities 853,1 944,6 937,2 1022 1135

Non-current liabilities

Derivative financial instruments 0,3 2,6 4 27 24 Non-current deffered income 0 52,6 56,6 59 46 Maintenance provisions 160,4 168,6 144,1 177 141 Deferred tax 108,1 76,7 147,9 179 198 Other non-current liabilities 68,8 Total non-current liabilities 337,6 300,5 352,6 442 409

Total operating liabilities 1190,7 1245,1 1289,8 1464 1544

Invested capital 1739,3 2081,5 2186,1 2234 2364

96

Appendix 13: Reformulated Balance sheet EasyJet – Financial

Financial 2008 2009 2010 2011 2012 Liabilities

Capitalized lease 774,9 813,4 714 763 665 Borrowings Current 56,7 117,6 127,4 155 129 Borrowings non-current 570,2 1003 1084,6 1145 828 Total financing liabilities 1401,8 1934 1926 2063 1622

Assets

Loan notes 12 12,6 13,1 11 10 Restricted cash non-current 42,9 48 32,5 33 29 Restricted cash current 23,30 24,3 23,1 90 130 Money market deposits 230,3 286,3 260 300 238 Cash and cash equivalents 632,2 788,6 911,9 1100 645 Total financing assets 940,7 1159,8 1240,6 1534 1052

Equity 1278,2 1307,3 1500,7 1705 1794

Net interest bearing debt 461,1 774,2 685,4 529 570

Invested capital 1739,3 2081,5 2186,1 2234 2364

97

Appendix 14: Regression analysis output SP500/NAS - Weekly

REGRESSION ANALYSIS OUTPUT SP500 AND NAS - WEEKLY

Regresjonsstatistikk Multippel R 0,43304009 R-kvadrat 0,18752372 Justert R-kvadrat 0,18489435 Standardfeil 0,065393 Observasjoner 311

Variansanalyse fg SK GK F Signifkans-F Regresjon 1 0,30497662 0,30497662 71,3187962 1,2022E-15 Residualer 309 1,3213596 0,00427624 Totalt 310 1,62633622

Koeffisienter Standardfeil t-Stat P-verdi Nederste 95%Øverste 95% Nedre 95,0%Øverste 95,0% Skjæringspunkt 0,00191968 0,00370829 0,51767258 0,60505714 -0,00537701 0,00921637 -0,00537701 0,00921637 X-variabel 1 1,01828228 0,12057748 8,44504566 1,2022E-15 0,7810255 1,25553907 0,7810255 1,25553907

Appendix 15: Regression analysis output SP500/NAS – Monthly

REGRESSION ANALYSIS OUTPUT SP500 AND NAS - MONTHLY

Regresjonsstatistikk Multippel R 0,450583303 R-kvadrat 0,203025313 Justert R-kvadrat 0,191474955 Standardfeil 0,165840671 Observasjoner 71

Variansanalyse fg SK GK F Signifkans-F Regresjon 1 0,483433611 0,483433611 17,57740466 8,04612E-05 Residualer 69 1,897715836 0,027503128 Totalt 70 2,381149447

Koeffisienter Standardfeil t-Stat P-verdi Nederste 95% Øverste 95% Nedre 95,0% Øverste 95,0% Skjæringspunkt 0,013361533 0,019700802 0,678222816 0,499898679 -0,025940491 0,052663558 -0,025940491 0,052663558 X-variabel 1 1,550194383 0,369750512 4,192541551 8,04612E-05 0,812562295 2,287826471 0,812562295 2,287826471

98

Appendix 16: Regression analysis output MSCI EAFE/NAS - Weekly

REGRESSION ANALYSIS OUTPUT MSCI EAFE AND NAS - WEEKLY

Regresjonsstatistikk Multippel R 0,47191173 R-kvadrat 0,22270068 Justert R-kvadrat 0,22018515 Standardfeil 0,06396171 Observasjoner 311

Variansanalyse fg SK GK F Signifkans-F Regresjon 1 0,36218618 0,36218618 88,5302596 1,1855E-18 Residualer 309 1,26415004 0,0040911 Totalt 310 1,62633622

Koeffisienter Standardfeil t-Stat P-verdi Nederste 95%Øverste 95% Nedre 95,0%Øverste 95,0% Skjæringspunkt 0,00102996 0,00362745 0,28393644 0,77664925 -0,00610766 0,00816759 -0,00610766 0,00816759 X-variabel 1 0,94808045 0,10076259 9,409052 1,1855E-18 0,74981283 1,14634806 0,74981283 1,14634806

Appendix 17: Regression analysis output MSCI EAFE/NAS - Weekly

REGRESSION ANALYSIS OUTPUT MSCI EAFE AND NAS - MONTHLY

Regresjonsstatistikk Multippel R 0,46182442 R-kvadrat 0,21328179 Justert R-kvadrat 0,20188008 Standardfeil 0,16477009 Observasjoner 71

Variansanalyse fg SK GK F Signifkans-F Regresjon 1 0,50785583 0,50785583 18,7061182 5,0348E-05 Residualer 69 1,87329362 0,02714918 Totalt 70 2,38114945

Koeffisienter Standardfeil t-Stat P-verdi Nederste 95%Øverste 95% Nedre 95,0%Øverste 95,0% Skjæringspunkt 0,00803444 0,0195585 0,41078985 0,68249959 -0,03098371 0,04705258 -0,03098371 0,04705258 X-variabel 1 1,22738814 0,28378542 4,32505702 5,0348E-05 0,66125171 1,79352457 0,66125171 1,79352457

99

Appendix 18: Regression analysis output MSCI EAFE/NAS – Weekly

FORECASTED BUDGET Mill NOK F2013 F2014 F2015 F2016 F2017 F2018 F2019 F2020 F2021 F2022 Passenger 13 580 16 377 17 607 19 155 20 644 22 708 24 979 26 977 28 865 31 175 Other revenues 293 354 380 414 446 490 540 583 623 673 Ancillary revenues 1 697 2 047 2 201 2 394 2 580 2 838 3 122 3 372 3 608 3 897 Total revenues 15 571 18 778 20 188 21 964 23 670 26 037 28 641 30 932 33 097 35 745

Sales and distribution expenses 311 376 404 439 473 521 573 619 662 715 Aviation Fuel 4 360 5 070 5 249 5 491 5 444 5 728 6 301 6 805 7 281 7 864 Airport charges 2 180 2 629 2 826 3 075 3 314 3 645 4 010 4 330 4 634 5 004 Handling charges 1 479 1 784 1 918 2 087 2 249 2 474 2 721 2 939 3 144 3 396 Technical maintenance expenses 965 1 127 1 211 1 208 1 302 1 432 1 432 1 547 1 655 1 787 Other aircraft expenses 623 751 808 879 947 1 041 1 146 1 237 1 324 1 430 Personell costs 2 569 3 004 3 230 3 404 3 314 3 775 3 981 4 238 4 369 4 647 Other operational expenses 747 845 848 922 994 1 094 1 203 1 299 1 390 1 501 Total operating costs 13 235 15 585 16 494 17 505 18 036 19 710 21 366 23 013 24 459 26 344 EBITDA 2 336 3 192 3 694 4 459 5 633 6 327 7 275 7 919 8 638 9 401

Lease depreciation 830 1 033 1 240 1 275 1 166 1 276 1 427 1 594 1 780 1 987 Depreciation and amortization 467,1 563,3 605,6 658,9 710,1 781,1 859,2 928,0 992,9 1 072,3 EBIT 1 038,5 1 595,5 1 848,8 2 524,8 3 757,0 4 270,1 4 988,7 5 396,2 5 865,0 6 341,6

Corporate tax 290,8 446,8 517,7 707,0 1 052,0 1 195,6 1 396,8 1 510,9 1 642,2 1 775,7 Tax shield 129,2 133,7 112,6 131,1 167,9 187,6 206,1 222,2 237,4 256,1 Operating tax -161,5 -313,0 -405,0 -575,9 -884,1 -1 008,1 -1 190,8 -1 288,7 -1 404,8 -1 519,6 NOPAT 877,0 1 282,5 1 443,8 1 949,0 2 872,9 3 262,0 3 797,9 4 107,5 4 460,3 4 822,1

Financial items 779,2 873,0 876,9 956,0 1 046,0 1 158,1 1 282,0 1 403,9 1 529,5 1 675,2 Lease interest -317,7 -395,5 -474,6 -488,0 -446,4 -488,3 -546,1 -610,2 -681,5 -760,5 Net financial items 461,5 477,5 402,3 468,1 599,6 669,8 735,9 793,7 848,0 914,7

Financial tax (28%) 129,2 133,7 112,6 131,1 167,9 187,6 206,1 222,2 237,4 256,1

Profit 1 467,7 1 893,7 1 958,7 2 548,1 3 640,4 4 119,4 4 739,9 5 123,4 5 545,7 5 992,8

Appendix 19: Balance sheet forecast assumptions

HISTORICAL Average FORECASTED 2008 2009 2010 2011 2012 F2013 F2014 F2015 F2016 F2017 F2018 F2019 F2020 F2021 F2022 In % of revenues In % of revenues Intangible assets 4,1 % 2,6 % 2,5 % 2,3 % 1,9 % 2,7 % 2 % 2 % 2 % 2 % 2 % 2 % 2 % 2 % 2 % 2 % Aircrafts, parts and installations 8,4 % 13,3 % 24,9 % 36,7 % 43,5 % 25,4 % 55 % 55 % 55 % 55 % 55 % 55 % 55 % 55 % 55 % 55 % Equiptment and fixtures 0,50 % 0,42 % 0,31 % 0,30 % 0,46 % 0,4 % 0,4 % 0,4 % 0,4 % 0,4 % 0,4 % 0,4 % 0,4 % 0,4 % 0,4 % 0,4 % Buildings 0,06 % 0,05 % 0,11 % 0,09 % 0,07 % 0,1 % 0,2 % 0,2 % 0,2 % 0,2 % 0,2 % 0,2 % 0,2 % 0,2 % 0,2 % 0,2 % Financial lease assets 0,00 % 0,36 % 0,37 % 0,26 % 0,19 % 0,2 % 0,24 % 0,24 % 0,24 % 0,24 % 0,24 % 0,24 % 0,24 % 0,24 % 0,24 % 0,24 % Prepayment aircraft manufacturers 11,33 % 19,30 % 23,82 % 20,20 % 22,15 % 19,4 % 22 % 22 % 22 % 22 % 22 % 22 % 22 % 22 % 22 % 22 % Inventory 0,5 % 0,6 % 0,8 % 0,8 % 0,5 % 0,6 % 0,6 % 0,6 % 0,6 % 0,6 % 0,6 % 0,6 % 0,6 % 0,6 % 0,6 % 0,6 % Trade and other recievables 14,7 % 11,4 % 10,0 % 10,2 % 8,5 % 11,0 % 9 % 9 % 9 % 9 % 9 % 9 % 9 % 9 % 9 % 9 % Non current operating liabilities 2,0 % 1,2 % 2,2 % 2,1 % 3,7 % 2,2 % 3,50 % 3,50 % 3,50 % 3,50 % 3,50 % 3,50 % 3,50 % 3,50 % 3,50 % 3,50 % Trade and other payables 11,2 % 10,2 % 12,7 % 11,7 % 12,2 % 11,6 % 12 % 12 % 12 % 12 % 12 % 12 % 12 % 12 % 12 % 12 % Air traffic settlement liabilities 9,6 % 10,8 % 11,4 % 11,5 % 13,5 % 11,4 % 14 % 14 % 14 % 14 % 14 % 14 % 14 % 14 % 14 % 14 %

100

Appendix 20: Forecasted balance sheet

millNOK F2013 F2014 F2015 F2016 F2017 F2018 F2019 F2020 F2021 F2022 In % of revenues Intangible assets 311,4 375,6 403,8 439,3 473,4 520,7 572,8 618,6 661,9 714,9 Aircrafts, parts and installations 8 563,9 10 327,6 11 103,5 12 079,9 13 018,5 14 320,3 15 752,3 17 012,5 18 203,4 19 659,7 Equiptment and fixtures 62,0 74,8 80,4 87,5 94,3 103,7 114,1 123,2 131,8 142,4 Buildings 31,1 37,6 40,4 43,9 47,3 52,1 57,3 61,9 66,2 71,5 Financial lease assets 36,9 44,5 47,8 52,0 56,1 61,7 67,8 73,3 78,4 84,7 Prepayment aircraft manufacturers 3 449,0 4 159,3 4 471,8 4 865,0 5 243,0 5 767,2 6 344,0 6 851,5 7 331,1 7 917,6 Operational lease 8 676 8 921 8 161 8 927 9 983 11 156 12 458 13 903 15 507 17 288 Total non-current assets 21 130,9 23 939,8 24 309,0 26 494,5 28 915,9 31 982,0 35 366,5 38 644,2 41 980,1 45 878,3

In % of revenues Inventory 93,4 112,7 121,1 131,8 142,0 156,2 171,8 185,6 198,6 214,5 Trade and other recievables 1 401 1 690 1 817 1 977 2 130 2 343 2 578 2 784 2 979 3 217 Total current assets 1 494,8 1 802,6 1 938,1 2 108,5 2 272,3 2 499,5 2 749,5 2 969,5 3 177,3 3 431,5

Total operating assets 22 625,7 25 742,4 26 247,0 28 603,0 31 188,3 34 481,6 38 116,0 41 613,6 45 157,4 49 309,8

In % of revenues Non current operating liabilities 544,98 657,21 706,59 768,72 828,45 911,29 1 002,42 1 082,61 1 158,40 1 251,07

Trade and other payables 1 868 2 253 2 423 2 636 2 840 3 124 3 437 3 712 3 972 4 289 Air traffic settlement liabilities 2 180 2 629 2 826 3 075 3 314 3 645 4 010 4 330 4 634 5 004 Total current liabilities 4 048 4 882 5 249 5 711 6 154 6 770 7 447 8 042 8 605 9 294

Total operating liabilities 4 593,39 5 539,37 5 955,53 6 479,24 6 982,63 7 680,89 8 448,98 9 124,90 9 763,64 10 544,73

Net working capital -2 553,6 -3 079,5 -3 310,9 -3 602,0 -3 881,9 -4 270,1 -4 697,1 -5 072,8 -5 427,9 -5 862,2

Invested capital 18 032,27 20 203,07 20 291,51 22 123,72 24 205,63 26 800,68 29 666,97 32 488,73 35 393,73 38 765,11

Net interest-bearing debt 14 245,50 15 960,42 16 030,29 17 477,74 19 122,45 21 172,54 23 436,91 25 666,10 27 961,05 30 624,43 Equity 3 786,78 4 242,64 4 261,22 4 645,98 5 083,18 5 628,14 6 230,06 6 822,63 7 432,68 8 140,67

101

102