Valuation of Norwegian Air Shuttle ASA as of 31.12.2010 Copenhagen Business School, January 2012 Program: Accounting Strategy and Control Number of pages: 80 Supervisor: Number of characters: 191 423 Jeppe Schoenfeld, external Executive summary The aim of the thesis was to estimate the share price of Norwegian Air Shuttle ASA as of 31.12.10 from an investor’s point of view. Strategic and financial analyses were conducted in order to forecast future financial statements and required rate of return to apply in a discounted cash flow model. The Nordic market for air travel was analyzed under the concept of a perfect market. This analysis concluded that the market, and especially the leisure segment, was highly competitive because of limited differentiation opportunities, low switching costs and brand loyalty, and few entrance barriers on new routes for existing airlines. Airlines’ cost structure were characterized by a high degree of fixed and batch costs, which implied significant economic of scale benefits. This has contributed to high capacity in the market after the low cost carriers (LCCs) entrance and been a driver of the heavy unit price decrease seen the last ten years. The strategic analysis also evaluated Norwegian’s future revenue growth potential in the Nordic market, partly based on historical development. Norwegian is positioned as the dominant actor in the Nordic leisure segment and challenges SAS in the business segment. The major finding of the financial analyses was that Norwegian has generated an unstable EBITDAR-margin, which has been the major underlying factor to the volatile return on invested capital. This development was solely explained by variations in the jet fuel price. Norwegian hedges a relatively low amount of fuel consumption and is therefore more exposed to fuel price fluctuations than other airlines. The risk analysis showed that Norwegian is highly levered compared to the chosen peers, and that this financial structure will remain as the aircraft acquisitions until 2016 primarily shall be financed by debt. Norwegian’s required rate of return to all capital providers were estimated by use of the WACC concept. The WACC applied was 7,53%. Required rate of return on equity was estimated by use of the CAPM- model. The discounted cash flow valuation gave an estimate of the share price at NOK 105,1 while the traded price as of 31.12.10 was NOK 117,50, which indicated that the share was overpriced in the market. The price estimate was primarily driven by the long-term growth rate in the overall economy and the long-term required rate of return. 1 Subsequently was the share price estimate supported by a multiple analysis. EV/EBITDAR and EV/Revenue resulted in prices of NOK -25,3 and 127,3 respectively. The EV/EBITDAR multiple was considered not appropriate to apply for a growth company with unstable margins currently. The EV/Revenue estimate indicates that there were several factors affecting the pricing in which the DCF-model not captured, and that the share in reality was underpriced as of 31.12.10. Lastly, was the share price estimate’s sensitivity to changes in the underlying assumptions tested. The sensitivity analysis found that if a one percentage point change in long-term growth and/or long-term WACC is considered likely, will realistic share prices ranges from NOK 0 to NOK 186. The conclusion was that the traded price as of 31.12.10 was too high under the assumption that the forecast derived is realistic, and “sell” is therefore would therefore been the recommended action. 2 Table of Contents 1. Introduction ................................................................................................................................... 5 1.1 Problem formulation ....................................................................................................................................................................... 6 1.2 Delimitations ...................................................................................................................................................................................... 7 2.0 Method .......................................................................................................................................... 9 2.1 Structure .............................................................................................................................................................................................. 9 2.2 Methodology .................................................................................................................................................................................... 10 2.2.1 Choice of theory ...........................................................................................................................................................................................10 2.2.2 Critique of theories .....................................................................................................................................................................................12 2.3 Data collection ................................................................................................................................................................................ 12 2.3.1 Choice of data ................................................................................................................................................................................................12 2.3.2 Critique of data .............................................................................................................................................................................................13 2.4 Reliability and validity ................................................................................................................................................................. 13 3. Overview of Norwegian Air Shuttle ASA ........................................................................... 14 3.1 The share and the group’s organizational structure......................................................................................................... 14 3.2 The low- fare business model and Norwegian’s business strategy .............................................................................. 16 3.3 Market position and traffic development ............................................................................................................................. 16 3.4 Key financials .................................................................................................................................................................................. 17 4. Strategic analysis ...................................................................................................................... 18 4.1 The Nordic market for air travel .............................................................................................................................................. 18 4.1.1 The structure of the Nordic market .....................................................................................................................................................18 4.1.2 The Nordic market’s price development ...........................................................................................................................................24 4.1.3 The size and growth of the Nordic market .......................................................................................................................................25 4.2 Norwegian’s revenue growth potential ................................................................................................................................. 30 4.2.1 Ticket revenue ..............................................................................................................................................................................................31 4.2.2 Ancillary revenue ........................................................................................................................................................................................36 5. Financial Statement analysis ............................................................................................... 37 5.1 Accounting data and its quality................................................................................................................................................. 38 5.1.1 Adjustments to the financial statements ...........................................................................................................................................38 5.1.2 Operating leasing in valuation of airlines ..........................................................................................................................................38 5.2 Analysis of Norwegian’s profitability ..................................................................................................................................... 39 5.2.1 EBITDAR .........................................................................................................................................................................................................40 5.2.2 Capital analysis .............................................................................................................................................................................................45 5.2.3 Return On Invested Capital .....................................................................................................................................................................48