Cash-Strapped Norwegian Bets on Fuel-Price Drop as IAG Circles

(Bloomberg) -- Norwegian Air Shuttle ASA is entering the critical summer travel season with a bet that jet fuel prices will recede from 3 1/2-year highs -- a position that risks weakening Chief Executive Officer Bjorn Kjos’s hand as he negotiates a potential buyout by the owner of British Airways.

The Oslo-based low-cost airline, known for offering $99 flights between Europe and the U.S., typically hedges about half its fuel needs to protect against abrupt jumps that could explode costs. But it started scaling back last year, after kerosene prices were already on the rise.

“We were reluctant to hedge at the high levels after the summer and have not hedged more for 2018,” said Lasse Sandaker-Nielsen, a spokesman.

Instead of dropping, though, fuel prices have continued their upward march -- advancing more than 20 percent since last summer to more than $700 a ton. Norwegian ended the first quarter with 27 percent of its fuel costs hedged this year, well below rivals like Ryanair Holdings Plc and Deutsche Lufthansa AG.

Kjos, who controls a 27 percent stake in Norwegian, is known as an industry maverick. The 71-year-old ex-fighter pilot has already stretched the balance sheet, spending billions on a fleet of more-efficient new aircraft and rapidly expanding long-haul routes. While he’s forced others to follow, he hasn’t proven his strategy can make money. Mounting fuel costs would exacerbate losses, making it harder to command top dollar from BA’s parent, IAG SA, or other suitors.

While hedging is meant to curb cost inflation and make earnings more predictable, it also limits the savings when fuel prices fall. Many airlines follow set hedging rules, though some allow a certain degree of speculation.

While Norwegian’s fuel-hedging position has already pushed up expenses, the carrier isn’t changing course, according to spokesman Sandaker-Nielsen. The company said in its quarterly report last week that every 1 percent drop in jet fuel prices will save it about 101 million kroner ($12.6 million), assuming fuel costs of $644 per ton this year.

But analysts at HSBC have also looked at the other side of the ledger. They estimate Norwegian’s fuel expense will rise 50 percent this year to about $1.37 billion, or $680 per ton. Should prices reach an average of $830 a ton this year, Norwegian would lose $291 million in operating profit.

To put that in perspective, in March the company raised $168 million in new equity to give itself breathing room to avoid breaching lender covenants. The company had about $3.1 billion in net debt at the end of March.

“If fuel prices continue to rise, Norwegian will have serious issues,” said Daniel Roeska, an analyst at Bernstein in London. “To a large extent, they’ve tied their future cash flows to the price of oil.”

The balance-sheet weakness that made Norwegian a takeover target for IAG hasn’t stopped Kjos from adding to his bets. In addition to the gamble on fuel, the CEO is starting a new domestic arm in Argentina, which he reckons is ripe for discount flights.

IAG acquired a 4.6 percent stake in Norwegian in April, and said it’s considering making a full offer. Kjos last week reversed a long-held position against a sale and hired advisers to manage interest from what he called “very serious” suitors.

“In an airline life you will always go up and down,” Kjos said in a recent interview. “You cannot always avoid risks.”

--With assistance from Alaric Nightingale and Alex Longley

To contact the reporters on this story: Benjamin Katz in London at bkatz38@bloomberg.net, Richard Weiss in Frankfurt at rweiss5@bloomberg.net.

To contact the editors responsible for this story: Anthony Palazzo at apalazzo@bloomberg.net, Christopher Jasper

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