We Increase Lufthansa’s FVE as We Update Our Model

Business Strategy & Outlook

Deutsche Lufthansa is a European network carrier utilizing a hub-and-spoke model. Its major hubs are Frankfurt, Munich, Vienna, and Zurich and flies under the Lufthansa, Swiss Air, and Austrian Airlines brands. As a result of the coronavirus downturn the group embarked on a cost and fleet restructuring program, which will see it emerge as a smaller business. Despite the smaller size the group to become a more profitable business as a result of structural cost reductions and fleet efficiencies and forecast EBIT growth of 8.5% per year to 2026 from 2019 pre coronavirus levels. However, the negative about the prospects for shareholder value creation due to the high level of indebtedness.

In 2020, the group received a government-backed support package totaling EUR 9 billion, which included an equity stake of 20% by the German government for EUR 306 million. As part of the approval process the European Commission required the group to surrender 26 slots at its Frankfurt and Munich hubs to new competitors. Despite the recent EUR 2.1 billion rights issue, the group remains highly indebted, which may require additional capital restructuring if cash flows don’t recover to suitable levels to deleverage organically. Due to the group’s indebtedness and highly uncertain timing of a recovery in cash flows, there is still a wide range of possible outcomes for the group’s equity value. The company will retire and dispose of its older fleet, which will see the group emerge with 100 to 150 fewer aircraft than its current 760-strong fleet. The group is in the process of restructuring its cost base and aims to reduce its current 138,000 employees by 16% and cut the management team by 20% by 2022. The group can drive higher load factors as a result of better utilization of a more efficient fleet and emerge with a structurally higher EBIT margin of 8% in 2025, which compares with an average margin of 7% over the five years pre-COVID-19.

Financial Strengths

The Lufthansa is in a weak financial position due to its high levels of indebtedness. The coronavirus pandemic dealt a heavy blow to the aviation industry, resulting in record losses, cash outflows, and growing debt levels. To bolster liquidity, the group agreed to a EUR 9 billion government support package, which included the German state taking a 20% ownership in the group. Net debt, including pension provisions of EUR 7.6 billion, at the end of December 2021 equated to EUR 15.6 billion. The group is highly geared, with a net debt to prepandemic EBITDA ratio of 3.5 times, and it could require multiple years of deleveraging to restore the balance sheet to maintainable levels.

Bulls Say

COVID-19 presents the group with a unique opportunity to structurally lower its cost base and emerge from the crisis with better profitability.

The airline has dominant positions at the key European hubs of Frankfurt and Munich, which could be an early beneficiary of a recovery in air travel.

Fleet reduction through the retirement of older and less efficient aircraft could lead to a more rational fleet with higher load factors and unit revenue.

Company Description

Deutsche Lufthansa is a European airline group. The company operates under the Lufthansa, Swiss Air, Austrian Airlines and Euro wings brands. In 2019, the company carried 145 million passengers to its network of 318 destinations globally. The group’s main airport hubs are Frankfurt, Munich, Vienna and Zurich. The company generated sales of EUR 36.4 billion in 2019.

(Source: Morningstar)

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