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Rating action

Scope Ratings GmbH (Scope) has today affirmed the issuer rating of Deutsche Lufthansa AG (Lufthansa Group) at BBB-. The rating Outlook has been changed to Stable from Negative. Scope has also affirmed the BBB- senior unsecured debt rating and the BB subordinated (hybrid) debt rating. The short-term rating has been upgraded to S-2 from S-3.

Rating rationale

The Outlook change reflects Scope’s expectation of improving credit metrics over the next two years, driven by the pace of recovery in air traffic and deleveraging efforts. Scope takes the EUR 2.1bn capital increase and repayment of state loans as signs that Lufthansa is regaining its financial independence, with an improved ability to generate cash flow supported by rising passenger travel revenue, its resilient cargo business and recovery in its other businesses.

The business risk profile (assessed at BBB-) is supported by the group’s leading position in its home markets (Germany, Switzerland, Austria and Belgium) and the large scale of its operations. Lufthansa Group expects capacity to recover in 2022 to around 75% of the pre-Covid-19 level (in 2019) but will need at least until 2024 to recover in full. The group is well placed to benefit from the early recovery of short-haul and leisure travel: subsidiary Eurowings is more competitive than it was before the crisis thanks to a structurally reduced cost base. Recovery out of the pandemic will be led by demand for intra-European and transatlantic routes and by Lufthansa’s increasing focus on the core airline business, with plans to exit the non-core areas of catering (LSG) and business travel management solution (Air Plus). Scope expects the group to retain its market position and try to take part in strategic and opportunistic M&A. For example, taking a stake in Italian airline ITA will strengthen the group’s position in that country, its second most important foreign market.

Diversification into other activities, especially cargo, has helped to offset the impact of reduced passenger traffic. The e-commerce boom and the supply-demand gap will ensure that the cargo business continues to be a major contributor to profit. Lufthansa Technik (maintenance, repair and operations) will also increasingly contribute as more aircrafts are deployed to meet rising demand.

Profitability is expected to remain weaker than the pre-pandemic level as a result of the lower capacity offered. In 2022, Lufthansa expects the load factor to improve and to continue decreasing unit costs. Targets by 2024 of an EBIT margin of at least 8% and cost savings of EUR 3.5bn continue to apply. Fuel and employees costs remain the most challenging. To this end, Lufthansa hedges part of its fuel consumption and continues to negotiate with social partners.

The financial risk profile (improved to BB from BB-) is based on improving credit metrics amid better cash generation and continued traffic recovery. At this stage, the Scope-adjusted debt (SaD)/EBITDA ratio is expected at below 5x and the funds from operations/SaD ratio at above 15% for 2022, with significant improvements expected thereafter due to cash inflow from ordinary operations, cost discipline and lower debt. Scope still expects 2022 revenues to be around 20% lower than in 2019. Assuming the recovery continues into 2023, Scope’s base case foresees credit metrics to improve, with a SaD/EBITDA of below 3.0x by 2023. Free operating cash flow may remain low to negative as capital expenditure will go up to around EUR 2.5bn or more due to fleet renewal and operations ramp-up.

The rating case does not account for proceeds from the possible divestment of non-core assets (AirPlus and LSG) or the option to sell a minority stake of Lufthansa Technik. Scope believes the Lufthansa net debt/EBITDA target of 3.5x can already be achieved through strong cash flow generation, importantly supported by the continuing traffic recovery and reinforced by Lufthansa’s restructuring efforts.

Liquidity is robust, bolstered by strong efforts to secure and preserve a comfortable cash buffer and reduce cash drain. Liquidity benefits from EUR 2.1bn in undrawn revolving credit lines, 84% unencumbered fleet and, possibly, proceeds from non-core disposals. The group’s long-term liquidity target is EUR 6bn to EUR 8bn. As of 31 March 2022, Deutsche Lufthansa AG has available balance sheet liquidity of EUR 7.9bn. Altogether, available liquidity can more than cover the EUR 1.69bn in outstanding short-term debt as of Q1 2022 and the negative free operating cash flow forecast for 2022.

The standalone rating is assessed at BB+ from BB, based on the stronger financial risk profile and expectation of improved credit metrics into 2023.

In terms of supplementary rating drivers, Scope decreased by one notch the parent support because the German and Swiss states have lowered their direct exposure. After German and Swiss governments terminated support measures, undrawn commitments were cancelled, limiting available support. The German government intends to fully divest its stake in Lufthansa by October 2023, currently 14% via its Economic Stabilization Fund (WSF). Scope believes visibility on Lufthansa’s future level of credit metrics will improve before that happens.

Financial policy continues to be neutral for the rating. The group cannot pay dividends as long as the Economic Stabilization Fund has a stake. The clear aim is to resume paying dividends in the medium to long term once profits return.

The rating assessment identifies labour management and CO2 emission as the main two ESG challenges to the airline industry (credit-negative ESG factor).

One or more key drivers of the credit rating action are considered ESG factors

Outlook and rating-change drivers

The Stable Outlook reflects the expectation that credit metrics will improve over the next two years, driven by the recovery in air traffic and deleveraging. It also assumes that parent support will gradually fade with the termination of stabilisation measures and the disposal of the WSF stake (by October 2023).

A positive rating action is currently remote, but could be warranted if industry and business conditions continued to improve, resulting in significantly higher operating cash flow and an improved financial risk profile, exemplified by Scope-adjusted debt/EBITDA leverage moving towards 2.0x or below on a sustained basis.

A negative rating action is possible if Lufthansa’s financial metrics remained constrained beyond 2022 with no medium-term recovery expectation, exemplified by Scope adjusted debt/EBITDA staying above 3.5x. This could be the result of a slower-than-expected recovery of operating cash flow amid a sluggish revival of international air travel. A negative rating action could also occur if state support abruptly diminished while results fell short of expectations.

Long-term and short-term debt ratings

Senior unsecured debt has been affirmed at BBB-, in line with the issuer rating.

Outstanding subordinated (hybrid) debt remains two notches below the issuer credit rating, at BB.

The upgrade of short-term rating to S-2 from S-3 is backed by the strong short-term liquidity cover and conservative liquidity management. The rating is further supported by well-established bank relationships and good standing in the capital markets, evidenced by the recently established revolving credit line. 

Stress testing & cash flow analysis
No stress testing was performed. Scope Ratings performed its standard cash flow forecasting for the company.

Methodology
The methodology used for these Credit Ratings and/or Outlook, (Corporate Rating Methodology, 6 July 2021), is available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other Services’, published on https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://scoperatings.com/governance-and-policies/regulatory/eu-regulation. Also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope Ratings’ definitions of default and Credit Rating notations can be found at https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Guidance and information on how environmental, social or governance factors (ESG factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The Outlook indicates the most likely direction of the Credit Ratings if the Credit Ratings were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The Rated Entity and/or its Related Third Parties participated in the Credit Rating process.
The following substantially material sources of information were used to prepare the Credit Ratings: public domain, the Rated Entity and Scope Ratings' internal sources.
Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting the Credit Ratings originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Ratings and/or Outlook and the principal grounds on which the Credit Ratings and/or Outlook are based. Following that review, the Credit Ratings were not amended before being issued.

Regulatory disclosures
These Credit Ratings and/or Outlook are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and/or Outlook are UK-endorsed.
Lead analyst: Azza Chammem, Senior Analyst
Person responsible for approval of the Credit Ratings: Henrik Blymke, Managing Director
The issuer Credit Rating/Outlook, the short term rating and the senior unsecured debt rating were first released by Scope Ratings on 4 November 2016. The Credit Ratings/Outlook were last updated on 8 July 2021.
The subordinated (hybrid) Credit Rating/Outlook was first released by Scope Ratings on 6 June 2018. The Credit Rating/Outlook was last updated on 8 July 2021.

Potential conflicts
See www.scoperatings.com under Governance & Policies/EU Regulation/Disclosures for a list of potential conflicts of interest related to the issuance of Credit Ratings.

Conditions of use/exclusion of liability
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