Scope affirms Deutsche Lufthansa at BBB-/Stable
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Scope Ratings GmbH (Scope) has today affirmed the issuer rating of Deutsche Lufthansa AG at BBB-/Stable. Scope has also affirmed the BBB- senior unsecured debt rating, the BB subordinated debt (hybrid) rating and the S-2 short-term rating.
The affirmation reflects Scope’s expectation of strengthening credit metrics over the next two years, driven by the pace of recovery in air traffic and confirmed by the H1 results. Guidance from Lufthansa after H1 2022 confirms further improvements, some of which exceed Scope’s previous expectations. While the explicit parent support is no longer built in Scope’s rating case after the German state sold its remaining stake1, the stronger financial risk profile and a slight overweight of the business risk profile assessment has resulted in Scope leaving the issuer rating unchanged.
The business risk profile (assessed at BBB-) continues to be supported by the group’s well-diversified portfolio and the individual business segments’ strengths.
The group’s leading position in its home markets and the large scale of its operations have allowed passenger revenues to recover. The full-year capacity for 2022 is still expected to be around 75% of the 2019 level. Despite limitations on capacity, the business model in the previous months focused on premium demand with stable yields and high load factors across the whole network, which benefited the group. With tight productivity management, the group expects capacity to further normalise in 2023 to 85%-90% of pre-crisis levels.
The robust market positions in Cargo and Lufthansa Technik (MRO) are strong contributors to this recovery. Lufthansa Cargo has also maintained its good performance. Cargo continues to benefit from capacity shortages in the air cargo market and disruptions in sea freight. Lufthansa Technik (MRO) demand is particularly strong across the key components and engine divisions as airlines have ramped up for the market recovery. With materials shortages remaining manageable and cost inflation largely being passed on to customers, MRO will contribute to the positive performance of group.
Lufthansa Group is well positioned to take advantage of the recovery in industry, even if the macro environment becomes more difficult in the home market of Germany. The trend towards an increasingly international and synergetic Lufthansa Group, which also takes advantage of growth opportunities outside of Germany, will continue.
The group is making material moves towards profitability with management guidance of adjusted EBIT of above EUR 500m for the full-year 2022. Yields are increasing across all traffic regions. The transatlantic is standing out based on stronger US-based demand for travel to Europe than in 2019. Unit costs are trending closer to 2019 levels as more cost savings are being realised and higher capacity is helping to leverage the fixed costs.
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 is hedging part of its fuel consumption and entered into agreements with different employee groups.
The financial risk profile has improved to BB+ from BB, based on improving credit metrics amid better than expected cash generation. H1 2022 results and guidance for the rest of the year have improved Scope’s base case. The strong pace of recovery in addition to cost savings is paving the way for significantly reduced net debt. At this stage, the Scope-adjusted debt/EBITDA leverage ratio is expected to go to around 3.5x in 2022. Scope still expects 2022 revenues to be around 15% lower than in 2019. Assuming the recovery continues into 2023, Scope’s base case foresees credit metrics to improve further, with a Scope-adjusted debt/EBITDA of around 2.5x by 2023 due to cash inflow from ordinary operations, cost discipline and lower debt. Free operating cash flow may remain weaker as capital expenditure will go up to around EUR 2.5bn 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, which may take place in 2023 or 2024.
Liquidity is robust, bolstered by efforts to secure and preserve a comfortable cash buffer and reduce cash drain. Liquidity benefits from EUR 2.1bn in undrawn revolving credit lines, more than 84% in unencumbered owned fleet and the potential proceeds from non-core assets disposals. The group’s long-term liquidity target is around EUR 6bn-8bn. As of 30 June 2022, Deutsche Lufthansa AG had centrally available liquidity of EUR 7.8bn. Altogether, available liquidity can more than cover the EUR 1.3bn in outstanding short-term debt as of H1 2022.
In terms of supplementary rating drivers, Scope has removed the one notch for parent support after the German Economic Stabilization Fund ended stabilisation measures and sold its remaining stake in Lufthansa on 13 September 2022.
Financial policy continues to be neutral for the rating. Management shows a disciplined strategy as well as a commitment to deleveraging and the investment grade level. Management’s aim is to resume paying dividends in the medium to long term once stability returns.
The rating assessment identifies labour management, CO2 emission, and indirect sustainability challenges as the three main 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 significantly improve over the next two years, driven by the recovery in air traffic and deleveraging.
A positive rating action could be warranted if industry and business conditions continued to improve, resulting in a significantly higher operating cash flow and an improved financial risk profile, exemplified by a Scope-adjusted debt/EBITDA sustained at close to or below 2.0x.
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 at or 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.
Long-term and short-term debt ratings
Senior unsecured debt has been affirmed at BBB-, in line with the issuer rating.
Outstanding subordinated debt (hybrid) remains two notches below the issuer credit rating, at BB.
The affirmed short-term rating of S-2 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.
The methodology used for this Credit Rating and/or Outlook, (General Corporate Rating Methodology, 15 July 2022), 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.
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 Credit Rating and the senior unsecured debt Credit Rating were first released by Scope Ratings on 4 November 2016. The Credit Ratings/Outlook were last updated on 11 July 2022.
The subordinated (hybrid) Credit Rating/Outlook was first released by Scope Ratings on 6 June 2018. The Credit Rating/Outlook was last updated on 11 July 2022.
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