DLAKF - Deutsche Lufthansa: Another Increase In Its Adj. EBIT Profit

Summary

• From a no-go to a possible capital increase in ITA Airways, we always favored Deutsche Lufthansa.
• No retroactive bonus to the company's Board.
• The company increased its operating profit guidance for a second time. Now, it is expected at €1.5 billion, and so we increase our valuation.

Today, we decided to deep-dive into Deutsche Lufthansa AG ( DLAKF ; DLAKY ). Here at the Lab, we already commented on the company's Q3 results and we were pretty positive . Indeed, we can report that Lufthansa was already expecting better Q4 results compared to the 2019 same period (before the pandemic outbreaks). In detail, in Q3, the adjusted EBIT reached €1.13 billion against €251 million achieved last year's end quarter. Travel demand remains strong despite inflation fears, economic slowdowns, and a sharp increase in tariffs. In conjunction with the account release, Deutsche Lufthansa revised upwards the forecast for its 2022 operating profits to €1.1 billion from a previous guidance of €500 million. However, last week, given the October and November performance, the company decided to increase its EBIT profit guidance once again. The airline group now expects an adjusted operating profit of approximately €1.5 billion for FY 2022. For the first time, looking at the note, the passenger division will significantly contribute to the company's P&L, so in Q4, this will be coupled with the positive momentum from the CARGO division (and Deutsche Lufthansa's maintenance sector called Technik). To achieve this, we are forecasting that the carrier will use about 80% of its pre-pandemic capacity. This is key to report even because, after a summer of chasing cancellations due to strikes and staff shortages, volumes were not great. However, higher ticket prices have offset lower flights and actually boosted margins. This positive trend is also confirmed both in Europe and in the United States.

ITA Airways: the story continued

Here at the Lab, we did a few updates on ITA Airways, and today we should revise our last publication called The Italian Government Had Chosen Air France Over The Favorite MSC-Lufthansa Consortium. Our readers know that we were more in favor of the Deutsche Lufthansa deal, so we were not surprised to see that the new Italian Government reopened the talks with the German flight operator. In recent days, Italian Minister Giorgetti has reopened the sale tender for the ITA equity stake, bringing the MSC-Lufthansa consortium back into play. We believe that this is a shareable decision. Our internal team has long maintained that the best industrial partner for ITA is Lufthansa and not the duo formed by Delta and Air France-KLM. The German company characteristics are complementary to those of the Italian market: a structure based on multiple hubs and mainly outbound traffic (Germans traveling from Germany to foreign countries). Features that go hand in hand with those of the Italian market which is mainly inbound. Therefore, there would be no competition, but important synergies between the two companies.

According to the latest rumors, as a first step, Lufthansa will enter ITA in a range between 40% and 49% through a capital increase with an option to be exercised for the remaining share. Lufthansa seems to replicate the Belgian experience, indeed, the Belgian national airline was acquired in two phases: in 2009 with a minority stake at 45%, and then the remaining was acquired in 2017 end. Speaking of numbers, Lufthansa's capital injection will be around €200 million, a figure which would now value ITA at around €400-€450 million. Of course, we are a long way from last January-March when ITA was valued at around €1.4 billion.

A preliminary sale agreement with the Italian Treasury could be signed in January. On the regulatory requirements, this was made possible thanks to the latest DPCM approved by the Italian government. However, we should consider the next steps too such as the EU Antitrust decision. We believe that there will be a green light. Again, we assign zero value to this potential transaction.

Conclusion and Valuation

The German government has expressed its opposition to the granting of retroactive bonuses for the six members of the board of directors of Lufthansa, which during the pandemic received free financing and loans for €9 billion. At the time, the plan envisaged that group members could not receive bonuses during the period of use of the public aid. As a reminder, we should note that the German state sold all its shares in the airline this September. With the latest update and its revised operating profit margin, we decided to increase our target price slightly to €7 per share. Deutsche Lufthansa's next catalyst will be its full-year 2022 results expected in early March. We continue to value the company based on long-term projections of an EBIT of 7.5% and a WACC of 9%. COVID-19 new waves are again all over the news, but we are most worried about the 2023 EU economic slowdown.

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