DLAKF - Deutsche Lufthansa Is Well Positioned For The Medium Term

2023-05-08 05:26:56 ET

Summary

• The company limited Q1 loss at €467 million and now estimates a record 2023 summer.
• Revenue was up 40% to €7.02 billion with an upgrade from S&P rating agency.
• Aside from the summer recovery, the group is confident for the whole year. Despite that, we decided to remain neutral.

After having commented about Ryanair (NASDAQ: RYAAY ) and easyJet ( OTCQX:ESYJY ), today it is time for a deep-dive into Deutsche Lufthansa AG ( OTCQX:DLAKF ; OTCQX:DLAKY ).

ITA upside

Before analyzing the company's latest quarterly figures, we would like to report the recent M&A optionality. Here at the Lab, in 2022, more than once, we commented about ITA development:

1. Lufthansa: Small Positive For The Operator
2. ITA Airways: the story continued

Almost 10 days ahead of the scheduled date for the agreement with the Italian government, Lufthansa CEO Carsten Spohr granted and confirmed the ITA share acquisition and reiterated the further goal to achieve full control. He used the word ' takeover ' and leaves us with no doubt. At the helm of the German group since 2014 and reconfirmed until 2028, on May 12th, the ITA final signature is expected . As already reported, Deutsche Lufthansa plan to acquire 40% of ITA share capital for a figure that should be close to €300 million. To Lufthansa's shareholders, he also explained to not confuse ITA with the former Alitalia. He emphasized how ITA has only founded in 2020 with 70 aircraft and almost 4,000 employees and is very well positioned in Milan and Rome. The letter also contains a passage to reassure those who fear that ITA will be deprived of national identity. Lufthansa is applying the same formula used with Austrian Airlines and Swissair. According to indiscretions, Lufthansa has a call option to secure ITA control over time. With this transaction, the German operator will strengthen its EU Europe and gain another highly attractive domestic market. In particular, we all know how Italy is very well positioned for travel leisure but is also the third basin after London and Paris. Indeed, Italy is the third EU largest economy and also the third air transport largest market with a solid demand both among business and private travelers for air travel to and from Italy. And we are sure that this step will make the Lufthansa Group even more successful. On a negative note, ITA's 2022 losses were about €480 million and this negative outcome will remain on the Italian public shareholder. ITA acquisition seems certain; however, we are still not providing any material upside on Lufthansa's valuation, and if the deal goes through, the German operator has a clear restructuring process to perform.

Q1 update

In the mind time, in Q1, Lufthansa delivered record revenues at €7.02 billion and was up by 40% on a yearly basis. This was due thanks to the continued high demand for private flight tickets and a strong order for the summer months. Adjusted EBITDA reached €272 million. The adjusted loss before interest and taxes decreased to €273 million (it was minus €577 million in the same period of 2022). Analysts had forecast revenue of €7.54 billion and a net loss of €289 million. So, Lufthansa managed to positively surprise the Wall Street investor community. In detail, the German operator carried 22 million passengers in the quarter, up from 13 million last year, bringing capacity to 75% of the pre-pandemic levels. Chief Financial Officer Remco Steenbergen also explained how “ the summer travel season will make an important contribution to achieving our 2023 goals ”. There are two points that we already incorporated in our estimates, wage inflation expected to be around 10%, higher costs to expand flight operations for the upcoming summer and the several strikes that might weigh down the company's results.

Source: Deutsche Lufthansa Q1 press release

On a positive note, we continue to like the company's Cargo division (Fig 1). Profits are normalizing from COVID-19 times; however, Lufthansa still yields up to 60%. On the debt side, the company is making further progress to be back at an investment grade status and S&P upgraded Lufthansa to a positive outlook assigning a BB+ rating (Fig 2).

Source: Deutsche Lufthansa Q1 result presentation - Fig 1

Fig 2

Conclusion and Valuation

The first quarter marked a clear improvement in European airlines. Here at the Lab, in the coming weeks, we believe that investors' attention will be entirely focused on the ITA match evolution and bookings trend. On the valuation side, based on long-term projections of a core operating profit of 7.5% and a WACC of 10%, we decided to remain neutral on Lufthansa with a target price of €11 per share (in line with the current stock price). Why? In the context of high inflation and a possible economic slowdown, we are still forecasting a travel rebound; however, we are more prone to invest in low-cost travel operators such as Ryanair (that carried also has less debt) and in the CARGO business, the other German company is raising the bar (have a look at our recent Deutsche Post analysis ).

For further details see: