DLAKY - Deutsche Lufthansa: Positive News But Valuation Is Fair

Summary

• The German flight operator just released a positive press release with adj. EBIT up to €1 billion for the year.
• We are more positive about low-cost-fare operators and short-haul destinations.
• We still see better alternatives within the industry.

Deutsche Lufthansa AG ( DLAKF ; DLAKY ) just released an important update ahead of the Q3 full presentation and Q&A session that the company plans to report on the 27th of October. Here at the Lab, we do have a good grip on the German airline operator, and this year we already commented about:

1. Q1 results with a positive upside on the CARGO business;
2. The latest company update on the M&A optionality with the Italian Government that had preferred Air France/KLM over the favorite MSC-Lufthansa consortium.
3. We also moved our sell rating to a neutral rating still highlighting the downside risks that include: jet fuel costs, a slowdown in economic activities; likely new COVID-19 wave; and lower travel demand.

Looking at the press release , Lufthansa revised its EBIT forecasts for 2022 to over €1 billion (from a previous statement of adj. operating profit at €500 million for the full year). This was due to the strong demand in air travel for the third quarter that made it possible to achieve " record results ". The Q3 preliminary data indicated that the German airline operator nearly doubled its year-on-year revenues to €10.1 billion, with an adjusted operating profit of €1.1 billion, while net debt fell to about €6.2 billion from €6.4 billion at the end of June. We should also mention the positive impact of the rising interest rate that consequently reduces its unfunded pension liabilities (thanks to a higher discount factor). These strong results were partially offset by the strikes' impact which reduced earnings by about €70 million in Q3, according to the airline. Still related to the union strikes, Eurowings which is the Lufthansa low-cost operator, began a strike yesterday. The carrier already cancelled 250 flights out of 488 with 25 thousand passengers involved.

Despite the company's good results (and stronger result versus consensus expectation), here at the Lab, we still hold our previous thesis where we highlight that we see better alternatives . Why?

We recently commented on EasyJet Q3 development and its implication for Ryanair. Here are the key takeaways:

1. Looking at the airline industry, as already mentioned, customers are switching from high-fare operators to low-cost ones such as EasyJet and Ryanair;
2. For the above reason, we are forecasting a lower load factor in Deutsche Lufthansa compared to low-cost airline operators;
3. Business-wise, in case of a recession event, the whole industry will suffer. However, we have a preference for short-haul compared to long-haul, in the latter is where Deutsche Lufthansa has a competitive advantage, but most likely will agonize the most.
4. There are companies such as Ryanair that were able to hedge fuel contracts until 2024. This is an important advantage over the Eurowings competition, making O'Leary company able to offer lower rates and move on with its game-changer strategy.

Conclusion and Valuation

It was a good move to increase Deutsche Lufthansa's rating from sell to neutral; however, COVID-19 new waves over the winter period are a reality and this is coupled with an imminent recession in the EU. Our long-term estimates still hold with the long-term EBIT set at 7.5%, WACC at 9%, and a terminal growth rate of 2%. We ended up with a price of €6 per share in line with the market. Our neutral rating is then maintained.

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