DLAKF - Deutsche Lufthansa To Benefit From Travel Recovery

2023-03-06 17:09:17 ET

Summary

• DLAKF 2022 results were impressive, and the company has several tailwinds that should drive future growth and profitability.
• Strong travel demand and rising yield trends are expected to continue, supported by a robust balance sheet.
• Management reiterated its EBIT margin target of at least 8% for FY24.

Overview

In my opinion, Deutsche Lufthansa's ( DLAKF ) 2022 results were very impressive. Although the stock price has already risen by 85%, I believe DLAKF has a few key advantages that will allow it to continue performing well. First, DLAKF's signaling of rising yield trends gives me reason to believe that the already high demand for air travel will only increase. Next, DLAKF has an exceptionally robust balance sheet relative to its industry, and I anticipate it will generate substantial FCF over the next few years. Finally, management reiterated their adj. EBIT margin target for FY24 at >=8%, which has helped ease the concerns of cost inflation impacting margin. In the near future, I also anticipate several catalysts. For instance, DLAKF could strengthen its balance sheet by continuing to sell off non-essential assets. I also expect that the reopening of Asia will lead to a revival in corporate travel in China and Japan, two significant markets that make up a considerable portion of the corporate business.

Overall, I think DLAKF is a buy because it has a simple story, was hurt by COVID, and is now set up to profit from rising air travel (thanks to the travel recovery) and pricing, all while being supported by a solid balance sheet. As a result, I believe FCF will surge rapidly over the next few years.

Strong travel demand

Since reports from all over the world have indicated a travel recovery, I don't think this should come as a surprise. In fact, DLAKF management anticipates a continuation of the robust demand for airline tickets in FY23, with current bookings suggesting a 1Q23 yield at the same level as Q4 22 and 21% higher than 2019. As travel continues to recover, especially during the Easter and summer holiday seasons, I anticipate a significant sequential improvement in DLAKF from 1Q23 levels. While I do anticipate brisk business over the holiday seasons, I would warn that there is no actual data that suggest that as of today, as such there is still a need to be cautious. On the expense side, I anticipate that the cost structure will remain a lot more sticky than expected due to persistent high wages, which should have some impact on the positive effect of industry-wide capacity tightness that is keeping yields high. That said, this could be seen as a positive for DLAKF as well, as I think DLAKF has a justifiable excuse to raise prices due to cost pressures. Considering that management has stated that yields are 20% ahead of 2019 levels, I take this as a promising portent of DLAKF's summer yields (if demand comes through). I guess what worries me is how long these yields will last, since basic economics suggests that a rise in price would reduce demand. Definitely keep an eye on this.

Corporate bookings have been relatively stable over the past few months at around 50% of 2019 levels, but are forecast to increase dramatically in 2024. I find this increase to be reasonable, given that by that time European tourists will have settled back into their regular routines, and that markets like China and Japan typically feature a higher concentration of business tourists than other markets.

Margin

Management's reiteration of a goal for an FY24 adjusted EBIT margin of at least 8%, up from the 4.6% reported in FY2022, is very encouraging. This is a massive increase of at least 340 basis points in margins, which suggests that profits will nearly double (340bps on 460bps margin). With regards to what drives margin expansion, the decline of ex-fuel unit costs due to capacity expansion, structural cost savings, and pricing support, should pave the way for margin expansion. In my opinion, the reiteration of the EBIT margin target is a very encouraging sign because it reduces investors' worries about the impact of inflation on margins.

Balance sheet

When comparing DLAKF to its peers, I find that the 1.7x ratio of net debt to EBTIDA in FY22 is indicative of a very healthy balance sheet. The complete sale of AirPlus and the Catering division, as well as the divestiture of a portion of MRO, will further strengthen the company's financial position. DLAKF's FCF in 2022 was its highest level ever reported, and I anticipate that the company's FCF profile will continue to strengthen over the coming years.

Conclusion

DLAKF's FY22 results were impressive and I believe the company has several tailwinds that will continue to drive outperformance. The strong demand for air travel and DLAKF signaling of rising yield trends, along with its robust balance sheet and restated EBIT margin target, all point to future growth and profitability. Additionally, the anticipated recovery of corporate traffic in Asia in 2024 is likely to act as catalysts for further growth. While there are some concerns regarding the stickiness of cost structures and the potential impact of rising prices on demand, I believe that DLAKF's strong balance sheet, and potential for rapid FCF growth make it a buy. Overall, I am optimistic about DLAKF's future prospects and expect the company to continue to perform well in the years to come.

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