DLAKF - Lufthansa Stock: Time To Upgrade To Buy?

Summary

• Lufthansa stock has gained over 60% since my last coverage.
• Management is executing extremely well on cost structure, liquidity and debt.
• I believe that Lufthansa remains a hold with some upside left.

Lufthansa ( OTCQX:DLAKF ) has been one of the European airlines that stood out for me, because of the way the company manages its liquidity and debt. Two or three years ago, the company was setting itself up for survival by taking on too much debt and today we see the airline deleveraging as it capitalizes on a strong demand environment for air travel. In this report, I will analyze the full year results. Generally, my earnings analysis looks at how the stock has performed since the last time I covered the company, the results, liquidity and debt as well as the guidance for next year. For this analysis, I will use that same format.

Lufthansa Stock Delivered

In June 2022, I covered Lufthansa’s financial results and attached a Hold rating and while a Buy rating might have been better suited holding shares has not hurt investors as the stock returned 64% compared to a 6% gain for the S&P 500.

Lufthansa Manages Impressive Turnaround

We can do a deep dive on Lufthansa’s 2022 performance, but the slide above really captures it all I think. Passenger numbers doubled and so did revenues allowing the adjusted EBIT to flip from a €1.7 billion loss to a €1.5 billion profit and there really is a lot to be positive about, because that adjusted profit does not fully reflect the strength of the airline part of the business and mostly reflects the strong MRO activity and logistics.

The airlines in the group were solidly profitable in the second half of the year, but losses for the year still amounted to €300 million. That also shows how different the demand environment was in the first half of the year was compared to the second half. In the first half of the year, there were pressures from the Omicron variant as well as the war in Ukraine, while the second half actually was business as usual or at least more profitable.

Due to constraints in the airline industry as well as the aircraft manufacturing industry, the ability for airlines to supply air travel is constrained which led to high yields and allowed airlines to pass higher costs on to the consumer. The airline still only operated 72% of its capacity which also goes to show that as capacity recovers further and oil prices drop, Lufthansa could see unit costs improve and largely absorb inflationary pressures. So for 2023, you can expect the cargo business to be somewhat weaker but still quite strong, but more importantly Lufthansa’s main business which is flying passengers around the world should be profitable.

Lufthansa: Superior Debt Management

Driven by €2.5 billion in adjusted free cash flow, Lufthansa stock achieved a €10.4 billion liquidity while significantly reducing its net debt by €6.7 billion and its leverage is now even below pre-pandemic levels. You’d almost say that if you liked Lufthansa before the pandemic, you will like it even better now.

Looking at the profile of the maturities including aircraft financing, we do see that Lufthansa doesn’t have a clear runway but with the current liquidity Lufthansa can cover its debt maturities up to and including 2026 which realistically are the most difficult years when it comes to debt maturing. So, I don’t foresee problems there but it's evident that Lufthansa does need the strong demand profile to continue in 2023 and 2024 to more comfortably cover its debt.

Lufthansa Guides For Further Recovery But Lower Free Cash Flow

For 2023, Lufthansa expects capacity to recover to up to 90% with adjusted EBIT significantly above 2022, which is not odd given that with a persistent strong demand environment for air travel we should see the airline replicating the H2 2022 strength over the entire year in 2023. I do expect some year-over-year pressure on air freight results as well as inflationary pressures which will hurt the unit costs excluding fuel but I also do expect that unit fuel costs will come down. Maybe it's somewhat unfortunate to see that adjusted free cash flow is guided down year-over-year to the €2 billion range but that is still €2 billion going towards the liquidity and further improving the leverage and net debt position.

Growth drivers for Lufthansa will be the re-opening of parts of the Asia-Pacific region as well as improvement in corporate travel volumes while unit costs excluding fuel will be stable year-over-year offsetting inflationary pressures. Lufthansa has not guided on revenues, but even if we assume that revenues remain constant which combined with capacity expansion would simulate weakening in unit revenues and apply a margin of 6.5%, adjusted EBIT could still come in at €2.13 billion up from €1.5 billion in 2022.

Is Lufthansa Stock A Buy?

To be honest, it's a bit tricky to assess whether Lufthansa stock is a buy especially after a >60% run up in stock prices and there are risks involved as well. Airlines are currently very confident about a continued strong demand environment for air travel in 2023 and they might not be wrong there but even the slightest sign of weakening could be bad for business as well as the stock. In 2019, Lufthansa achieved a €2 billion EBIT or €2.98 per share. Over the course of that year share prices declined with a high of €16.40 per share meaning that the stock traded at roughly 5.5x adjusted EBIT as measured from the highest price point.

Applying that to the €2.13 billion projection for 2023 gives us a €9.85 price target. So, is Lufthansa a Buy? No, I would say it's a hold. The company needs another 12-24 months of strong performance and its plan to pay a dividend is admirable but it is really the higher share count that keeps the value I see in Lufthansa down. So, they might want to consider bringing that share count down and that will allow stock prices to rise with a legitimate reason. Otherwise, we see results improve but from a price-to-earnings perspective the stock would remain pricey.

In case we see a strong pricing environment persists, the stock price target would increase to €11.80. So, there's upside if the year goes as Lufthansa expects it to go.

Conclusion: Lufthansa Management Is Executing Well But I Maintain A Hold Rating

I'm absolutely impressed with the way Lufthansa is managing the business and have little doubt that the strong demand environment will persist this year, but the reality is that a lot of that seemingly already is reflected in the current stock price and I see at most 13.5% upside left for the stock. So, even with a dividend for 2024, I don’t see a reason to upgrade from Hold to Buy. Maybe that will change over the course of the year if results come in stronger than expected but at this point, I feel like Lufthansa shares are a safer hold than buy. The buy opportunity actually already presented itself in June 2022.

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