CORPORATES
CREDIT OPINION Deutsche Lufthansa Aktiengesellschaft 5 September 2018 Update to credit analysis; stronger earnings in past 12-18 Update months more strongly positions Lufthansa in Baa3 rating Summary Deutsche Lufthansa Aktiengesellschaft’s (Lufthansa, Baa3 Stable) rating reflects its leading positions in the European airline sector, its diversified route network and business segments, in part a consequence of the company's acquisitive strategy. Recent acquisitions have RATINGS included the purchase of shares in Brussels Airlines that it did not already own (January Deutsche Lufthansa Aktiengesellschaft 2017), Luftfahrtgesellschaft Walter (LGW in January 2018) and around 48 aircraft from Air Domicile Koeln, Germany Berlin Plc (Air Berlin) following Air Berlin's insolvency in August last year. These acquisitions Long Term Rating Baa3 Type LT Issuer Rating - Dom have also helped consolidate the airline industry and alleviate some market overcapacity. Curr Outlook Stable Over the last 12-18 months Lufthansa capitalised strongly on Air Berlin's demise and improved its non-fuel cost base. Earnings and cash flow generated were significantly higher Please see the ratings section at the end of this report than we forecast such that Lufthansa's credit metrics improved materially beyond our for more information. The ratings and outlook shown reflect information as of the publication date. expectations. Lufthansa's Moody's-adjusted gross leverage was 2.7x in H1-18 versus 4.4x in 2016, while RCF/net debt improved strongly to around 36.1% from levels typically below 25%. We expect earnings will be lower through 2019 than they were in 2017, but further
Contacts reductions in the company's pension obligation and funded debt levels should mean that gross leverage begins to meet our positive rating trigger of 2.5x by 2019 (see Exhibit 1) and Jeanine Arnold +49.69.70730.789 VP-Sr Credit Officer RCF/net debt comfortably exceeds our RCF/net debt trigger of materially above 30%. [email protected] Exhibit 1 Matthias Hellstern +49.69.70730.745 An improvement in Moody's gross adj. leverage to sustainable below 2.5x could support positive MD-Corporate Finance [email protected] rating action Adj. EBITDA Moody's adj- gross debt/EBITDA Marcella Pavesi +49.69.70730.742 6,000 7.0 6.0 Associate Analyst 5,000 [email protected] 5.0 4,000
4.0 3,000 CLIENT SERVICES 3.0 2,000 Positive rating trigger: < 2.5x Moody's adj. debt/EBITDA 2.0 Americas 1-212-553-1653 1,000 1.0 Asia Pacific 852-3551-3077 0 0.0 2013 2014 2015 2016 2017 2018e 2019e 2020e Japan 81-3-5408-4100 Source: Moody's EMEA 44-20-7772-5454 However, we expect competition in Europe to remain considerable in the short-term. There are also a number of operational headwinds facing the aviation industry, including higher fuel costs, currency volatility and potential flight disruption, which could be caused by air traffic controller strikes or Brexit, though regarding Brexit we expect Lufthansa to be less exposed than other European players even in a 'no-deal' scenario. MOODY'S INVESTORS SERVICE CORPORATES
In view of these pressures, we would expect earnings of Lufthansa's point-to-point business (especially Eurowings) to become more strongly positive and a much more solid footing for there to be positive rating action. We would also expect there to be a visible improvement in the company's cost base following the company's implementation of numerous cost-efficiency measures over the past few years, which would make the company more resilient to competitive pressures. We would expect operating margins to grow to levels more in line with other investment grade-rated peers and for there to be greater evidence that Lufthansa's earnings will exhibit less earnings volatility through the industry cycle. However, any positive rating action would take into consideration what Lufthansa´s intentions are with regards to its participation in any further consolidation of the airline industry. Credit strengths » Leading market positions in Europe with operations on a global scale
» Positive trajectory of Lufthansa's operating profitability over the last couple of years, with markedly higher profits in 2017
» Wage agreements with pilots, cabin crew and ground staff, which limits the risk of future industrial action, at least until 2019
» Lufthansa's active participation in European market consolidation and its financial flexibility (given strong liquidity and stronger key credit metrics) to continue doing so
» Strong key credit metrics in the context of the company's Baa3 credit rating due to higher profitability and proactive de-risking of pension liabilities
» Conservative financial strategy as evidenced by the company's public commitment to strong financial targets and the recent de- risking of its pension liabilities
Credit challenges » Earnings have been subject to some volatility in the past and despite increasing consolidation and the company's strong 2017 and H1-18 results, competition is expected to remain considerable
» Lufthansa’s market position remains under pressure from low-cost carriers in the short-haul segment; other European network carriers are also rationalising cost bases
» Relatively low Moody's adjusted EBIT margins compared with other investment-grade-rated airlines, which reflect strong market competition but also efficiency measures, which still need to be implemented in order to rationalise the company's cost base (including full integration of Air Berlin assets)
» Industry headwinds including higher fuel prices, currency volatility, air traffic industrial disputes and Brexit, although Lufthansa will likely be less affected than most other European players with regards to the latter
Rating outlook The stable outlook reflects our view that Lufthansa’s financial profile will strengthen further over the next 12-18 months, supported by strong demand in the European airline market and the benefits from Lufthansa’s structural progress in terms of cost reductions and the transformation of point-to-point traffic. The outlook also reflects our expectation that Lufthansa’s financial policy will continue to prioritize an investment-grade financial profile over shareholder returns. Factors that could lead to an upgrade A higher rating would likely require a prolonged period of proven resilience and sustainable performance through the industry cycle. Quantitatively, there could be positive rating pressure for Lufthansa if the company strengthens its liquidity and if its:
(1) gross adjusted leverage falls below 2.5x
This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on www.moodys.com for the most updated credit rating action information and rating history.
2 5 September 2018 Deutsche Lufthansa Aktiengesellschaft: Update to credit analysis; stronger earnings in past 12-18 months more strongly positions Lufthansa in Baa3 rating MOODY'S INVESTORS SERVICE CORPORATES
(2) the retained cash flow / net debt metric increases materially above 30%
(3) adjusted EBITDA margin moves toward 20%, indicating resilience to competitive pressures. Factors that could lead to a downgrade The rating could come under negative pressure if Lufthansa's gross adjusted leverage exceeds 3.5x on a sustainable basis. In addition, the rating could come under negative pressure if the company's RCF/net debt were to fall below 25% on a sustained basis or if its liquidity weakened materially. Key indicators
Exhibit 2 Deutsche Lufthansa Aktiengesellschaft [1] Deutsche Lufthansa Aktiengesellschaft Moody´s -18 LTM Month Forward US Millions Dec-13 Dec-14 Dec-15 Dec-16 Dec-17 (Jun-18) view Revenue 39,876.4 39,874.2 35,591.1 35,030.6 40,199.5 42,428.8 43,500 - 44,500 EBIT Margin % 4.0% 2.5% 5.9% 6.5% 9.0% 9.1% 7% - 8% EBITDA Margin % 10.4% 8.3% 11.5% 12.7% 14.9% 15.1% 13%-14% Debt / EBITDA 4.3x 6.1x 4.2x 4.4x 2.8x 2.7x 2.4x - 2.6x RCF / Debt 19.1% 15.3% 20.3% 17.2% 26.4% 25.8% 30% - 35% (FFO + Interest Expense) / Interest E 4.5x 4.9x 4.9x 6.2x 7.3x 8.9x 11x - 13x
[1] All ratios are based on 'Adjusted' financial data and incorporate Moody's Global Standard Adjustments for Non-Financial Corporations. [2] Forward view incorporates the effects of the company adopting IFRS 15 and IFRS 16, which have a modest impact on the company's financials Source: Moody's Financial Metrics™
Profile Lufthansa, headquartered in Cologne, Germany, is the leading European airline in terms of revenue. In LTM June-18 (company's financial year to December) it reported revenue of €35.6 billion and adjusted EBIT of €3,244 million. The group’s revenue is derived principally from five divisions: i) Network Airlines (Lufthansa German Airlines, Swiss and Austrian Airlines); ii) Point-to-Point airlines (Eurowings, Germanwings, Brussels Airlines, LGW and Lufthansa's equity investment in SunExpress ); iii) Logistics, a cargo provider focusing on the airport-to-airport business; iv) MRO, a supplier of maintenance, repair and overhaul services for civil aircraft; and v) LSG group, which is a leading airline caterer. As at H1-18, the route network of the company’s passenger division comprised around 287 destinations in 86 countries. The passenger division consisted of 751 aircraft, with an average age of 11.4 years.
Exhibit 3 Lufthansa's 2017 revenues by business segment
Other Catering 0.8% 7.2% MRO 10.0%
Logistics 7.0%
Point-to-Point Network Airlines 11.4% 63.6%
Source: Lufthansa 2017 Annual Report
3 5 September 2018 Deutsche Lufthansa Aktiengesellschaft: Update to credit analysis; stronger earnings in past 12-18 months more strongly positions Lufthansa in Baa3 rating MOODY'S INVESTORS SERVICE CORPORATES
Detailed credit considerations Strong European market position and extensive network a consequence of Lufthansa's participation in market consolidation With revenue of around €35.6 billion in 2017, Lufthansa is one of the largest airlines globally and the largest in Europe. Passenger numbers of around 104 million on an H1-18 LTM basis and Revenue Seat Kilometer (RSK) of around 230 billion compare favourably to those of the International Airlines Group (IAG, unrated), and Air France-KLM (unrated) - see Exhibits 4 and 5.
Exhibit 4 Exhibit 5 Lufthansa's passenger numbers in 2017 are greater than its closest Lufthansa's revenue per seat kilometres in 2017 are greater than its European peers closest European peers In millions In billions
140 130 300 261.2 248.5 252.8 120 250 105 98.7 100 200
80 150 60
100 40
50 20
0 0 Lufthansa Air France-KLM IAG Lufthansa Air France-KLM IAG Source: Annual Reports Source: Annual Reports
The scale of Lufthansa's business, and its leading market positions, especially in Germany, Austria, Switzerland and Belgium, reflect a number of acquisitions made over the last 10-15 years (see Exhibit 6). These included Swiss Airlines in 2005, Austrian Airlines in 2009 and more recently the remaining 55% stake that it did not own in Brussels Airlines in 2017, Luftfahrtgesellschaft Walter (LGW) in early 2018 and its acquisition of the majority of Air Berlin's fleet in 2017-8. Besides strengthening the company's network, these acquisitions have also allowed Lufthansa to help consolidate what remains a still very fragmented aviation market in Europe.
We understand that Lufthansa intends to continue to play an active role in the consolidation of the industry in Europe. Lufthansa has also shown an interest in acquiring parts of AliItalia (unrated), but Lufthansa has been clear that this would not be at any cost, given Alitalia's highly unsustainable cost base. Lufthansa has also expressed an interest in Norwegian Air Shuttle ASA (Norwegian, unrated), though Norwegian's shareholders appear unwilling to sell.
The Air Berlin transaction:
After Air Berlin entered insolvency proceedings, in October 2017 Lufthansa reached an agreement with Air Berlin to purchase LGW. This added 17 Bombardier Dash 8s and 13 A320s to Lufthansa's total fleet (which now stands at 751 aircraft) while further purchase and lease agreements with Air Berlin´s lessors added another 45 A320s. Furthermore, Lufthansa signed wet-lease agreements with TUIfly to operate 7 B737s.
These transactions boost the size, which now stands at around 190 aircrafts, and scope of Eurowings and establish it as one of the largest European low-cost airlines after Ryanair, which operates more than 430 aircraft, and easyJet plc, with around 300 aircraft. Reaching a critical scale is an important milestone in Lufthansa’s strategy for Eurowings.
4 5 September 2018 Deutsche Lufthansa Aktiengesellschaft: Update to credit analysis; stronger earnings in past 12-18 months more strongly positions Lufthansa in Baa3 rating MOODY'S INVESTORS SERVICE CORPORATES
Exhibit 6 Lufthansa has acquired several smaller airlines in the past decade Airlines by revenue, 2007 and 2017
Bubble size represents revenue in euro. Source: Moody's Investors Service
Different business segments provide economies of scale and some diversification; a more profitable point-to-point business would help limit earnings volatility Lufthansa's various divisions benefit from mutual synergies and economies of scale. For example, Lufthansa Logistics transports a large proportion of freight in the belly capacities of Lufthansa's airlines business, while the company's MRO business also maintains and repairs the group's sizeable fleet, in addition to being a MRO service provider to many other airlines.
We positively view the company's exposure to different business segments, in particular recent efforts to further expand its lower- cost point-to-point business in order to grow and diversify its passenger base. While Lufthansa's network carrier business will remain the company's premium segment, the company's point-to-point business should offer customers more competitive pricing as well as better respond to the competitive pressures posed by low, and ultra low-cost carriers as well as other network carriers that are also growing their own low-cost operations.
A balancing of the company's network and point-to-point businesses, should gradually help reduce the volatility of Lufthansa's overall earnings, which have been negatively affected in the past because of shifts in the balance between demand and supply, fluctuating fuel costs and the greater competition from low-cost airlines in the short-haul segment - adjusted EBIT margins (Moody's calculated) for the group as a whole fell to as low as 2.5% in 2013 and only began to exceed levels of around 6% back in 2015. We understand that Lufthansa aims to substantially improve earnings in its point-to-point segment by 2019, through cost-saving initiatives and the full integration of Air Berlin aircraft. The weak performance in 2017 and H1-18 was on account of the slower than anticipated integration of Air Berlin aircraft.
In addition, while the company's MRO business only comprises around 10% of the company's revenues, adj. EBIT margins (based on the company's definition) have been historically robust, typically above 8%, and higher than the group average. This has to some extent offset weaker performances in some of the company's other divisions. Performance in 2017 and H1-18 was less strong given some decline in engine aircraft maintenance, but as the world’s leading independent provider of maintenance, repair and overhaul services
5 5 September 2018 Deutsche Lufthansa Aktiengesellschaft: Update to credit analysis; stronger earnings in past 12-18 months more strongly positions Lufthansa in Baa3 rating MOODY'S INVESTORS SERVICE CORPORATES
for civil commercial aircraft, we expect this segment to take advantage of the longer-term positive outlook as fleet capacity increases globally.
Earning contributions by the company's catering division have been relatively weak and margins have been consistently low relative to the group as a whole. Lufthansa's restructuring program aims to lower the operating costs of this division, for example, by moving kitchen facilities to lower-cost countries, but we expect market conditions for the airline catering market will remain exceptionally challenging. Lufthansa's catering segment is a global leader in the industry alongside gategroup Holding AG (gategroup, B1 stable), but the market is still fragmented and the changing business model of low-cost carriers, with buy-on-board offers instead of complementary snacks and drinks, means there is significant volume and pricing pressure.
Lufthansa's cargo business has performed well over the last 12-18 months due to its strong network and the geographic position of its primary hub at Frankfurt airport, which has key industrial players and global companies in its catchment area. In 2017 and H1-18 adj. EBIT margins (company reported) approached 10%. But similar to other legacy airlines the logistics segment is characterized by significant earnings volatility and in past years adj. EBIT (company reported) has been negative (-€50 million in 2016).
Exhibit 7 Lufthansa's network airlines business is the greatest contributor to earnings, but MRO and Catering businesses have tended to be more stable contributors to earnings€ Million
2016 EBIT Adjusted 2017 EBIT Adjusted 2016 EBIT Adjusted Margin 2017 EBIT Adjusted Margin 2500 12%
10% 2000 8%
1500 6%
4% 1000 2%
500 0%
-2% 0 -4%
-500 -6% Network Airlines Point-to-Point Logistics MRO Catering Source: Moody's
Operating performance over last 12-18 months significantly exceeded our expectations due to Air Berlin insolvency and efficiency measures, but margins still low compared to peers Lufthansa's operating performance improved dramatically in 2017 and far exceeded what we expected when we upgraded Lufthansa in August 2017. Moody's adj. EBIT grew to around €3.2 billion from €2.1 billion in 2016 and in H1-18 was just over €1 billion, in line with H1-17.
The main driver of this improvement was the increased demand for flights (+5.8% RPK in 2017; +8.2% in H1-18), which exceeded growth in capacity (+3.1% ASK in 2017; +9.2% in H1-18) and higher yields. This was primarily due to the increasing consolidation of the European airline market and in particular the bankruptcy of Air Berlin. In H1-18 Lufthansa also partly benefited from industrial actions at Ryanair, which caused them to make a number of flight cancellations.
Lufthansa was also successful in reducing unit costs, excluding fuel and currency effects. These cost reductions included identifying greater synergies across the group's business segments and across different airlines as well as lower airport charges at Frankfurt airport and process optimization. They also reflected ongoing efforts to reduce personnel costs including the reduction of management positions, committees and executive boards as well as wage agreements reached with labour unions. These are not only important to keep costs down, but also to reduce the potential for future strikes. We understand that Lufthansa has reached labour agreements with its pilots until 2022, and its cabin crew and ground staff until 2019. Many of the wage agreements reached include wage increases, but there are caps to these wage increases depending on the margins achieved by Lufthansa's individual segments.
However, despite Lufthansa’s materially improved operating profitability, the airline remains less profitable than other investment- grade-rated peers, such as Delta Air Lines, Inc. (Baa3 stable), American Airlines Group Inc. (Ba1 stable) and British Airways Plc (British
6 5 September 2018 Deutsche Lufthansa Aktiengesellschaft: Update to credit analysis; stronger earnings in past 12-18 months more strongly positions Lufthansa in Baa3 rating MOODY'S INVESTORS SERVICE CORPORATES
Airways, Baa3 stable), which achieved a Moody's-adjusted EBIT margin of 13.3% in 2017 (see Exhibit 8). Lufthansa's still high cost base its integration of its Air Berlin operations are key factors for the lower margin, but they can also be explained by the diluting impact of Lufthansa's structurally lower-margined catering business. Large US airlines profit from a high degree of market consolidation relative to European carriers as a whole, while British Airways' margins benefit from its hub operations at the slot-constrained London Heathrow airport.
Exhibit 8 EBIT margins of Lufthansa and its main peers
British Airways Lufthansa Delta Air Lines American Airlines Group 25.0%
20.0%
15.0%
10.0%
5.0%
0.0%
-5.0% FY 2007 FY 2008 FY 2009 FY 2010 FY 2011 FY 2012 FY 2013 FY 2014 FY 2015 FY 2016 FY2017
Lufthansa, Delta and American Airline Group's fiscal year ends in December. Fiscal year of British Airways before 2011 ended in March; from 2011, its fiscal year ends in December. Source: Moody's Investors Service
Outlook broadly positive, but evolving competitive environment and headwinds could pressure future earnings Lufthansa forecasts that their adjusted EBIT in 2018 will be only slightly lower than the level achieved in 2017. We are more conservative in our forecasts and expect that Moody's EBIT will fall from the €3.2 billion generated in 2017 to around €2.8 billion in 2018 (still higher than 2016 levels) and that EBIT margins will fall back down to between 7-8% through 2019 from the 9% level generated in 2017 (see Exhibit 9). IFRS 15 will have a modest positive effect on EBIT margins of around 30bps.
Exhibit 9 Moody's adj. EBIT and margins will likely fall from the highs generated in 2017, but grow steadily 2018-20 in €m
Adj. EBIT Adj. EBIT margin Adj. EBITDA margin 3,500 Positive rating trigger: > 20% adj. EBITDA margin 22% 20% 3,000 18%
2,500 16% 14% 2,000 12% 10% 1,500 8% 1,000 6% 4% 500 2% 0 0% 2013 2014 2015 2016 2017 2018e 2019e 2020e Source: Moody's
Still strong earnings will be generated by strong growth in RPKs, especially in Lufthansa's main markets, Europe and North America, where we expect RPKs to grow by mid-single digits. In addition, we still expect earnings to benefit from the company's plans to continue cutting costs by 1-2% per annum - in 2018 the company forecasts this will be around 1%. In particular, we expect the company will begin to benefit more from the company's purchase of more modern, standardised and fuel-efficient fleet.
7 5 September 2018 Deutsche Lufthansa Aktiengesellschaft: Update to credit analysis; stronger earnings in past 12-18 months more strongly positions Lufthansa in Baa3 rating MOODY'S INVESTORS SERVICE CORPORATES
However, we expect the competitive market could place some unexpected pressure on earnings. While Lufthansa acquired the large proportion of Air Berlin's fleet, Air Berlin's assets, including airport slots, were divided among a number of European airlines. This has allowed the likes of easyJet to gain an increasing foothold in Berlin, and Ryanair in Austria given its majority-ownership in Laudamotion (formerly known as NIKI airlines). Ryanair has also sought to increase slots in some of Germany's primary airports such as Frankfurt and Dusseldorf. On transatlantic routes there are also a growing number of players looking to offer low-cost, point-to-point long-haul flights, which could compete with Lufthansa's ambitions to also grow its low-cost, long-haul operations.
Other headwinds include industrial action by European air traffic controllers and a shortage of air traffic control manpower, which led to significant flight disruption across Europe in the last few months. Higher fuel costs are another significant factor. In H1-18 the average oil price was USS71.15/barrel, an almost 35% increase year on year, while the jet fuel crack increased 45.7%, leading to a 36.7% increase in the fuel price. In H1-18 the effects were offset by the more favourable Euro relative to the USD, but the Euro has depreciated against the USD since April 2018 and are likely to remain below the 1.2 level to the end of 2018. H1-18 Lufthansa upped its guidance on the negative impact that fuel would have on its 2018 earnings to €850 million compared with 2017, from the €700 million it guided to on publication of its 2017 accounts.
Brexit is not a key risk for Lufthansa given its exposure to the UK is limited. Our base case also assumes that a withdrawal agreement will be signed and that there will be a transition period to the end of 2020, which should allow the UK and the EU to substantially replicate existing aviation agreements and minimise the impact on the business profiles and financial metrics of European Airlines. But a 'no-deal' scenario could create significant flight disruption for the European airline industry and Lufthansa's network operations in the short-term. Macroeconomic factors could also negatively weigh on demand and earnings, especially due to currency volatility in the short-term. We expect any benefits, including new market consolidation opportunities if financially weaker market participants suffer from any Brexit-related effects, to be longer-term.
Stronger credit metrics more strongly position Lufthansa at current rating level; sustainability and track record will be key to any positive rating action Over the last 12-18 months Lufthansa's key credit metrics have improved materially and beyond our expectations because of the higher earnings generated in 2017 and H1-18. The company's de-risking of its material pension obligation to reduce the company's adjusted debt levels was factored into our forecasts, and was one of the considerations for why we upgraded Lufthansa to Baa3 over 12 months ago.
Lufthansa's Moody's-adjusted gross leverage was 2.8x in 2017 compared with 4.4x in 2016 (2.7x in H1-18), while RCF/net debt improved strongly to around 36.2% (36.1% in H1-18) from levels, which have tended to be below 25% in the past. When we upgraded Lufthansa we had expected gross leverage to reach only 3.5x in 2017 and for RCF/net debt to be closer to 30%.
While we expect earnings will fall to more sustainable levels through 2019, further reductions in the company's pension obligation and funded debt levels should further improve credit metrics through 2019, albeit at a more gradual pace than we have seen over the last 12-18 months. Leverage should begin to meet our positive rating trigger of 2.5x while RCF/net debt will comfortably remain in excess of our RCF/net debt trigger of materially above 30%. The adoption of IFRS 16 is likely to reduce leverage by around 0.2x.
This improvement in credit metrics more strongly positions Lufthansa within the Baa3 rating level. However, before we decide to take positive rating action, we would like to see more evidence that the company's credit metrics will remain at the levels we expect for a Baa2 rating on a sustainable basis.
In view of the inherently volatile nature of the Airline industry and some of the industry headwinds we have identified, we would expect the earnings of Lufthansa's point-to-point business become more strongly positive and for there to be a visible improvement in the company's cost base. This should limit any significant earnings volatility through the industry cycle. We expect the company will generate strong free cash flow over the next 12-18 months, but this is dependent on the company's ability to generate strong operating cash flow to cover the company's high capex needs over the next few years to modernise its fleet and support the company's competitive position. In 2018 we expect gross capex to remain at around €3.5 billion as in 2017 and for capex to remain above €3 billion in 2019.
8 5 September 2018 Deutsche Lufthansa Aktiengesellschaft: Update to credit analysis; stronger earnings in past 12-18 months more strongly positions Lufthansa in Baa3 rating MOODY'S INVESTORS SERVICE CORPORATES
However, any positive rating action would take into consideration what Lufthansa´s intentions are with regards to its participation in any further consolidation of the airline industry. Conservative financial policy, further evidenced by proactive de-risking of pension liability Lufthansa retains a number of financial targets that we consider evidence of a conservative financial policy. These include minimum liquidity of €2.3 billion (€4.1 billion at the end of H1 2018) and an Adjusted Net Debt/Adjusted EBITDA target below 3.5x to maintain financial stability. The 60% increase in the 2017 dividend relative to 2016 is sizeable, but is consistent with the significant increase in earnings and cash flows generated during the year, as well as the still solid earnings and cash flow, which we expect the company will generate through 2019. Our forecasts are for FCF/debt to increase gradually towards 10% through 2019 and reach levels of just under €1 billion.
In addition, we positively view the company's proactive de-risking of its material pension liability, which drove a €3.2 billion decrease in the company's pension provision in 2017. This was due to a €1.7 billion one-off cash contribution to plan assets and a €1.3 billion reduction in the pension obligation as a result of agreements reached with Lufthansa's pilots to transition to a defined contribution pension scheme. The pension deficit accounted for around 32% of the total adjusted debt of €14.6 billion as at 2017, a sharp reduction from the 57% in 2016. Liquidity Lufthansa's liquidity is strong. As at H1-18 cash and equivalents of €1.5 billion and short-term securities of €2.6 billion compared strongly with its low short-term debt of €721 million.
In addition Lufthansa had undrawn committed short-term credit lines of €855 million. Combined, total liquidity was significantly above its minimum liquidity target of €2.3 billion. Despite increases in capex, we expect liquidity to strengthen given the level of free cash flow we forecast and be available to make scheduled debt repayments.
9 5 September 2018 Deutsche Lufthansa Aktiengesellschaft: Update to credit analysis; stronger earnings in past 12-18 months more strongly positions Lufthansa in Baa3 rating MOODY'S INVESTORS SERVICE CORPORATES
Rating methodology and scorecard factors Per the Global Passenger Airlines rating methodology grid Lufthansa maps to a Baa3 rating based on metrics for the 12-month period ended 30 June 2018, which is in line with the actual rating assigned.
The indicative rating per our 12-18 month forward-looking grid is one notch higher at Baa2, which evidences Lufthansa's positive rating momentum. At the same time, the grid does not incorporate the competitive market environment and headwinds we believe could pressure future earnings or take into consideration a more prolonged period of proven resilience, which we consider is important for a higher rating.
Exhibit 10 Rating factors Deutsche Lufthansa Aktiengesellschaft
Current Moody's 12-18 Month Forward View Passenger Airlines Industry Grid [1] LTM 6/30/2018 As of 9/3/2018 [2][3] Factor 1 : Scale (10%) Measure Score Measure Score a) Revenue (USD Billion) $42.4 A $43.5 - $44.5 A Factor 2 : Business Profile (25%) a) Market Position and Network Strength Baa Baa Baa Baa Factor 3 : Profitability and Efficiency (12.5%) a) EBIT Margin (EBIT / Revenue) 9.1% B 7% - 8% B Factor 4 : Leverage and Coverage (37.5%) a) Debt / EBITDA 2.7x Baa 2.4x - 2.6x Baa b) RCF / Debt 25.8% Baa 30% - 35% Baa c) (FFO + Interest Expense) / Interest Expense 8.9x Baa 11x - 13x A Factor 5 : Financial Policy (15%) a) Financial Policy Baa Baa Baa Baa Rating: a) Indicated Outcome from Scorecard Baa3 Baa2 b) Actual Rating Assigned Baa3
[1] All ratios are based on 'Adjusted' financial data and incorporate Moody's Global Standard Adjustments for Non-Financial Corporations. [2] This represents Moody's forward view; not the view of the issuer; and unless noted in the text, does not incorporate significant acquisitions and divestitures. [3] Forward view incorporates the effects of the company adopting IFRS 15 and IFRS 16, which have a modest impact on the company's financials Source: Moody’s Financial Metrics™
Appendix
Exhibit 11 Peer comparison Deutsche Lufthansa Aktienges British Airways, Plc Delta Air Lines, Inc. easyJet Plc Wizz Air Holdings plc Baa3 Stable Baa3 Stable Baa3 Stable Baa1 Stable Baa3 Stable
FYE FYE LTM FYE FYE FYE FYE FYE LTM FYE FYE LTM FYE FYE FYE (in US millions) Dec-16 Dec-17 Jun-18 Dec-15 Dec-16 Dec-17 Dec-16 Dec-17 Jun-18 Sep-16 Sep-17 Mar-18 Mar-16 Mar-17 Mar-18 Revenue $35,031 $40,200 $42,429 $17,319 $15,446 $15,756 $39,639 $41,244 $43,139 $6,650 $6,397 $7,166 $1,578 $1,724 $2,279 Operating Profit $1,980 $3,306 $3,484 $2,089 $2,005 $2,327 $7,605 $6,529 $6,000 $744 $574 $823 $333 $365 $443 EBITDA $4,432 $5,971 $6,400 $3,246 $3,303 $3,633 $10,477 $9,607 $9,245 $1,129 $973 $1,259 $483 $587 $764 Total Debt $18,472 $17,506 $16,811 $10,075 $12,004 $10,222 $26,998 $27,071 $28,019 $1,677 $2,182 $2,264 $1,722 $2,206 $2,511 Cash & Cash Equiv. $4,153 $4,741 $4,792 $2,939 $3,083 $3,805 $2,762 $1,814 $1,886 $1,259 $1,782 $2,278 $736 $828 $1,205 EBIT / Int. Exp. 3.3x 4.9x 6.2x 4.4x 4.8x 6.8x 5.9x 5.1x 5.0x 18.9x 9.2x 13.2x 4.4x 3.8x 4.1x Debt / EBITDA 4.4x 2.8x 2.7x 3.2x 4.0x 2.7x 2.6x 2.8x 3.0x 1.6x 2.1x 1.7x 3.5x 3.9x 3.1x RCF / Net Debt 22.2% 36.2% 36.1% 32.1% 23.9% 40.6% 31.4% 18.4% 27.3% 163.9% 157.3% -7407.7% 43.7% 34.5% 52.9% FCF / Debt 2.7% 8.6% 2.3% 2.6% 0.9% 21.0% 17.1% 15.1% 10.0% -15.4% 2.0% 15.9% 9.7% 3.5% 4.7%
All ratios are based on 'Adjusted' financial data and incorporate Moody's Global Standard Adjustments for Non-Financial Corporations. Source: Moody’s Financial Metrics™
10 5 September 2018 Deutsche Lufthansa Aktiengesellschaft: Update to credit analysis; stronger earnings in past 12-18 months more strongly positions Lufthansa in Baa3 rating MOODY'S INVESTORS SERVICE CORPORATES
Exhibit 12 Reconciliation of Moody's-adjusted debt
FYE FYE FYE FYE FYE (in EUR Millions) Dec-13 Dec-14 Dec-15 Dec-16 Dec-17 Jun-18
As Reported Debt 6,337 5,958 6,370 6,575 6,814 6,632 Pensions 4,716 6,926 6,391 8,364 5,116 5,116 Operating Leases 2,145 2,010 2,682 2,429 2,753 2,753 Hybrid Securities 0 0 0 0 -250 -250 Non-Standard Adjustments 144 207 66 145 145 147
Moody's-Adjusted Debt 13,342 15,101 15,509 17,513 14,578 14,398
Source: Moody’s Financial Metrics™
Exhibit 13 Reconciliation of Moody's-adjusted EBITDA
FYE FYE FYE FYE FYE LTM (in EUR Millions) Dec-13 Dec-14 Dec-15 Dec-16 Dec-17 Jun-18
As Reported EBITDA 2,819 2,101 4,101 4,281 5,530 5,584 Pensions -12 -46 28 -675 -548 -548 Operating Leases 429 402 397 468 458 458 Unusual -13 101 -734 -10 -37 -10 Non-Standard Adjustments -91 -77 -111 -58 -118 -119
Moody's-Adjusted EBITDA 3,132 2,481 3,681 4,006 5,285 5,365
Source: Moody’s Financial Metrics™
11 5 September 2018 Deutsche Lufthansa Aktiengesellschaft: Update to credit analysis; stronger earnings in past 12-18 months more strongly positions Lufthansa in Baa3 rating MOODY'S INVESTORS SERVICE CORPORATES
Exhibit 14 Overview of Moody's-adjusted financial data for Lufthansa
FYE FYE FYE FYE FYE LTM (in EUR Millions) Dec-13 Dec-14 Dec-15 Dec-16 Dec-17 Jun-18 INCOME STATEMENT Revenue 30,027 30,011 32,056 31,660 35,579 35,566 EBITDA 3,132 2,481 3,681 4,006 5,285 5,365 EBIT 1,190 762 1,902 2,072 3,215 3,244 Interest Expense 731 657 822 627 651 519 BALANCE SHEET Cash & Cash Equivalents 4,698 2,738 3,093 3,937 3,948 4,104 Total Debt 13,342 15,101 15,509 17,513 14,578 14,398 Net Debt 8,644 12,363 12,416 13,576 10,630 10,294 CASH FLOW Funds from Operations (FFO) 2,567 2,540 3,165 3,242 4,094 4,082 Cash Flow from Operations (CFO) 3,155 1,962 3,185 3,440 5,037 4,842 Capital Expenditures (Capex) 2,797 3,066 2,996 2,741 3,545 4,143 Dividends 14 222 12 232 244 361 Retained Cash Flow (RCF) 2,553 2,318 3,153 3,010 3,850 3,721 RCF / Debt 19.1% 15.3% 20.3% 17.2% 26.4% 25.8% Free Cash Flow (FCF) 344 -1,326 177 467 1,248 338 FCF / Debt 2.6% -8.8% 1.1% 2.7% 8.6% 2.3% PROFITABILITY % Change in Sales (YoY) -0.4% -0.1% 6.8% -1.2% 12.4% 5.9% EBIT Margin % 4.0% 2.5% 5.9% 6.5% 9.0% 9.1% EBITDA Margin % 10.4% 8.3% 11.5% 12.7% 14.9% 15.1% INTEREST COVERAGE (FFO + Interest Expense) / Interest 4.5x 4.9x 4.9x 6.2x 7.3x 8.9x Expense EBIT / Interest Expense 1.6x 1.2x 2.3x 3.3x 4.9x 6.2x EBITDA / Interest Expense 4.3x 3.8x 4.5x 6.4x 8.1x 10.3x LEVERAGE Debt / EBITDA 4.3x 6.1x 4.2x 4.4x 2.8x 2.7x Net Debt / EBITDA 2.8x 5.0x 3.4x 3.4x 2.0x 1.9x
All ratios are based on 'Adjusted' financial data and incorporate Moody's Global Standard Adjustments for Non-Financial Corporations. Source: Moody’s Financial Metrics™
Ratings
Exhibit 15 Category Moody's Rating DEUTSCHE LUFTHANSA AKTIENGESELLSCHAFT Outlook Stable Issuer Rating -Dom Curr Baa3 Senior Unsecured -Dom Curr Baa3 Source: Moody's Investors Service
12 5 September 2018 Deutsche Lufthansa Aktiengesellschaft: Update to credit analysis; stronger earnings in past 12-18 months more strongly positions Lufthansa in Baa3 rating MOODY'S INVESTORS SERVICE CORPORATES
© 2018 Moody’s Corporation, Moody’s Investors Service, Inc., Moody’s Analytics, Inc. and/or their licensors and affiliates (collectively, “MOODY’S”). All rights reserved. CREDIT RATINGS ISSUED BY MOODY'S INVESTORS SERVICE, INC. AND ITS RATINGS AFFILIATES (“MIS”) ARE MOODY’S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES, AND MOODY’S PUBLICATIONS MAY INCLUDE MOODY’S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES. MOODY’S DEFINES CREDIT RISK AS THE RISK THAT AN ENTITY MAY NOT MEET ITS CONTRACTUAL, FINANCIAL OBLIGATIONS AS THEY COME DUE AND ANY ESTIMATED FINANCIAL LOSS IN THE EVENT OF DEFAULT. CREDIT RATINGS DO NOT ADDRESS ANY OTHER RISK, INCLUDING BUT NOT LIMITED TO: LIQUIDITY RISK, MARKET VALUE RISK, OR PRICE VOLATILITY. CREDIT RATINGS AND MOODY’S OPINIONS INCLUDED IN MOODY’S PUBLICATIONS ARE NOT STATEMENTS OF CURRENT OR HISTORICAL FACT. MOODY’S PUBLICATIONS MAY ALSO INCLUDE QUANTITATIVE MODEL-BASED ESTIMATES OF CREDIT RISK AND RELATED OPINIONS OR COMMENTARY PUBLISHED BY MOODY’S ANALYTICS, INC. CREDIT RATINGS AND MOODY’S PUBLICATIONS DO NOT CONSTITUTE OR PROVIDE INVESTMENT OR FINANCIAL ADVICE, AND CREDIT RATINGS AND MOODY’S PUBLICATIONS ARE NOT AND DO NOT PROVIDE RECOMMENDATIONS TO PURCHASE, SELL, OR HOLD PARTICULAR SECURITIES. NEITHER CREDIT RATINGS NOR MOODY’S PUBLICATIONS COMMENT ON THE SUITABILITY OF AN INVESTMENT FOR ANY PARTICULAR INVESTOR. MOODY’S ISSUES ITS CREDIT RATINGS AND PUBLISHES MOODY’S PUBLICATIONS WITH THE EXPECTATION AND UNDERSTANDING THAT EACH INVESTOR WILL, WITH DUE CARE, MAKE ITS OWN STUDY AND EVALUATION OF EACH SECURITY THAT IS UNDER CONSIDERATION FOR PURCHASE, HOLDING, OR SALE. MOODY’S CREDIT RATINGS AND MOODY’S PUBLICATIONS ARE NOT INTENDED FOR USE BY RETAIL INVESTORS AND IT WOULD BE RECKLESS AND INAPPROPRIATE FOR RETAIL INVESTORS TO USE MOODY’S CREDIT RATINGS OR MOODY’S PUBLICATIONS WHEN MAKING AN INVESTMENT DECISION. IF IN DOUBT YOU SHOULD CONTACT YOUR FINANCIAL OR OTHER PROFESSIONAL ADVISER. ALL INFORMATION CONTAINED HEREIN IS PROTECTED BY LAW, INCLUDING BUT NOT LIMITED TO, COPYRIGHT LAW, AND NONE OF SUCH INFORMATION MAY BE COPIED OR OTHERWISE REPRODUCED, REPACKAGED, FURTHER TRANSMITTED, TRANSFERRED, DISSEMINATED, REDISTRIBUTED OR RESOLD, OR STORED FOR SUBSEQUENT USE FOR ANY SUCH PURPOSE, IN WHOLE OR IN PART, IN ANY FORM OR MANNER OR BY ANY MEANS WHATSOEVER, BY ANY PERSON WITHOUT MOODY’S PRIOR WRITTEN CONSENT. CREDIT RATINGS AND MOODY’S PUBLICATIONS ARE NOT INTENDED FOR USE BY ANY PERSON AS A BENCHMARK AS THAT TERM IS DEFINED FOR REGULATORY PURPOSES AND MUST NOT BE USED IN ANY WAY THAT COULD RESULT IN THEM BEING CONSIDERED A BENCHMARK. All information contained herein is obtained by MOODY’S from sources believed by it to be accurate and reliable. Because of the possibility of human or mechanical error as well as other factors, however, all information contained herein is provided “AS IS” without warranty of any kind. MOODY'S adopts all necessary measures so that the information it uses in assigning a credit rating is of sufficient quality and from sources MOODY'S considers to be reliable including, when appropriate, independent third-party sources. However, MOODY’S is not an auditor and cannot in every instance independently verify or validate information received in the rating process or in preparing the Moody’s publications. To the extent permitted by law, MOODY’S and its directors, officers, employees, agents, representatives, licensors and suppliers disclaim liability to any person or entity for any indirect, special, consequential, or incidental losses or damages whatsoever arising from or in connection with the information contained herein or the use of or inability to use any such information, even if MOODY’S or any of its directors, officers, employees, agents, representatives, licensors or suppliers is advised in advance of the possibility of such losses or damages, including but not limited to: (a) any loss of present or prospective profits or (b) any loss or damage arising where the relevant financial instrument is not the subject of a particular credit rating assigned by MOODY’S. To the extent permitted by law, MOODY’S and its directors, officers, employees, agents, representatives, licensors and suppliers disclaim liability for any direct or compensatory losses or damages caused to any person or entity, including but not limited to by any negligence (but excluding fraud, willful misconduct or any other type of liability that, for the avoidance of doubt, by law cannot be excluded) on the part of, or any contingency within or beyond the control of, MOODY’S or any of its directors, officers, employees, agents, representatives, licensors or suppliers, arising from or in connection with the information contained herein or the use of or inability to use any such information. NO WARRANTY, EXPRESS OR IMPLIED, AS TO THE ACCURACY, TIMELINESS, COMPLETENESS, MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE OF ANY SUCH RATING OR OTHER OPINION OR INFORMATION IS GIVEN OR MADE BY MOODY’S IN ANY FORM OR MANNER WHATSOEVER. Moody’s Investors Service, Inc., a wholly-owned credit rating agency subsidiary of Moody’s Corporation (“MCO”), hereby discloses that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and preferred stock rated by Moody’s Investors Service, Inc. have, prior to assignment of any rating, agreed to pay to Moody’s Investors Service, Inc. for appraisal and rating services rendered by it fees ranging from $1,500 to approximately $2,500,000. MCO and MIS also maintain policies and procedures to address the independence of MIS’s ratings and rating processes. Information regarding certain affiliations that may exist between directors of MCO and rated entities, and between entities who hold ratings from MIS and have also publicly reported to the SEC an ownership interest in MCO of more than 5%, is posted annually at www.moodys.com under the heading “Investor Relations — Corporate Governance — Director and Shareholder Affiliation Policy.” Additional terms for Australia only: Any publication into Australia of this document is pursuant to the Australian Financial Services License of MOODY’S affiliate, Moody’s Investors Service Pty Limited ABN 61 003 399 657AFSL 336969 and/or Moody’s Analytics Australia Pty Ltd ABN 94 105 136 972 AFSL 383569 (as applicable). This document is intended to be provided only to “wholesale clients” within the meaning of section 761G of the Corporations Act 2001. By continuing to access this document from within Australia, you represent to MOODY’S that you are, or are accessing the document as a representative of, a “wholesale client” and that neither you nor the entity you represent will directly or indirectly disseminate this document or its contents to “retail clients” within the meaning of section 761G of the Corporations Act 2001. MOODY’S credit rating is an opinion as to the creditworthiness of a debt obligation of the issuer, not on the equity securities of the issuer or any form of security that is available to retail investors. It would be reckless and inappropriate for retail investors to use MOODY’S credit ratings or publications when making an investment decision. If in doubt you should contact your financial or other professional adviser. Additional terms for Japan only: Moody's Japan K.K. (“MJKK”) is a wholly-owned credit rating agency subsidiary of Moody's Group Japan G.K., which is wholly-owned by Moody’s Overseas Holdings Inc., a wholly-owned subsidiary of MCO. Moody’s SF Japan K.K. (“MSFJ”) is a wholly-owned credit rating agency subsidiary of MJKK. MSFJ is not a Nationally Recognized Statistical Rating Organization (“NRSRO”). Therefore, credit ratings assigned by MSFJ are Non-NRSRO Credit Ratings. Non-NRSRO Credit Ratings are assigned by an entity that is not a NRSRO and, consequently, the rated obligation will not qualify for certain types of treatment under U.S. laws. MJKK and MSFJ are credit rating agencies registered with the Japan Financial Services Agency and their registration numbers are FSA Commissioner (Ratings) No. 2 and 3 respectively. MJKK or MSFJ (as applicable) hereby disclose that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and preferred stock rated by MJKK or MSFJ (as applicable) have, prior to assignment of any rating, agreed to pay to MJKK or MSFJ (as applicable) for appraisal and rating services rendered by it fees ranging from JPY200,000 to approximately JPY350,000,000. MJKK and MSFJ also maintain policies and procedures to address Japanese regulatory requirements.
REPORT NUMBER 1139179
13 5 September 2018 Deutsche Lufthansa Aktiengesellschaft: Update to credit analysis; stronger earnings in past 12-18 months more strongly positions Lufthansa in Baa3 rating MOODY'S INVESTORS SERVICE CORPORATES
CLIENT SERVICES
Americas 1-212-553-1653 Asia Pacific 852-3551-3077 Japan 81-3-5408-4100 EMEA 44-20-7772-5454
14 5 September 2018 Deutsche Lufthansa Aktiengesellschaft: Update to credit analysis; stronger earnings in past 12-18 months more strongly positions Lufthansa in Baa3 rating