Valuation of and the Changing Market Environment Following the Insolvency of Airberlin Program: MSc Applied Economics and Finance Authors: Karen Patricia Steffe (Student number: 106981) Maria Frederiksen (Student number: 57417) Supervisor: Bo Danø Date of submission: 15th of May, 2018 Master Thesis Copenhagen Business School 2018 Number of pages: 114 Executive Summary This master thesis is a valuation of Lufthansa Group as of December 31st, 2017 in light of the changing market environment driven by the insolvency of airberlin Group. Objective The airline industry is at constant change § The objective of this Some structural challenges increasingly define the business master thesis is to environment for Lufthansa with large implications on the corporate evaluate the share price of Lufthansa Group within agenda. Since the liberalization of the EU flight market, competition its current market position significantly increased. The entry of Low Cost Carriers as well as and to give an outlook on ongoing consolidation in the sector puts high pressure on ticket industry changes prices, while costs are driven by fuel expenses as well as following the insolvency employees’ salaries and wages. of airberlin. Insolvency of airberlin strengthens Lufthansa’s market position Lufthansa at a Glance Through the insolvency of airberlin, Lufthansa’s market share on § Founded in 1926, intra-German flights increased from 69% to 87%, making it the Lufthansa Group is based dominant player in this country. It also helped Lufthansa to report a in Germany and is record high net income in 2017 and made the share price increase currently the largest by almost 150% during that year. airline group in Europe § Lufthansa operates three "Nobody has yet endangered Lufthansa, but surely many have business segments: challenged us.” Carsten Spohr, CEO Lufthansa Group 1) Network Airlines Highlights 2) Point-to-Point Airlines 3) Aviation Services Lufthansa revenue, EUR million Share price development 2017 § As of December 31st, +4.2% p.a. 40 40000 37961 2017, Lufthansa had 38000 30 471,259,644 shares out- 36000 35091 30% 32228 33939 standing, trading at a 34000 20 32176 share price of EUR 30.72 32000 10 15% Aviation Market Europe 30000 28000 0 § In 2017, there were 146 2013 2014 2015 2016 2017 01 / 2017 12 / 2017 aviation companies active Conclusion in the European market § By employing both valuation methodologies and other analysts Market shares based on predictions, a suggested value range of EUR 18.49 – 39.50 is available passenger seats obtained Others 16% DCF 36% 16% 9% 13% 10% Multiple Problem Statement § What is a fair share price for Lufthansa as of Other December 31st, 2017 and Analysts how will the insolvency of airberlin change the company’s position in the 17 21 25 29 33 37 41 EUR market? Contents 1 Introduction ................................................................................................................... 5 1.1 Background......................................................................................................................... 5 1.2 Purpose and Problem Statement ........................................................................................ 5 1.3 Structure of the Paper ........................................................................................................ 6 2 Methodology .................................................................................................................. 7 2.1 Research Design.................................................................................................................. 7 2.2 Theory ................................................................................................................................ 8 2.3 Data Collection ................................................................................................................... 8 2.4 Data Limitation and Criticism .............................................................................................. 8 3 Strategic Analysis ........................................................................................................ 10 3.1 Company Introduction – Lufthansa Group......................................................................... 10 3.1.1 Lufthansa in Brief ........................................................................................................ 10 3.1.2 Lufthansa Group’s Business Segments and Products.................................................... 11 3.1.3 Investors ..................................................................................................................... 12 3.1.4 Corporate Governance ................................................................................................ 13 3.1.5 Company Strategy ....................................................................................................... 14 3.1.6 Alliances and Partner Airlines ...................................................................................... 16 3.2 External Factors – Market Assessment .............................................................................. 17 3.2.1 The Global Flight Market ............................................................................................. 17 3.2.2 PESTLE Analysis ........................................................................................................... 21 3.2.3 Porter’s Five Forces ..................................................................................................... 26 3.3 Internal Factors – Competitive Position ............................................................................. 31 3.3.1 SWOT Analysis ............................................................................................................ 31 4 Selection of Peers ......................................................................................................... 37 5 The Analytical Financial Statements .......................................................................... 41 5.1 Accounting Quality............................................................................................................ 41 5.2 Classifications ................................................................................................................... 42 5.2.1 Income Taxes and Corporate Tax Rate ......................................................................... 42 5.2.2 Cash and Cash Equivalents .......................................................................................... 42 5.2.3 Capitalized Operating Leases ....................................................................................... 43 6 Financial Analysis ....................................................................................................... 45 6.1 Profitability Analysis ......................................................................................................... 45 6.1.1 Return on Equity ......................................................................................................... 46 6.1.2 Operating Analysis ...................................................................................................... 47 6.1.3 Trend and Common-Size Analysis of Income statement ............................................... 50 6.1.4 Profit Margin Conclusion ............................................................................................. 56 6.1.5 Asset Turnover Analysis: Turnover Rate of Invested Capital ......................................... 56 2 6.1.6 Conclusion Asset Turnover .......................................................................................... 60 6.2 Growth Analysis ................................................................................................................ 61 6.2.1 Sustainable Growth Rate ............................................................................................. 61 6.2.2 Value of Growth .......................................................................................................... 63 6.3 Risk Analysis ..................................................................................................................... 64 6.3.1 Liquidity Risk Analysis .................................................................................................. 64 6.3.2 Fuel Price Risk ............................................................................................................. 69 6.3.3 Exchange Rate Risk ...................................................................................................... 70 6.3.4 Interest Rate Risk ........................................................................................................ 70 6.4 Financial Analysis Conclusion ............................................................................................ 70 7 Cost of Capital ............................................................................................................. 72 7.1 Weighted Average Cost of Capital (WACC) Formula .......................................................... 72 7.2 Weighted Average Cost of Capital for Lufthansa ............................................................... 73 7.2.1 Capital Structure ......................................................................................................... 73 7.2.2 Required Rate of Return on Equity .............................................................................. 73 7.2.3 Risk-Free Interest Rate ...............................................................................................