oAfter the weak first half of 2021, demand in intra-European air passenger traffic, especially for holidays and leisure destinations, picked up in the summer. Considering the increasing rate of vaccinations and easing travel restrictions across Europe, as well as the anticipated reopening of some important long-haul destinations such as North America, we expect the global air passenger traffic demand to continue its recovery, albeit from the very low 2020 levels.
oIn 2021, we expect Deutsche Lufthansa AG (Lufthansa) to see demand as measured in revenue-passenger-kilometers (RPK) at only about 30% of the pre-pandemic level. Despite the delayed traffic recovery in 2021, Lufthansa stabilized its liquidity through proactive cash flow management and external funding. In 2022, demand in air passenger traffic should recover to up to 70% of the pre-pandemic level, and teamed with the cost-reduction measures, should improve adjusted EBITDA to EUR2.0 billion-EUR2.5 billion from the break-even forecast for this year and translate into credit metrics commensurate with the current rating.
oWe therefore revised the outlook on Lufthansa to stable from negative. At the same time, we affirmed the 'BB-/B' long- and short-term issuer credit ratings on Lufthansa, the 'BB-' rating on the group's senior unsecured debt, and the 'CC' rating on the junior subordinated debt.
oThe stable outlook is based on an expected continued recovery in air traffic, allowing Lufthansa to restore its credit ratios in line with the current ratings, and a markedly lower likelihood of a downgrade.
FRANKFURT (S&P Global Ratings) --S&P Global Ratings today took the rating actions listed above.
Air traffic demand recovery for European airlines should accelerate in 2022.
In Europe, air passenger traffic in 2021 (as measured by RPK) will reach only 30% of 2019 levels (at best). This is the lower end of the 30%-50% range we published Feb. 18, 2021 (see "Europe's 2021 Air Passenger Traffic Likely To Stall At 30%-50% Of 2019 Level," published on RatingsDirect). In 2022, the intra-Europe traffic will recover to 60%-75% of pre-pandemic levels, Europe-North America traffic will rebound to 50%-65% of 2019-base, while Europe-Asia and North America-Asia travel will continue lagging behind other regions, with 20%-25% of pre-crisis levels, according to our base case. Our current estimates are based on assumptions of no further prolonged lockdowns or renewed border closures beyond those currently in place.
After the sluggish first half of 2021, Lufthansa's recovery is taking shape.
In response to the delayed recovery in the intra-European traffic and very low intercontinental demand during that period, Lufthansa limited its capacity (available seat kilometres [ASK]) to 21% and 29% of 2019 level in the first and second quarters, respectively, while the 49% load factor was significantly below the pre-pandemic level. With the start of significant demand recovery for the short-haul leisure and holiday destinations in July, Lufthansa built up the third-quarter capacity to 50% of the pre-pandemic level and plans to deploy about 60% of 2019 ASK in the fourth quarter. For the full year, this translates to 40% of 2019 levels and below our previous forecast of 50%-55% (see "Lufthansa Downgraded To 'BB-' From 'BB' On Lower Air Traffic; Outlook Negative," published Nov. 19, 2020, on RatingsDirect). After incurring EUR915 million reported EBITDA loss (before results of equity investments) in the first six months, Lufthansa's EBITDA is likely to turn positive in the second year-half, fuelled by the demand recovery, extraordinary strong performance of the cargo business, and cost-savings measures (70% of the EUR3.5 billion cost-savings target by 2024 was achieved to date). Nevertheless, we expect EBITDA for the full year to only break-even compared with our previous forecast of substantial EBITDA.
We anticipate the air traffic demand will continue climbing in 2022 and contribute to the airline's financial recovery.
We envisage Lufthansa's operating performance improving in 2022, driven by the continued recovery of the European short-haul traffic and resumption in long-haul flights to North America, which was one of its most profitable destinations before the pandemic. Lufthansa plans to deploy 65% of its 2019 capacity in first-quarter 2022 and ramp it up to 80% in the second half of the year, encouraged by the recent pre-bookings trend of 80% of the pre-pandemic level. This compares with our air passenger traffic forecast for Lufthansa of up to 70% of the pre-pandemic level. We factor in risks of slower demand recovery in business and corporate travelling as compared with travelling for leisure and visiting family and friends, and we do not exclude structural segment losses in the medium term. We also anticipate a delayed and sluggish recovery in Europe-Asia passenger traffic. The uncertainty about the interplay between yields development, increased oil prices, and potential inflationary pressure on consumer sentiment is only partly captured in our forecasts and may exert additional pressure. We now anticipate Lufthansa's EBITDA, as adjusted by S&P Global Ratings, will rebound in 2022 to EUR2.0 billion-EUR2.5 billion. This translates to S&P Global Ratings-adjusted funds from operations (FFO) to debt of at least 6%, which is commensurate with our rating guideline. That said, we do not expect Lufthansa to generate positive free operating cash flow (FOCF; after leases) given the planned capital expenditure (capex) increases up to the annual EUR2.2 billion.
Repayment of silent participation I and good cash flow management caps adjusted debt in 2021 at the previous year level, which supports the recovery in credit metrics.
The weak start of the year and the EUR900 million deferred tax payments in the second year-half should constrain operating cash flow in 2021, albeit we expect it close to break-even, which is a material improvement as compared to EUR2.4 billion negative in 2020, as the revenue contribution increases and proactive working capital management enhances the benefits of traffic recovery. At the same time, we expect S&P Global Ratings-adjusted debt at end-2021 (carrying forward the pension obligation from Dec. 31, 2020) to not exceed EUR15.9 billion, the level recorded at end-2020. This is supported by the capital increase completed in October with the total proceeds of EUR2.2 billion, EUR1.5 billion of which were used to repay the outstanding drawing under silent participation I in the same amount, which we treated as akin to debt under our hybrid criteria. Lufthansa is also limiting the cash burn with another year of subdued capex of EUR1.5 billion, versus EUR1.2 billion in 2020 and EUR3.7 billion in 2019.
We believe Lufthansa will enter 2022 with ample liquidity.
We forecast that Lufthansa following several rounds of external funding measures (including recent capital increase) in 2021 will increase its cash on hand by year-end to about EUR6.6 billion, as compared to EUR5.5 billion recorded at end-2020. This, along with about EUR1.5 billion undrawn amount under the company's committed credit lines maturing beyond next 12 months (including the Swiss and Belgian state aid, but excluding the silent participations as they are planned to be cancelled by year-end), is slightly above the company's new target liquidity range of EUR6 billion-EUR8 billion (considerably above the EUR2.3 billion minimum liquidity target before the pandemic) and should provide Lufthansa with ample headroom for unforeseen setbacks or operational headwinds, as the traffic recovery is unfolding.
The planned cancellation of silent participation I and II by Lufthansa does not alter our view on the airline's government-related status.
After the repayment of the EUR1.5 billion drawing under EUR4.5 billion silent participation I, Lufthansa plans to repay the EUR1 billion silent participation II and cancel both hybrid instruments, which were provided as part of the German state aid package by the Economic Stabilization Fund, by year-end. In our November 2020 review we anticipated this early redemption of the hybrids, among others due to their multiple material coupon step-ups. The German government stake in Lufthansa share capital fell to 14% following the October capital increase from initially 20%. We understand that the German government can sell its stake six months after the capital increase completion and must exit the shareholder structure of Lufthansa no later than 24 months after the capital increase, provided that the silent participations are repaid and contractual conditions are met. The anticipated termination of the state aid package does not, however, alter our view of the moderate likelihood of extraordinary support Lufthansa could receive from the German government under a stress scenario. This translates into one notch uplift from our 'b+' assessment of Lufthansa's stand-alone credit profile (SACP). We base our view on the important role Lufthansa plays for the German government, rather than its link, which we continue assessing as limited.
The stable outlook reflects our expectation that the air passenger traffic recovery will continue. Consequently, for Lufthansa we expect its EBITDA to turn positive in the second-half 2021, increasing (but still well below pre-pandemic levels) in 2022. This should produce credit ratios supportive of the rating with adjusted FFO to debt of at least 6% in 2022, with further improvements thereafter. Furthermore, we consider a sustained solid liquidity position, a critical and stabilizing rating factor.
Downside scenario
We could lower ratings if we expect credit ratios to deteriorate materially, with adjusted FFO to debt returning to less than 6% on a sustainable basis. This could occur if there is a major resurgence of the pandemic, prompting renewed prolonged lockdowns and deterioration in consumer confidence. In this scenario, we might conclude that the fundamental risk characteristics of the industry have worsened, particularly for airlines that rely significantly on business and long-haul international travel and reflect that in our assessment of business risk.
We could lower the rating if we revise down our assessment of the likelihood of government support and Lufthansa's SACP does not improve to 'bb-' in the meantime. This could occur if the pandemic-related adverse effect on the industry eases, passenger air traffic returns towards normal levels, and therefore the rationale for government support diminishes, while the airline stabilizes its financial position.
Upside scenario
We could raise the ratings if Lufthansa improves its adjusted FFO to debt to 6%-12% and start generating a sustained positive FOCF (after leases).
Environmental, social, and governance (ESG) credit factors for this change in credit rating/outlook and/or CreditWatch status:
oHealth and safety
Related Criteria
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Related Research
oLufthansa Downgraded To 'BB-' From 'BB' On Lower Air Traffic; Outlook Negative, Nov. 19, 2020
oEurope's 2021 Air Passenger Traffic Likely To Stall At 30%-50% Of 2019 Level, Feb. 18, 2021
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