Frankfurt am Main, March 17, 2020 -- Moody's Investors Service, ("Moody's") has today downgraded Deutsche Lufthansa Aktiengesellschaft ('Lufthansa') senior unsecured ratings to Ba1 from Baa3. Concurrently, Moody's has today assigned a Ba1 Corporate Family Rating and a Ba1-PD Probability of Default Rating to Lufthansa. The issuer's senior unsecured EMTN program rating has also been downgraded to (P)Ba1 from (P)Baa3. All ratings of Deutsche Lufthansa AG are placed on review for downgrade.
The rapid and widening spread of the coronavirus outbreak, deteriorating global economic outlook, falling oil prices, and asset price declines are creating a severe and extensive credit shock across many sectors, regions and markets. The combined credit effects of these developments are unprecedented. The passenger airline sector has been one of the sectors most significantly affected by the shock given its exposure to travel restrictions and sensitivity to consumer demand and sentiment. More specifically, the weaknesses in Lufthansa's credit profile, including its exposure to most destinations across the world have left it vulnerable to shifts in market sentiment in these unprecedented operating conditions and Lufthansa remains vulnerable to the outbreak continuing to spread. We regard the coronavirus outbreak as a social risk under our ESG framework, given the substantial implications for public health and safety. Today's action reflects the impact on Lufthansa of the breadth and severity of the shock, and the broad deterioration in credit quality it has triggered.
The downgrade was prompted by the very sharp decline in passenger traffic since the outbreak of coronavirus started during January 2020, which will result in a significant negative free cash flow in 2020, a weakening liquidity profile and a significantly higher leverage. From a regionally contained outbreak the virus has rapidly spread to many different regions severely denting air travel. The International Air Travel Association's (IATA) latest scenario analysis forecasts a decline in passenger numbers of between 11% and 19% for the full year 2020.
Moody's base case assumptions are that the coronavirus pandemic will lead to a period of severe cuts in passenger traffic over at least the next three months with partial or full flight cancellations and aircraft groundings, with all regions affected globally. The base case assumes there is a gradual recovery in passenger volumes starting in the third quarter. However there are high risks of more challenging downside scenarios and the severity and duration of the pandemic and travel restrictions is uncertain. Moody's analysis assumes around a 50-60% reduction in Lufthansa's passenger traffic in the second quarter and a 20% fall for the full year, whilst also modelling significantly deeper downside cases including a full fleet grounding during the course of Q2.
Lufthansa has felt the negative impact from declining passenger traffic earlier than other European competitors due its strong long haul network to China and the APAC region. The spreading of the virus beyond APAC has dented traffic on most of its network forcing the issuer to announce capacity cuts of up to 25% on 29th February and up to 50% on 06th March to react to sharply declining revenue passenger kilometers and forward bookings for the next few weeks. The travel ban announced by the United States on non-US citizens from 26 European nations will further affect many of Lufthansa's routes and Moody's expects travel restrictions to deepen. The sharp decline in demand comes at a time when Lufthansa has no headroom under its current rating category. Moody's expects the issuer's adjusted gross debt / EBITDA to be around 3.5x at fiscal year-end 2019, offering no breathing space against a downgrade trigger of 3.5x. As a consequence of the negative free cash flow generation, leverage metrics will be materially below the requirements for the previous rating category going forward at least in 2020. The recovery in metrics to a level commensurate with the current rating within 12 to 18 months is seen as very remote at the present time hence the downgrade of Lufthansa's senior unsecured rating to Ba1.
Moody's acknowledges that Lufthansa is currently focusing on managing its way through this very volatile market environment by reducing costs as much as possible and by shoring up its liquidity profile. The issuer has reduced all discretionary spending, has offered unpaid leave to employees and will hopefully soon be able to implement shortened working hours ('Kurzarbeit') following the parliamentary vote to ease the access to this scheme in Germany two weeks ago. The issuer has also raised funds in the German private placement market ('Schuldschein') to beef up its liquidity profile and counteract the lower working capital inflows from reduced pre-booking fees. Lufthansa had slightly less than 10% cash / revenue as per 30th September, a relatively low level compared to certain other European rated airlines. We believe that Lufthansa's monthly cash burn rate is currently elevated and that additional liquidity measures will be required if the slump in demand extends well into Q2 and possibly into Q3. Lufthansa should be able to use its access to various funding markets and its sizeable unencumbered fleet to protect liquidity even in a prolonged period of depressed demand. As per 13th March 2020, Lufthansa had €4.3 billion of cash on balance sheet and approximately €800 million availability under undrawn credit facilities without financial covenants.
Moody's also anticipates that the airline industry will require continued and further support from regulators, national governments and labour representatives to alleviate pressures on slot allocations, provide indirect or direct financial support and manage airlines' cost bases. An extension of slot alleviation beyond the current provisions to June 2020 in Europe is also likely to be important.
However, we expect the measures taken to shore up the group's liquidity profile alongside the cash burn due to lower pre-bookings and passenger traffic to deteriorate Lufthansa's balance sheet by adding additional debt. The longer the current situation lasts the higher the balance sheet deterioration will be. In any instance we expect credit metrics of Lufthansa to significantly exceed our downgrade trigger in 2020. The recovery in metrics to a level commensurate with the current rating within our rating horizon of 12 to 18 months is seen as very remote at the present time hence the downgrade of Lufthansa's senior unsecured rating to Ba1.
The review process will be focusing on (i) the current market situation with a review of current passenger traffic conditions and pre-booking trends for the next few weeks, (ii) 2019 results and company's guidance for 2020 including capex and operating performance, (iii) the liquidity measures taken by the company and their impact on the company's balance sheet, (iv) other measures being taken by the company to alleviate balance sheet and credit metrics stress, if any, and (v) a comprehensive review of Lufthansa's debt structure to assess the ranking of unsecured debt in a scenario where Lufthansa's credit rating would remain below investment grade for a prolonged period of time.
Lufthansa's liquidity position is considered as just adequate in light of the very challenging market conditions the issuer is currently facing. As per 13th March 2020, Lufthansa had approximately €4.3 billion of cash on balance sheet and €774 million availability under credit facilities without any financial covenants. Significantly lower pre-bookings and very depressed passenger traffic will lead to material cash burn at the least in the short term. Lufthansa will need to undertake extraordinary measures to bolster its liquidity. Lufthansa has initiated discussions to obtain lending collateralized by aircrafts and senior unsecured lending both in the banking and German private placement market.
WHAT COULD CHANGE THE RATING UP / DOWN
Given the current market situation we do not anticipate any short term positive rating pressure. A stabilization of the market situation leading to a recovery in metrics to pre-outbreak levels could lead to positive rating pressure. More specifically adjusted Debt/EBITDA would have to drop back sustainably below 3.5x and RCF/net debt to increase sustainably above 25% to pave the way back to an investment grade rating.
Further negative pressure would build if Lufthansa fails to stabilise its liquidity profile. A prolonged and deeper slump in demand than currently anticipated leading to more balance sheet deterioration and a longer path to restoring credit metrics in line with a Ba1 credit rating could also lead to further negative pressure on the rating.
LIST OF AFFECTED RATINGS:
..Issuer: Deutsche Lufthansa Aktiengesellschaft
Assignments and Placed on Review for Downgrade:
.... LT Corporate Family Rating, Assigned Ba1
.... Probability of Default Rating, Assigned Ba1-PD
Downgrades and Placed on Review for further Downgrade:
....Senior Unsecured Medium-Term Note Program, Downgraded to (P)Ba1 from (P)Baa3
....Senior Unsecured Regular Bond/Debenture, Downgraded to Ba1 from Baa3
.... LT Issuer Rating, Withdrawn , previously rated Baa3
....Outlook, Changed To Rating Under Review From Stable
The principal methodology used in these ratings was Passenger Airline Industry published in April 2018. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.