On 21 December 2017, Scope Ratings affirmed its BBB- corporate credit rating on Germany-based aviation group Lufthansa and raised the Outlook on the long-term rating to Positive from Stable. The short-term rating is unchanged and affirmed at S-2. Senior unsecured debt continues to be rated BBB-.
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Financial risk profile
The Outlook change for the long-term rating is driven mainly by Scope’s belief that financial credit metrics for Lufthansa are likely to improve in the medium term, supporting a more favourable view of its financial risk profile. The reasons for this are twofold, in Scope’s view: i) the peak to the capex on the fleet renewal programme in 2017, resulting in a gradual decline that should boost free cash flow going forward; and ii) the expectation of a final agreement with the German pilots’ union, Vereinigung Cockpit, which should reduce the pension deficit substantially.
The agency likewise expects Lufthansa to use most projected free cash flow from 2017 to make a one-time contribution to pension assets (EUR 1.6bn). Scope does not believe that Lufthansa will deviate from its longstanding financial policy, including its dividend policy. Coupled with Scope’s updated projections for 2018F and beyond, Lufthansa should generate free cash flow of substantially above expected dividend payments, leading to a gradual deleveraging as well as more headroom to accommodate unexpected deteriorations in trading conditions.
Scope also believes that the expansion of the point-to-point business – through the addition of Brussels Airlines and the expected closing of the Air Berlin transaction – should support a positive earnings contribution from this area going forward, eventually boosting cash flow. While the rebound in the logistics business could prove short-lived if international trade activities weaken, Scope sees the operating turnaround in the division as supportive for further earnings contributions and cash flow generation in 2018F.
Business risk profile
Scope’s assessment of Lufthansa’s business risk profile remains unchanged. This recognises the group’s improved market position and prospects following the full takeover of Brussels Airlines, the acquisition of significant parts of Air Berlin, and benefits afforded by the reduced number of market players following the Air Berlin insolvency and the troubles of Alitalia. However, these effects do not change Scope’s view that the business risk profile continues to be limited by the risk of marked cyclicality in the airline industry, including the risk of material fluctuations in operating profits resulting from swings in either passenger or cargo traffic demand.
Lufthansa’s business risk profile is less favourable than its financial risk profile. Scope’s forecasts for 2017F point to a Scope-adjusted debt (SaD)/EBITDA ratio of 1.6x and funds from operations (FFO)/SaD of 52%. The forecasts for 2017 and subsequent years include: i) the estimated increase in operating lease obligations due to the acquisition of aircraft from Air Berlin and Brussels Airlines; ii) the effect of the expected agreement with the pilots’ union on Scope’s pension adjustment (EUR 0.9bn) and the resulting anticipated reduction in staff costs from 2018 onwards; and iii) the acquisition price for significant parts of Air Berlin and integration costs.
Lufthansa’s liquidity is solid. Financial obligations in the medium term are covered by cash, committed credit lines and the expected excess of free cash flow over dividend payments. Further financial flexibility also results from the high share of unencumbered aircraft in the fleet. In Scope’s view, Lufthansa’s financial policy is cautious and prepared to balance the interests of both debtholders and shareholders, as demonstrated during the financial crises in 2009 and 2011 when dividend payments were cut due to weaker earnings.
This credit rating and/or rating outlook is issued by Scope Ratings AG.
The rating analysis has been prepared by Werner Stäblein, Executive Director. Responsible for approving the rating: Olaf Tölke, Managing Director
The rating was first assigned by Scope on 04.11.2016. / The rating was last updated on 21.12.2017.
The methodologies used for this rating and/or rating outlooks are Rating Methodology Corporate Ratings 2017 Jan. Available on www.scoperatings.com.
Historical default rates of Scope Ratings can be viewed in the rating performance report on https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA Please also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope’s definition of default as well as definitions of rating notations can be found in Scope ’s public credit rating methodologies on www.scoperatings.com.
The rating outlook indicates the most likely direction of the rating if the rating were to change within the next 12 to 18 months.
Stress testing & cash flow analysis
No stress testing was performed. Scope performed its standard cash flow forecasting for the company under review.
Solicitation, key sources and quality of information
The rated entity and/or its agents participated in the rating process.
The following substantially material sources of information were used to prepare the credit rating: public domain, the rated entity, third parties and Scope internal sources. Scope considers the quality of information available to Scope on the rated entity or instrument to be satisfactory. The information and data supporting Scope’s ratings originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data.
Prior to publication, the rated entity was given the opportunity to review the rating and/or outlook and the principal grounds on which the credit rating and/or outlook is based. Following that review, the rating was not amended before being issued.
Please see www.scoperatings.com. for a list of potential conflicts of interest related to the issuance of credit ratings.