Rating action

Scope Ratings GmbH (Scope) has today affirmed the issuer rating of Deutsche Lufthansa AG at BBB-/Negative. Scope has also affirmed the BBB- senior unsecured debt rating and the BB contractually subordinated debt (hybrid) rating. The S-3 short-term rating has also been affirmed.

The latest information on the rating, including rating reports and related methodologies, is available on this LINK.*

Rating rationale

The rating affirmation is based on Lufthansa Group’s improving financial situation despite the slow recovery of air traffic. The Outlook remains Negative, however, reflecting the continuing uncertainty regarding the pandemic’s impact and a potential recovery, even with state aid and the measures taken to reduce cash burn and secure liquidity (including a potential equity increase).

The business risk profile (assessed at BBB-) reflects the fact that Lufthansa remains among the largest airline group globally, with a worldwide presence via multiple hubs. This is despite Lufthansa having downsized its fleet in response to the lower demand, a step also taken by most of its peers during the pandemic. In addition, the group aims to not only defend its market position but also strengthen it, both inside and outside its hubs. While the pace of recovery remains uncertain, the group is ready to meet any surge in demand by providing a segmented offering and exploiting growth opportunities. Further, diversification into other activities, especially the cargo business, has helped to offset the impact of reduced passenger traffic, a major revenue driver. The group is taking the opportunity to restructure during the crisis, with the aim to thrive in a new norm that may see the downfall of weaker airlines.

With vaccinations accelerating, bookings have risen, especially among leisure customers on European short haul and transatlantic flights. The group is expecting a recovery this year to around 40% of 2019 capacity, though pre-crisis levels are not anticipated before 2024 or 2025.

Profitability is still weak with the load factor remaining below 70%. While EBITDA remains negative, the group is expected to break even either this year or early in the next, helped by the gradual traffic recovery and efforts to reduce costs by accelerating fleet restructuring and modernisation, simplifying operations and reducing overheads and personnel costs.

The financial risk profile (assessed at BB-) is based on the still weak credit metrics due to the limited cash generation. At this stage, the Scope-adjusted debt (SaD)/EBITDA ratio is expected at above 10x and the funds from operations/SaD ratio at around 4% for 2021, with gradual improvements thereafter due to cash inflow from ongoing operations, costs discipline and no dividend payments. Scope still expects revenues in 2021 to be around 55% lower than in 2019. Assuming the recovery continues into 2023 and given the actions taken to reduce capex and fixed cash costs, Scope’s base case foresees credit metrics to improve, with a SaD/EBITDA of below 3.5x by 2023. The analysis assumes a capital increase of at least EUR 2bn, as the group was authorised to draw up to EUR 5.5bn subject to conditions being met¹. Net proceeds from the capital increase would be directed towards repaying part of the stabilisation funds (provided by Germany’s Economic Stabilisation Fund) as well as strengthening the balance sheet. Scope did not account for proceeds from possible divestments of non-core assets (AirPlus and LSG) or the option to draw the full EUR 4.5bn silent participation 1 of the state aid package. Scope believes the group can achieve its net debt/EBITDA target of 3.5x via the ongoing restructuring, cost-cutting, possible divestitures, undrawn state aid funds and, more importantly, the traffic recovery that will ensure strong free operating cash flow.

Liquidity is robust, bolstered by huge efforts to secure and preserve a comfortable cash buffer and reduce the cash drain. Liquidity is further strengthened by the undrawn state aid, unused credit lines of EUR 360m as of 2021Q1, a more than 70% unencumbered fleet, and a potential direct equity injection (subject to state-aid conditions). As of 31 March 2021, Deutsche Lufthansa AG had centrally available liquidity of EUR 3.7bn. A further EUR 4.5bn is available from the Economic Stabilisation Fund (Silent Participation I). Altogether, the group’s available liquidity comes to EUR 10.6bn, which is more than sufficient to cover around EUR 2.1bn in outstanding short-term debt as of 2021Q1 and the negative free operating cash flow forecast for 2021. For 2022, Scope expects free operating cash flow to be positive, which will support coverage of financial maturities in that year and boost unrestricted liquidity.

The standalone rating remains at BB, based on the expectation that credit metrics will remain weak into 2022.

Supplementary rating drivers in terms of parent support result in a two-notch uplift above Lufthansa’s standalone credit quality. The German government’s EUR 300m direct equity injection did not result in majority ownership, but 20% of voting rights. Despite this seemingly low representation, Scope believes Lufthansa remains strategically important to the German state, therefore we are upholding the two-notch rating uplift for parent support.

Outlook and rating change drivers

This Negative Outlook reflects the persistent uncertainty around the speed at which international air traffic and, subsequently, Lufthansa’s operating performance will recover over the next few years.

Scope may downgrade the rating further if it expects Lufthansa’s financial metrics to remain weak beyond 2022 with no medium-term recovery of SaD/EBITDA to below 3.5x. This could be the result of a slower-than-expected recovery of free operating cash flow amid a sluggish revival of international air travel or new governmental travel restrictions imposed.

A positive rating action (i.e. Outlook back to Stable) could be warranted if free operating cash flow and the potential capital increase allowed SaD/EBITDA to reach below 3.5x on a sustained basis.

Long-term and short-term debt ratings

Senior unsecured debt has been rated BBB-, which is in line with the issuer rating.

Outstanding contractually subordinated debt (hybrid) remains two notches below the issuer credit rating, at BB.

The short-term rating has been affirmed at S-3.

Rating driver references
1. 14 June 2021 Lufthansa Group announces medium-term targets and makes preparations for a capital increase

*Editorial note: This sentence was added on 8 July 2021.

Stress testing & cash flow analysis
No stress testing was performed. Scope Ratings performed its standard cash flow forecasting for the company.

Methodology
The methodology used for these Credit Ratings and/or Outlook, (Corporate Rating Methodology, 6 July 2021), is available on https://www.scoperatings.com/#!methodology/list.
Scope Ratings GmbH and Scope Ratings UK Limited apply the same methodologies/models and key rating assumptions for their credit rating services, while Scope Hamburg GmbH’s methodologies/models and key rating assumptions are different from those of Scope Ratings GmbH and Scope Ratings UK Limited.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other Services’, published on https://www.scoperatings.com/#!governance-and-policies/rating-scale. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA. 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 Ratings’ definitions of default and Credit Rating notations can be found at https://www.scoperatings.com/#governance-and-policies/rating-scale. Guidance and information on how environmental, social or governance factors (ESG factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://www.scoperatings.com/#!methodology/list.
The Outlook indicates the most likely direction of the Credit Ratings if the Credit Ratings were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The Rated Entity and/or its Related Third Parties participated in the Credit Rating process.
The following substantially material sources of information were used to prepare the Credit Ratings: public domain, the Rated Entity and Scope Ratings' internal sources.
Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting the Credit Ratings originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Ratings and/or Outlook and the principal grounds on which the Credit Ratings and/or Outlook are based. Following that review, the Credit Ratings were not amended before being issued.

Regulatory disclosures
These Credit Ratings and/or Outlook are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and/or Outlook are UK-endorsed.
Lead analyst: Azza Chammem, Senior Analyst
Person responsible for approval of the Credit Ratings: Henrik Blymke, Managing Director
The issuer Credit Rating/Outlook, the short term rating and the senior unsecured debt rating were first released by Scope Ratings on 4 November 2016. The Credit Ratings/Outlook were last updated on 14 July 2020.
The junior subordinated Credit Rating/Outlook were first released by Scope Ratings on 6 June 2018. The Credit Rating/Outlook were last updated on 14 July 2020.

Potential conflicts
See www.scoperatings.com under Governance & Policies/EU Regulation/Disclosures for a list of potential conflicts of interest related to the issuance of Credit Ratings.

Conditions of use/exclusion of liability
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