Lufthansa: Crisis Could Last Six Months or Longer

Madhu Unnikrishnan

March 22nd, 2020


  • A “state of emergency.” That’s how Germany’s Lufthansa described the current crisis that grips the world’s airline industry. During its discussion of financial results for 2019, the airline spent at least as much time talking about the dire circumstances it faces in 2020. Net bookings are now nearly zero, with operations all but grounded — all of the Lufthansa group airlines combined will (starting March 24) be flying just 5% of their original schedule. It has 700 planes sitting on the ground.

    Forgetting even about its pre-crisis flirtations with Alitalia, Lufthansa has rather heavy exposure to the Italian market, specifically the northern Italian market which now stands as ground zero for the Covid-19 virus pandemic. It even owns an Italian regional airline called Air Dolomiti.

    But the entire world right now is a dysfunctional market, so like every other airline in the world, Lufthansa is wholly focused on survival. That means doing everything it can to preserve and raise cash. Just as importantly, it means pleading for government support. It’s already received some, in the form of deferred taxes, relaxed airport slot regulations, and some relief (not enough according to airlines) on passenger compensation rules. In addition, Germany’s federal government expanded its “short-time work” wage subsidies, enabling Lufthansa to cut working hours for staff.

    The airline is talking directly to unions as well, insisting it needs more support from all stakeholders, not just governments. It did note that extracting fixed labor costs can be more difficult in Europe than in markets with less rigid labor laws and union politics. Roughly 60% of Lufthansa’s cost base is variable, meaning it fluctuates up and down depending on how many ASKs it flies. The biggest variable cost is fuel. But with its entire operation essentially grounded, it can also eliminate passenger service costs and airport fees.

    Any airline’s biggest fixed cost is labor, though the more accurate term is probably “semi-fixed,” in the sense that labor costs can be cut. How? The short-time work policy, for one. In addition, Lufthansa is reducing overtime hours, imposing unpaid work leave, freezing new-hires, and cancelling non-safety related staff training. At the same time, it’s stopped all marketing, deferred non-essential maintenance, cancelled all of its wet-lease contracts, suspended dividend payments, and drastically reduced its capital spending (which could affect aircraft orders).

    The group is comforted by the fact it owns 87% of its planes, and most are not yet mortgaged. That theoretically means it can use them as collateral to get new loans, assuming lenders still see value in aircraft. In any case, Lufthansa still has $1b in unused credit lines with banks, meaning it’s already preapproved to borrow that money. How long will the money last? Executives say they’re planning for three different scenarios, in which its planes are grounded for a) three months, b) six months, or c) 12 months.

    Oh, about fourth-quarter earnings, which was what Lufthansa’s presentation was supposed to be about. How did the company do in the final quarter before the world started fraying? Not great. Operating margin was just 3%, as usual a bit better than Air France/KLM’s 1% figure but grossly lower than IAG’s 12%. Under the new accounting rules Lufthansa is using, Q4 revenues increased 1% y/y on flat capacity, while operating costs were up fractionally. Though blissful in comparison to what’s happening this year, 2019 was no picnic for Europe’s largest airline group —  it earned just a 5% operating margin for the year.

    The group faced weakness in mainland China, Hong Kong, and Brazil while enduring intense pricing battles in German and Austrian shorthaul markets. The export-heavy German economy was badly hurt by a combination of tariff wars and China’s slowing economy, thus damaging Lufthansa’s large cargo business. The airline struggled with labor tensions. It had to navigate through Brexit uncertainty, Airbus NEO delays, escalating public pressure to reduce carbon emissions, and parts of its own business that badly needed restructuring.

    These include Eurowings, which decided to abandon longhaul flying, and Austrian Airlines, whose home hub Vienna became a hornet’s nest of LCCs. Both units did show significant y/y improvements last quarter, but Eurowings still ended Q4 with a negative 7% operating margin. Austrian’s was just above break even. The core Lufthansa-branded business didn’t do all that much better, earning just a 3% Q4 margin. Cargo did fine (5%). Same for maintenance (7%). And Swiss as usual was the all-star of the group (8%, and 11% for the full year). The Eurowings entity now includes Brussels Airlines, itself undertaking a much-needed restructuring. Brussels was hit by the bankruptcy of Thomas Cook’s Belgian unit, with which it had a close relationship.

    During the last quarter of the year, Lufthansa’s crucial North American franchise saw a rather sharp reduction in yields, which was almost as bad as the yield degradation it saw in Asia and Latin America. Already, last fall, the carrier began seeing weaker longhaul premium demand in general. There were some flight attendant strikes last quarter too.

    At some point in the future, people will be flying on airplanes again. And when that time comes, Lufthansa wants to focus more on the airline business, as opposed to its past strategy of acting as an aviation conglomerate. That’s not to say it wants to sell its giant maintenance business. But it’s already sold much of its catering business.

    Key pre-crisis highlights of Lufthansa’s airline strategy include growing its loyalty plan, enhancing digital capabilities, working with joint venture partners (United, Air Canada, Air China, and Singapore Airlines), and re-fleeting with A220s, A320 NEOs, A350s, B787s, and B777-9s. It planned to create a new German longhaul leisure unit as well, modeled after Edelweiss.

    Does Lufthansa think the current crisis will trigger more consolidation? Yes, if it lasts only a few weeks. But executives don’t think it will. More likely, the crisis will persist for six months or longer, and that “probably slows down consolidation.” Added CEO Carsten Spohr: “If this lasts a year, this will get so expensive that many airlines in the world, even with government support, probably couldn’t come out of this in a healthy way.”

Aegean: ‘We are a resilient company’

  • Reviewing 2019 financial results feels like a class on ancient history. But for the record, Aegean Airlines, based in country famed for its ancient history, had a good year. It managed a 9% operating margin, lifted by its first-ever profitable fourth quarter. That’s usually an offpeak period for Greek tourism. But this time, Aegean eked out a 1% operating margin. Revenues rose an impressive 12% y/y on just 7% ASK capacity. Even better, operating costs rose just 4%, with fuel outlays up 7% and labor costs up 5%.

    The airline didn’t grow its fleet last year. But it did try to “stretch” the summer peak by keeping elevated levels of capacity and utilization into the fall. Its success in this regard was a big victory, because Aegean’s business is highly seasonal — any money it can make in the shoulder seasons is a big plus. Athens is its most important base, with new service last year to Marrakech, Casablanca, Ibiza, Valencia, Sarajevo, Tunis, and Skopje. But it operates from eight bases in total, including many of the popular Greek islands.

    Late last year, Aegean began receiving its first A320 NEOs (it currently has four). It also made a bid for Croatia Airlines and struck a deal to buy a Romanian startup carrier. But it never, unlike more adventurous European rivals, bit the poison apple of intercontinental flying. Such conservatism has served it well, surviving multiple crises over the years, including the meltdown of the Greek economy in 2010. Through these sobering experiences, the airline built deep relationships with suppliers, which should serve it well as it navigates the current shock.

    “We are a resilient company that knows how to deal with crises,” said chairman Eftichios Vassilakis. He didn’t take questions about the current state of affairs, promising to hold another call in the next three or four weeks, when the picture is hopefully clearer. The company did say, however, that it was flying just about 20% of its schedule as of early last week. Roughly 72% of costs are variable, i.e. fuel and passenger services. But even if totally grounded, it would still have to pay about $40m a month in fixed costs, i.e. overheads, leases, and labor. Like every other airline on planet earth, it’s now looking for government aid to help mitigate the Covid-19 crisis.

VietJet Commands Local Market

  • VietJet, a fast-growing LCC, didn’t even exist yet during the global financial crisis of 2008-09. Today, barely eight years old, it’s an airline with roughly 80 planes and an order book for 200-plus more. More importantly, it’s consistently earned profits, ending 2019’s fourth quarter with a 10% operating margin. That marked strong y/y improvement at its core airline operations as revenues spiked 25% y/y. Operating costs rose just 13%. Close to 30% of its airline revenue comes from ancillaries.

    It commands a leading share in Vietnam’s domestic market. And it’s aggressively expanded its international footprint while (like Aegean) refraining from intercontinental adventurism — lots of NEO and MAX orders but no widebodies. Vietnam, to be sure, is a tough airline market, characterized by severe airport congestion and intense competition.

    Vietnam Airlines is VietJet’s chief rival, fielding both mainline service and a Jetstar-branded LCC jointly run with Qantas (Jetstar Pacific). Bamboo Airways is a new rival, with others poised to enter. On the other hand, AirAsia is repeatedly stymied in its attempts to launch a Vietnamese venture.

    Entering the weekend, Vietnam had close to 100 known Covid-19 cases but no deaths yet. The country, seeking to limit the pathogen’s spread, ordered a halt to all inbound international flights. VietJet is selling “Sky Covid Care” insurance to domestic passengers, covering the cost of their health care if infected with the virus (under any circumstances, not necessarily while flying).

AirBaltic Eyes A220 Future

  • Latvia’s airBaltic, 80% owned by its government, posted its financial results for 2019. The net figure was negative $7m, though that included some one-off charges. At the operating level, the carrier’s margin was a decent 6%, up from 4% the year before. That’s especially satisfying given the aggressive capacity growth the airline pursued last year. It grew ASKs 22% y/y, adding nine new routes. Revenues increased 23%, while operating costs rose only 20%.

    Based in Riga, the capital of Latvia, airBaltic is well-positioned to connect much of western Europe to eastern Europe and the former Soviet Union. Riga is in some sense a mini-hub for the Nordic region. It flies from Estonia’s capital Tallinn too, as well as Lithuania’s capital Vilnius. It thus positions itself as the leading carrier for the entire Baltic region, though dividing its assets across multiple hubs limits economies of scale. (SAS knows all too well the dangers of having three hubs with limited scale).

    Last year, it benefitted from some favorable supply developments, including the reduction of some Baltic-area capacity by Ryanair and Norwegian. Estonia’s Nordica ended scheduled operations from Tallinn. And declining fuel prices later in the year helped too.

    If there’s one thing that stands out about airBaltic’s business model, it’s the early bet it made on the A220, when it was still called the CSeries. It already has more than 20 in service, with more on the way. Before long, as it phases out B737s and Q400s, the whole fleet will be A220-300s. airBaltic gets some of its revenue from wet-leasing crews and planes to other airlines including Lufthansa. It codeshares with SAS and Air France/KLM among others.

    This year — before the crisis hit anyway — it was planning to add a slew of new routes from all three Baltic capitals. The first two months of 2020, it said, were strong. But now it’s asking for state support. All of its flights are suspended through mid-April.

Bear-Lines

AirlineY/Y change
Air Arabia10%
VietJet-14%
Ryanair-25%
ANA-26%
Wizz Air-28%
China Eastern-34%
Aeroflot-35%
Air China-36%
Southwest-36%
China Southern-36%
Singapore Airlines-38%
IndiGo-39%
Cathay Pacific-40%
Turkish Airlines-44%
Allegiant-45%
Japan Airlines-49%
Aegean-51%
easyJet-51%
Volaris-51%
Cebu Pacific-51%
Aeromexico-52%
Finnair-54%
Korean Air-54%
Lufthansa-55%
SAS-55%
Brent Crude Oil-56%
JetBlue-56%
Air France/KLM-56%
Air New Zealand-57%
Delta-57%
Alaska-57%
Qantas-57%
BA/Iberia (IAG)-60%
Air Canada-61%
SkyWest-61%
SpiceJet-62%
Copa-62%
Hawaiian-66%
American-66%
Azul-66%
Kenya Airways-68%
United-69%
Virgin Australia-71%
LATAM-73%
Thai Airways-75%
AirAsia-76%
Gol-76%
Avianca-77%
Norwegian-79%
Spirit-83%
  • It’s the mother of all bear markets for airline stocks
  • Price change from one year ago

Madhu Unnikrishnan

March 22nd, 2020