03-May-2013 4:40 PM

Lufthansa juggles more balls more quickly as it reports unchanged 1Q2013 operating loss

Analysis

Lufthansa on 2-May-2013 reported a 1Q2013 operating loss of EUR359 million, an identical loss as in the same period in 2012. All the main business segments improved their operating result, but restructuring costs weighed on the group result.

The quarter was characterised by capacity cuts, yield and load factor increases, and restructuring aimed at future profit improvements. Labour unrest, never far from the surface, returned during the quarter. Recent union agreements have reduced the risk in this area, although talks with the pilot union are on-going.

Pricing was generally fairly healthy, with yield and load factor growing, but weakness was again apparent in Asia-Pacific. On the analyst conference call to discuss 1Q2013 earnings, Lufthansa CFO Simone Menne did not rule out the possibility of using new partnerships as a more offensive solution to Lufthansa's Asian problems, than the more defensive approach of capacity cuts and cabin mix changes.

Management will need to keep juggling these and other key issues - such as the 'new' Germanwings, office closures and headcount reductions - if it is to have a chance of reaching its FY2015 operating result target of EUR2.5 billion.

Revenues and operating loss unchanged on first quarter 2012

Lufthansa Group reported a 1Q2013 operating loss of EUR359 million, exactly the same as for the year earlier period (restated to reflect pension accounting changes). Revenues of EUR6.628 billion were also virtually unchanged from 1Q2012 (+0.1%), in spite of a cut in total capacity (ATK) of 4.1%.

The net loss for the quarter widened by EUR65 million to reach EUR459 million, mainly due to non-cash adverse changes in the valuation of non-current borrowing. The stable operating result is after EUR65 million of restructuring costs.

Lufthansa Group financial highlights 1Q2013 vs 1Q2012

Capacity down, load factor up

The Lufthansa Group cut passenger capacity (ASK) in the quarter by 2.7% compared with the same period last year, but increased load factor by 2.0ppts to 76.1%. The number of flights fell by 6.5%, but the number of passengers fell by only 1.6%, reflecting larger aircraft and longer sectors. Cargo capacity (ACTK) was down by 5.3% and cargo load factor grew by 0.6ppts to reach 70.5%.

Lufthansa Group operating figures 1Q 2013 vs 1Q2012

Asia-Pacific yield down 4.7%, but how will Lufthansa tackle the region?

The 2.7% cut in ASK capacity varied by region, with the Americas seeing an increase of 4.1%, the Middle East and Africa a cut of 7.2% and Europe and Asia-Pacific a cut of around 5%. Passenger yield grew in Europe and the Americas, but fell in Asia-Pacific, Middle East and Africa. Overall yield grew by 0.9%.

Although there were load factor gains in all regions, the heavy yield decline in Asia-Pacific (-4.7%) and a load factor that was only just better than flat (+0.4ppts) suggest that Lufthansa struggled to match supply to demand in the region. Asia-Pacific yields were also affected by currency movements, in particular the weakness of the Japanese yen (although the joint venture with ANA is helping to defend against weak yields) but the price pressure experienced in the region gives further credence to reports that the Group is considering establishing some kind of low-cost operator for Asia-Pacific, either by itself or, more likely, with a partner.

Indeed, Ms Menne told analysts on the 1Q2013 results conference call that Lufthansa is closely monitoring developments in Asia-Pacific, especially Southeast Asia, where competition and yield pressure are most intense. She pointed to three options, not mutually exclusive, in terms of how to respond to the situation.

First, a move to a two class fleet with no First Class (Lufthansa is already reducing the proportion of its long-haul fleet with a First Class cabin); second, retreat from specific markets (e.g. Hyderabad); and third, partnerships. Regarding the partnership option, Ms Menne said she had "nothing to report".

See related reports:

Lufthansa Passenger Airlines Group development of capacity, traffic and yield 1Q2013

Strikes hit traffic, but pay deals now agreed (except pilots)

Traffic was affected by a nationwide warning strike on 21-Mar-2013 called by trade union ver.di in the course of negotiations for around 33,000 ground staff at the Lufthansa Group in Germany. In Jan-2013 and Feb-2013, the trade union ver.di also called several strikes while negotiating with private security services at individual airports, disrupting Lufthansa Group companies at these sites.

A strike by cabin crew and ground staff also led to cancellations on 22-Apr-2013 (after the end of 1Q2013). However, an agreement has since been reached with ver.di, under which workers will receive pay increases over the 26 months from 1-Feb-2013 and a guarantee of no compulsory redundancies.

For the first time, pay increases will be differentiated according to the performances of the different business segments. The deal needs to be approved by union members by 14-May-2013.

Employees of Deutsche Lufthansa (i.e. the passenger airline) will receive two 1.5% pay rises, on 1-Aug-2013 and 1-Aug-2014. Lufthansa Technik and Lufthansa Cargo employees will have an increase of 2.4% on 1-Aug-2013 and 2.3% on 1-Aug-2014. For Lufthansa Systems, the increases will be as for Technik and Cargo, but on 1-Nov-2013 and 1-Nov-2014.

Trainees will receive a total of 5.2% in two stages, while LSG SkyChefs had already reached a pay deal with staff in Feb-2012. The union agreed to a pay freeze for the first six months of the period.

Wage talks with the Vereinigung Cockpit Pilots' union for pilots at Lufthansa Passenger Airlines, Lufthansa Cargo and Germanwings are ongoing. According to Ms Menne, the union has requested a 10% pay increase over 24 months. The company will seek a similar deal to that agreed with ver.di and will also look for productivity gains.

Operating costs up 1.7% in spite of capacity cut

Total operating costs increased by 1.7% year-on-year, but, adjusting for non-operating items such as impairment losses and non-cash movements in the value of non-current borrowings, the underlying growth in costs was 0.9%, still ahead of capacity. Fuel costs increased by 2.2%, although Lufthansa currently anticipates full year fuel costs will fall from EUR7.4 billion last year to EUR7.0 billion in 2013

Staff costs, the biggest single cost item, grew by 4.3% in spite of a 0.6% reduction in staff numbers. This was mainly due to restructuring costs and higher interest rate-related additions to pension provisions.

Lufthansa Group expenses: 1Q2013 vs 1Q2012

As part of Lufthansa's SCORE cost reduction programme, the Group adopted a number structural changes to administrative functions, making decisions to close several sites while transferring functions from the areas of finance, purchasing and human resources to shared services centres in Germany and abroad. These include the Group head office in Cologne, with 365 employees, and the headquarters of Lufthansa Revenue Services GmbH (LRS) in Norderstedt, with 350 employees.

Implementation is to take place by 2017. In Hamburg, 80% of the nearly 200 jobs in Group administration are to be transferred to a specialised service company. At Lufthansa Technik, around 650 administrative jobs are to be cut and Lufthansa CityLine is examining whether to move its headquarters from Cologne to Munich.

First quarter is always weak and no guide to full year result

The first quarter of the year is historically a weak one for profits and is not a good guide to the likely full year result. Lufthansa has reported operating losses in the first quarter for each of the past five years, but has consistently achieved an operating profit for the full year. Since 2009, the Group's best 1Q operating result was a loss of EUR44 million. This was reported in 2009, the year that saw the lowest full year operating profit of the five year period.

Lufthansa Group first quarter operating and net result: 1Q2009 to 1Q2013

Passenger Airline Group biggest segment and biggest loser

By segment, the Passenger Airline Group dominates revenues, with 74% in 1Q2013. Its operating loss for the quarter was EUR363 million, a reduction of 15% compared with its loss for the same period last year.

The Passenger Airline Group consists of Lufthansa Passenger Airlines (which also includes Germanwings), SWISS and Austrian Airlines. Lufthansa Passenger Airlines, still the weakest single entity in the overall group in terms of operating result, narrowed its operating loss by 20% to EUR292 million. Austrian Airlines also narrowed its operating loss by 16%, to EUR56 million, but SWISS - typically the best airline performer in the group - widened its operating loss to EUR16 million (from EUR3 million).

The three other principal segments, Logistics (Lufthansa Cargo), MRO (Lufthansa Technik) and Catering (LSG SkyChefs) all recorded increased operating profits in the quarter. Only the small IT Services segment saw a deterioration of its operating result (from EUR4 million to EUR3 million) and the operating segments collectively posted a EUR95 million improvement in their operating result. This improvement, however, was offset by a EUR95 million deterioration in 'other and consolidation' results, owing to EUR64 million of restructuring costs and a net EUR31 million of exchange rate losses.

Lufthansa Group revenue and operating result by segment: 1Q2013

Passenger Airline Group loss narrowed

Looking at the main operating entities of the Passenger Airline Group in a little more detail, Lufthansa Passenger Airlines improved its operating result by EUR77 million. Revenue grew by 0.7% to EUR3.7 billion. It reduced the number of flights by 7.2% year-on-year, with ASKs down by 3.0% and RPKs down by 0.8%, with passenger load factor up by 1.7ppts to 75.5%.

Lufthansa Passenger Airlines carried 15.5 million passengers in the quarter (-2%), but higher yields lifted traffic revenue by 1.0% to EUR3.4 billion. Business was affected by warning strikes leading to delays and cancellations. For the full year 2013 Lufthansa Passenger Airlines expects an increase in revenues and the operating result. It also expects that efficiency gains from merging decentralised European traffic with Germanwings will lead to "noticeable earnings improvements" in 2013.

SWISS' earnings were depressed by high fuel costs, which could not be recouped by higher revenue. Revenue grew to EUR987 million (+2.1%), but the operating loss fell to EUR16 million (2012 loss: EUR3 million). For the full year, SWISS is forecasting higher passenger numbers and revenue and anticipates that the operating result will be "roughly on par with last year's".

At EUR426 million, Austrian Airlines' revenue was down 3.4% on last year, but the operating loss narrowed by 16% to EUR56 million. Austrian is continuing with the restructuring that began last year. Following the transfer of operations to the Tyrolean Airways subsidiary, further changes in operational and administrative functions are to be implemented in 2013.

The migration of all Tyrolean Airways administrative functions from Innsbruck to Vienna will eliminate duplication and make operating processes more efficient. For the full year, Austrian is expecting demand to remain volatile and fuel costs to stay high. It anticipates revenue growth and cost savings, with the help of the restructuring programme, and aims to achieve a positive operating result.

1.0% growth in capacity (ASK) for 2013

Lufthansa plans capacity (ASK) growth in the Passenger Airline Group of 1.0% in 2013, with 2.5% on long-haul and a cut of 1.9% on short-haul. With the group seeing a capacity cut of 2.7% in the first quarter, the summer schedule will grow by 1.6%. Long-haul capacity growth is driven by larger aircraft and an increase in the mix of Economy versus Business Class seats. SWISS will grow by 2.7%, while Austrian will see a capacity cut of 1.9%.

The group says that forward bookings currently show a positive trend, with load factors increasing. Yield performance continues to be positive in Europe, while long-haul yields are seeing dilution due to the expansion of Economy Class (although yields are growing on the Americas).

Lufthansa Passenger Airline Group capacity plans for 2013

'Short-haul making a profit'

Ms Menne told analysts that, while in the past, the short-haul business was subsidised by long-haul, which it was there to feed, this is no longer the case: "Short-haul is now stabilised and is making a profit".

She also expressed confidence in the programme to transfer non-hub continental traffic to Germanwings, which is "going a little better than planned". Some German media coverage suggests that passenger acceptance of the changes has been mixed, but Ms Menne said it would inevitably take time for the market to adapt and that things were not as depicted in the media.

For the full year 2013, the Passenger Airline Group expects a "modest increase" in revenue and operating profit for 2013, "on the assumption that conditions remain the same". Profitability is only forecast to improve significantly at a later date, when SCORE and investments in the product have been completed.

Lufthansa Cargo expects demand to recover in second half

In 1Q2013, Lufthansa Cargo saw freight volumes fall by 7.2% year-on-year, but CTKs fell only by 5.9% due to changes in the route profile. ACTKs were down by 7.4% and cargo load factor improved by 1.1ppts. The fall in tonnage was steepest in the Asia-Pacific region, particularly in Japan and Southeast Asia, although major Chinese markets recovered slightly.

Load factor gains were seen in the Americas, in spite of falling volumes, and load factor grew more significantly in Europe, where capacity was cut sharply. Only in the Middle East/Africa was there an increase in freight volumes, although cargo load factor was down.

Lufthansa Cargo traffic and revenue by region: 1Q2013

Lufthansa Cargo expects demand to recover in 2H2013 and will retain a focus on managing capacity in line with demand to support load factors and yields. For the financial year 2013, Lufthansa Cargo plans flat capacity and expects an operating profit in the three-digit million euro range higher than last year's result.

MRO market is 'stable'

Lufthansa Technik says that the market for maintenance, repair and overhaul (MRO) services was stable in 1Q2013, but it faces the key challenges of financial and earnings situation of the airline industry and the global expansion of MRO capacities in a consolidating market, including both measures across the group and specific activities in the areas of engines and components. Thanks to efficiency and productivity programmes as part of the group-wide SCORE programme, the 1Q2013 result improved by EUR16 million, although revenue fell slightly.

Lufthansa Technik signed 76 new contracts in the quarter, with a sales value of EUR169 million for 2013. These included a contract to overhaul thrust reversers for Etihad for the next 11 years, a contract with Airbus for the repair of 12 Qantas A380s in Manila and a five-year component supply contract with Russian carrier Rossiya Airlines for up to 25 A320s.

An agreement was also reached with Germanwings on technical support for the aircraft transferred from Lufthansa. Lufthansa Technik expects a moderate increase in revenue and stable earnings in 2013, "subject to the fundamental condition of a stable development of the airline industry".

LSG SkyChefs now 'an important part of the Lufthansa Group'

LSG SkyChefs signed a number of new customer contracts and renewed contracts with existing customers, including Emirates, United/Continental, Jet Airways, TAP and Transaero. It also benefited from the growth of existing customers, such as Etihad in Washington and Sao Paulo and American Airlines in Duesseldorf and Seoul.

Initiatives to increase productivity in the core functions of purchasing, product development, production and sales are on-going. The Catering segment now expects full year 2013 revenue to be on par with last year, but that the operating result will increase.

Lufthansa CFO Simone Menne said: "Catering is and remains an important part of the Lufthansa Group… We are confident that we can continue to develop LSG SkyChefs without a partner".

This appears to remove the 'For Sale' sign that has been hanging over the segment for some years. Moreover, Ms Menne hinted that LSG SkyChefs may even be in the market for acquisitions, evaluating a possibility in Africa, "but nothing major".

Group operating result still expected to improve in 2013, but that is just the start

For the full year 2013, the Lufthansa Group still expects revenue to be up on 2012 and an operating result higher than the EUR524 million reported in 2012, with the airlines (the Passenger Airline Group and Lufthansa Cargo) generating the bulk of the operating result. It cautions that "especially as exchange rates remain highly volatile, the forecast is still subject to great uncertainty. In addition to general market trends, the ability to implement the restructuring of the Company promptly by means of the SCORE programme will be decisive".

The group also acknowledges the gap between current levels of profitability and that targeted for 2015, noting that this year "is the year in which we want to show that we are capable of implementing our ambitious plans. We intend to reach an entirely new level of profitability by 2015 with an operating profit of EUR2.3 billion."

Just maintaining the same first quarter loss as last year has been an impressive achievement, but at least Lufthansa has kept all its balls in the air. Reaching the 2015 target will be the airline management equivalent of the juggler who adds knives and flaming torches to the spectacle.