Lufthansa earnings fall 27% as outlook deteriorates further

Lufthansa Group's 3Q2011 operating result fell 27% to a relatively strong EUR575 million, with group earnings driven largely by SWISS, Lufthansa Passenger Airlines and its MRO businesses, which proved sufficient to offset losses at the bmi, Austrian Airlines and Germanwings units. The fall was due to an unfortunate combination of factors, with consumer and business confidence falling sharply and fuel costs remaining stubbornly high, squeezing the group. "Fears of a recession and concerns about the effects of the debt crises in Europe and the US have already had a clear effect," CEO Christoph Franz said.

Lufthansa has pinned its hopes on a sale of bmi - whose competitive position and losses deteriorated even further in the third quarter - further and more drastic short-term capacity cuts and a possible sale of multiple non-strategic investments.

The EUR575 million operating result from the third quarter, seasonally the group's strongest, pushes the group back into the black for the nine months to 30-Sep-2011, with a EUR578 million operating profit.

"The third quarter was characterised by wide swings in earnings developments," the group said. "At the same time the booking prospects for the months ahead have deteriorated substantially." These trends prompted the executive board to adjust the earnings outlook for the full year back in September and to take opposing action.

Despite an expected revenue increase for the full-year, the board warned that the group will no longer increase the year-on-year operating result. It expects an operating profit in the "upper three-digit million euro range". Such vague guidance captures the mood in Europe accurately: despite only two remaining months until the group's full-year results are known, extreme volatility in markets and in booking indicators are making it impossible to give more precise guidance.

Group revenue up 7% in 3Q2011

Group revenue increased 6.7% to EUR8.1 billion in the third quarter, driven solely by traffic (passenger and cargo) revenue, as revenue from IT, catering, MRO and other services fell slightly. Passenger revenue accounts for 85% of total revenue.

The key Passenger Airline Group segment increased revenue by 9.7% to EUR6.5 billion, on the back of a 4.9% increase in passenger numbers to 30.5 million, reflecting the steadily improving yield environment and the group's yield-supportive measures such as fuel surcharges and air traffic taxes.

Lufthansa Group third quarter total revenue: 3Q2008 to 3Q2011

Source: CAPA - Centre for Aviation & company reports

Lufthansa provides the following graph, which shows YTD revenue relative to previous years.

Total revenue (EUR millions): Jan-Sep-2007 to 2011

Source: Lufthansa

While revenue has been on a steady increase in recent years, often growing at a faster clip than passenger numbers, the cost side has shown interesting changes.

Cost increases outpace revenue gains, hurting results

Lufthansa's poorer year-on-year result is due entirely to ballooning costs, which have been on the rise despite the deteriorating macroeconomic outlook, meaning the cost base has swelled at a time when Lufthansa can least afford it. Total operating costs in the third quarter increased 10.5% to EUR7.5 billion, led, unsurprisingly, by "materials and services", or fuel, expenses. Materials (chiefly fuel) expenses increased 10.1% to EUR4.6 billion. Staff costs were unchanged despite an increase in staff headcount.

Lufthansa Group total operating costs: 3Q2008 to 3Q2011

Source: CAPA - Centre for Aviation & company reports

Lufthansa a strong contributor to earnings

As a whole, the earnings position of the passenger business deteriorated over the course of the third quarter, delivering a weaker year-on-year result. Difficulties in the key foreign markets of Japan, North Africa and the Middle East were compounded in the third quarter by growing fears of a global recession. Persistently high oil prices and the German air traffic tax in Germany and Austria also inflated the cost base, Lufthansa stated. In the quarter these developments led to wide fluctuations in results, as forward bookings declined considerably at the same time.

Lufthansa Passenger Airlines, the group's largest single business unit, delivered a weaker year-on-year performance, with operating income down EUR100 million, or 27%, to EUR261 million.

Passenger numbers increased 12.1% to 49.4 million in the nine months to 30-Sep-2011, while load factors fell 2.1 ppts to 77.8%. Yields, including fuel surcharges and air traffic taxes, increased 4.2% in the nine-month period. Total revenue increased 14.2% to EUR11.7 billion. Lufthansa Passenger Airlines' operating costs increased by EUR1.3 billion, lead by fuel, which increased EUR567 million year-on-year, and higher fees and charges, which increased EUR418 million.

In response to worsening economic conditions, Lufthansa Passenger Airlines CEO Carsten Spohr has announced plans to reduce winter capacity growth from 12% to 4% by delaying new route launches, reducing frequencies and using smaller aircraft. Part of this capacity reduction includes the shut down of Milan Malpensa-based subsidiary Lufthansa Italia on 31-Oct-2011, the end of the summer timetable.

The airline also plans to decommission 38 older aircraft, which, after the delivery of new, more fuel-efficient and less maintenance-intensive aircraft, will result in a net reduction of six aircraft. Lufthansa Passenger Airlines has taken a knife to capacity expansion plans, with plans to reduce capacity expansion from 12% to 3% in 2012. The airline said it continues to monitor developments with a view to making further adjustments. Lufthansa Passenger Airlines is not expected to improve on FY2010's operating result in FY2011, despite sharp revenue increases.

SWISS delivers another strong result

SWISS continues to be the strongest business in the group, delivering another solid performance. In the nine months to 30-Sep, SWISS recorded a 15.7% increase in revenue to EUR2.96 billion, outpacing the 14.9% implied increase in operating costs to EUR2.71 billion. The airline's operating profit in the nine-month period increased 25.8% to EUR240 million, making it the largest single contributor to the group's operating result (Lufthansa Passenger Airlines generated EUR161 million in the nine-month period).

The Zurich-based airline also enjoyed a relatively strong third quarter. Implied revenue growth was 11.7% to EUR1.1 billion, slightly outpaced by operating costs, which were up 13.7% at 947 million. The operating result was unchanged at EUR140 million for the third quarter.

SWISS' nine-month result was in line with expectations, the group said, with a strong performance from the airline in the summer months compensating for various adverse affects, including the strong Swiss franc. Lufthansa Group warned of yield pressure, however, due to strong capacity deployment by international carriers in Switzerland, seeking to take advantage of the strong local currency and relative economic strength.

Passenger traffic increased 9.4% in the nine-months to 12.4 million, while loads are down slightly, falling 0.8 ppts to 81.5%. Lufthansa expects SWISS to deliver a full-year result "similar" to FY2010's, which, when considering SWISS' operating result at the end of the third quarter was up 25.8% year-on-year, indicates a particularly poor outlook for the current quarter.

Austrian in the black in 3Q, narrows YTD loss

Austrian Airlines continues to improve its performance, narrowing the losses in the nine-months to 30-Sep-2011 despite flat revenue growth, reflecting the hard work done to reign in costs. Revenue increased only 0.7% in the period to EUR1.55 billion as the airline put a break on capacity growth due to skittishness in troubled North African and Middle East markets, where Austrian has a significant capacity deployed. Passenger numbers are up 2.5% to 8.6 million, while the workforce has fallen 3.2% to 6836. Operating costs were unchanged in the period while output was increased, which allowed a 27.7% improvement in the operating result, to EUR-34 million.

The airline finished the third quarter in the black at the operating level, with an implied profit of EUR30 million, a 30.4% increase. Revenue increased 4.5% in the period to EUR600 million and operating costs increased 3.4% to EUR570 million.

Lufthansa stated that it does not expect Austrian airline to finish the year with an operating profit, although a stronger year-on-year result is still expected.

In the third quarter the Lufthansa Group reiterated its support for Austrian Airlines amid the group's talk about potential assets sales, which struggling bmi put up for sale. Lufthansa's restructuring efforts have proved far more effective at Austrian than at bmi, with a notable turnaround in Austrian's year-on-year results, despite the more turbulent trading conditions in 2011. Board member and chief officer Stephan Lauer said that Lufthansa's appointment of former Star Alliance CEO and Austrian Airlines CEO demonstrates Lufthansa's commitment to the airline. The same cannot be said for bmi.

bmi losses worsen, with the airline to be sliced up and sold

bmi went in the opposite direction as Austrian in 3Q2011 and in the nine-months to 30-Sep-2011, providing further evidence that Lufthansa's efforts to turn the UK-based airline around have proved futile. Losses have swelled even further in 2011 due to an unfortunate combination of a slow UK economy, crises in key North African and Middle East markets and cost blowouts that are further crippling the economy. Lufthansa has admitted it is likely to slice up bmi and sell it off in parts in a bid to gain maximum value for the airline from interested parties, because as a whole, it has proved all but worthless.

In the nine-months to 30-Sep-2011, bmi has made an operating loss of EUR-129 million, an incredible feat for an airline that employees 3811 people (a 3.4% year-on-year increase) and carried 4.5 million passengers (7.4% fewer than the year-ago period). bmi's loss is equivalent to an operating loss of EUR34 per passenger carried. Revenue is down 5.5% to EUR658 million.

In the third quarter, implied revenue was EUR262 million, a 6% year-on-year fall, while the operating loss was EUR-34 million, in comparison with a profit in 3Q2010 of EUR14 million. Due to restructuring activities and no doubt helped along by lower output, third quarter costs fell 14% to EUR228 million.

Lufthansa said that it is "still vigorously pursuing its strategy of replacing loss-making routes", which so far has led to the closure of bases in Glasgow, Cardiff and Manchester, and a reorganisation of the network. Reflecting the ongoing difficulties in implementing turnaround initiatives, Lufthansa does not expect bmi to improve on FY2010's revenue result in FY2011. Losses are almost certain to worsen this year.

In a bid to stem losses, and reflecting Lufthansa's intentions to split bmi up into various parts, bmi is starting selling off its most prized asset: its Heathrow slot portfolio. The airline sold six slot pairs to British Airways, which were already leased to other carriers or couldn't be used profitably by bmi. On 28-Sep-2011, bmi confirmed it was in "advanced talks" with a Scotland-based group of investors, led by Graeme Ross and Ian Woodley (two founders of a regional airline bmi acquired in 1996), about the sale of bmi Regional, with Scotland possibly to see another carrier call the country home.

Germanwings struggles in the LCC sector

Germanwings, the group's LCC unit, like many LCCs in Germany, has had a particularly difficult year, and the third quarter was no different. Germanwings has reduced capacity this year due to the German government's introduction of an air travel tax, which disproportionately affects low-cost travel. As a result of capacity cuts, average yield and load factors have risen, Lufthansa noted.

In the nine months to 30-Sep-2011, revenue is up 9.1% to EUR530 million, although passenger numbers have fallen 2.8% to 5.8 million, reflecting the stronger pricing environment and fare increases passed through this year. The operating loss, however, has doubled to EUR-23 million, due to increasing costs of taxes and fuel.

In the third quarter, implied revenue increased 7.7% to EUR237 million while the operating profit fell to EUR23 million from EUR28 million. Operating costs increased 11.5% to EUR214 million.

Lufthansa stated that heightened cooperation with Lufthansa Passenger Airlines has made "a vital contribution" to Germanwings' revenue increase. This cooperation includes the LCC using Lufthansa's Miles & More frequent flyer programme and presence on GDS', which allows improved connectivity between the two brands.

Revenue at Germanwings is expected to improve year-on-year, although the operating result is expected to worsen as there appears to be no respite in costs and competition remains intense, Lufthansa said.

SWISS on top

Swiss remains the most profitable airline in the Lufthansa Group, with an operating margin of 8.3%. Lufthansa is the only other profitable airline in the group.

Revenue and operating result (in EUR million) and operating margin for Lufthansa, SWISS, Austria bmi and Germanwings: nine months to 30-Sep-2011

Source: CAPA - Centre for Aviation & Lufthansa Group

While hope remains for Austrian and Germanwings, it is clear how poor bmi's performance has been. The UK carrier's operating margin is a miserable -23.4%.

Slower growth ahead

Due to the weaker year-on-year performances from most parts of the group in the third quarter and persisting economic uncertainty in key markets, Lufthansa is once again tempering growth plans. While the airline is not expecting a "double dip" scenario, the forward bookings profile is displeasing and Lufthansa is scaling back growth plans accordingly.

The most significant downward revision was made to 2012's capacity growth plans, which have been cut from 9% to just 3%. bmi is no longer the only unit up for sale, with CEO Christoph Franz confirming the airline is considering disposing of multiple "non-strategic investments" and analysing the profitability of these companies. Jade Cargo International, a cargo JV with Shenzhen Airlines, and Lufthansa Systems are two units being considered for sale. Mr Franz said in Sep-2011 that the group is also looking at selling its minority stake in New York JFK-based JetBlue due to that unit's diminishing strategic value.

Further capacity cuts have already been confirmed for the winter period, which CAPA looked at in Sep-2011.

See related article: German airlines adjust strategies as outlook darkens

In positive news, CFO Stephan Gemkow said the group is considering "multiple bids" for its bmi subsidiary, stating it could finalise a sale by year-end. CFO Stephan Gemkow confirmed the carrier is "in talks with potential buyers and we have made a lot of progress". "We would like to sell bmi as part of a share deal, as part of an overall sale," Mr Gemkow said. "But several options and variants are on the table and various parts should come together for us to achieve the best result for us and for bmi."

Lufthansa's executive board has revised downward its earnings forecast for the current financial year (joining a raft of airlines), with the group now expecting an operating profit "at the upper end of its three-digit million Euro range". Lufthansa made EUR876 million at the operating level in FY2010. The board said its previous guidance of a year-on-year increase in operating profit "no longer appears to be achievable".