Deutsche Lufthansa AG (LHA) Earnings Call Transcript & Summary

Hello and welcome to the Deutsche Bank Deposit Receipts Virtual Investor Conference, DBVIC. I'm pleased to announce that our next presentation will be from Deutsche Lufthansa from Germany. Before we go to our speaker, a few points to note. Please submit your questions in the questions box to the left of the slides. Once the Q&A session is ended, don't log out. You'll be automatically transferred to the Deutsche Lufthansa booth, where you can continue to ask questions via chat and access shareholder materials. On a final note, all today's presentation is recorded and can be accessed via the Deutsche Bank website, adr.db.com. At this point, I'm very pleased to welcome Shreya Parmar, Investor Relations Manager from Deutsche Lufthansa, which trades on the [indiscernible] under the symbol LHA, and in the U.S. on the OTCQX market as DLAKY. Over to you, Shreya.

Hi, [indiscernible]. Thanks for introducing me. Hello, everybody. Good afternoon, good morning, wherever you're located. My name is Shreya, I am an Investor Relations Manager at Lufthansa Group. I've been in the position 2 years, and I'm quite happy to now present the group to you. So to just set you up for the rest of the presentation, I'll begin with portfolio and strategy of Lufthansa Group to explain a bit about the business segments that we have, and then dive into the industry trends that we see at the moment. Then I'll follow up with our results from third quarter and the financial outlook for the coming months, and leave it to Q&A towards the end of it. So we will start now with the portfolio and strategy here. So the Lufthansa Group is an aviation company with operations worldwide. It plays a leading role in its European home market with about 108,000 employees located in over 90 countries. The group generated revenue of about EUR 16 billion in the financial year 2021, and most recently, generated EUR 1.1 billion in adjusted EBIT in the third quarter. The group is composed of the segment's Passenger Airlines and the Aviation Services. Aviation Services particularly include Logistics, MRO and Catering segments. The group also includes additional business and group functions, which are so -- it's the name sake. This business segment includes, in particular, Lufthansa AirPlus, Lufthansa Aviation Training and Lufthansa Systems. We have been evaluating potential asset divestitures, and I would like to emphasize that our recent success in deleveraging and strengthening the balance sheet does not change our view on these asset divestitures. The decision to divest, for example, AirPlus and the remaining part of the Catering business around LSG was made based on strategic considerations. So the sales processes continue as planned in both cases. The same is true for Lufthansa Technik, where we prepare for a partial divestiture or a partial IPO in 2023. Moving on to the Airline segment, the Passenger Airlines business segment comprises Lufthansa German Airlines, SWISS, Austrian Airlines, Eurowings, Edelweiss and Brussels Airlines. These airlines offer the customers a premium experience, and most essentially, the multi-hub strategy of its passengers a comprehensive route network, along with the greatest possible flexibility for their journey. Lufthansa German Airlines also includes regional airlines, Lufthansa CityLine and Air Dolomiti as well as Eurowings Discover. Eurowings Discover is the new holiday airlines from the Lufthansa Group, which started operations in July 2021 and focuses on the touristic segment. Eurowings focus on short-haul traffic in European point-to-point traffic. And that's essentially how Lufthansa Group Passenger Airlines is set up to cover all relevant market segments. Moving on to Cargo. With the turnover of about EUR 4 billion and the transport performance of 7.2 billion freight time kilometers in 2021, Lufthansa Cargo is one of the world's leading companies in transport of air freight. The company currently employs around 4,000 people worldwide, and its focus is on the airport-to-airport business. The world network covers around 300 destinations in more than 100 countries using both freighter aircraft and cargo capacity from passenger aircraft operated by Lufthansa, Austrian Airlines, Brussels Airlines, Eurowings Discover and SunExpress, as well as [ trucks ]. And the majority of the Cargo business is handled via our factory Airport. Lufthansa Technik is the world's leading independent provider of maintenance, repair and overhaul services for commercial aircraft. So Lufthansa Technik serves more than 800 customers worldwide, including OEMs, aircraft leasing companies and operators of VIP jets, as well as airlines holding international licenses for maintenance, design and production. Lufthansa Technik provides tailored maintenance programs, modification, completion and conversion, as well as carbon products, material pooling or engine services, including digital fleet support. So I'll now jump into the current industry as we see it. Having already returned to profitability in the past quarter, we now aim to further increase our earnings power and generate sustainably higher cash flows and the signs that we see are good for this because global aviation will not return to the overcapacities we witnessed in pre-pandemic times anytime soon because capacity deployment will be limited by several factors. First factor is that like any other industry, our industry is affected by global supply chain bottlenecks too. We're seeing semiconductors or various other components and parts cause massive delays in the delivery of new aircraft, as well as repairs and overhauls. To name one example, it was currently nearly impossible to obtain cockpit windows for the Boeing 787 and other aircraft types because of supplier insolvencies and shortages of both staff and materials. Secondly, the industry-wide personnel shortages of the past summer have not yet been fully overcome across the entire value chain. The many still unfilled vacancies at airports, ground service providers and security organizations continue to limit any capacity expansion. And last but not least, the high cost of fees, materials and fuel raised the hurdle for additional capacity deployment to be profitable, preventing expansion as well. Against these limitations on the supply side, several factors continue to support demand. Business travel, for instance, continues to recover for us to some 70% of precrisis levels in terms of revenues as seen in Q3 2022. When it comes to visiting friends and relatives, or the VFR traffic and leisure traffic, one summer was not enough to delete all the demand, which is built during the pandemic. For many people, travel has obviously become more important in their hierarchy of needs, especially in the U.S., our distribution partners report high levels of demand for travel to Europe, also in the next few months and quarters. We also see further potential beyond our home markets. Asia hasn't been a factor in the recovery of our industry yet. With the opening of Japan, traditionally, our high-yielding market, this is changing now. Travel restrictions are also being lifted in Hong Kong, and most recently, in China, as announced last week. And there is reason to be confident that this could also serve as a blueprint for Mainland China in terms of how we see demand pick up from opening of Asian markets. In some -- supply chain constraints in our industry will limit the addition of capacity and global aviation in the years to come. And at the same time, the post-pandemic recovery is far from being over, structurally supporting demand even in economically more challenging times. Moving on to our sustainability targets. We want to be a leader in our industry when it comes to climate protection. That is why we have set ourselves very ambitious goals. By 2030, the Lufthansa Group wants to have its net carbon emissions compared with 2019. And by 2050, we want to operate completely carbon-neutral. In this context, the most important levers for us to improve our carbon footprint are an accelerated fleet modernization, sustainable aviation tools and the optimization of flight operations. Our clearly defined reduction part is now also being validated by the science-based targets initiative, or the SBTI, and we were the first aviation group in Europe to receive this validation. A carbon reduction target has thus been scientifically validated as being in line with targets of the Paris Climate Agreement of 2015. The unit of measurement for SBTI is carbon intensity, which means carbon emissions for payload carried. And this -- it's a very technically formulated category, which not only includes freight, but also passengers. And according to SBTI criteria, the Lufthansa Group will reduce its carbon intensity by more than 30% by 2030 compared to 2019, convert it into absolute carbon reductions. This value corresponds to 18% less carbon emissions by 2030. And we will achieve the remaining 32 percentage points towards our self-imposed target of 50% less carbon emissions through voluntary compensation measures. I now jump into the results and outlook section of the presentation. Our Q3 results are indeed also do not show any signs of crisis anymore. In the third quarter, our adjusted EBIT amounted to more than EUR 1.1 billion, net income exceeded EUR 800 million and all business units contributed to the positive result, justifying to the strength of our portfolio. And importantly, we generated a positive free cash flow of EUR 410 million despite a EUR 1.1 billion cash flow related to seasonality of customer bookings. As a result, we continue to deleverage and we strengthened equity. Now let me present you the results of the different parts of our business in more detail. The Passenger Airlines offered 78% of precrisis capacity in the third quarter, with short haul being back to almost 90% and long haul to 70% of 2019 levels. Total capacity offered was lower compared to original plans because of flight cancellations in response to the significant system-wide operational disruption in June and July, which eased significantly for the further course of the quarter. However, the additional buffers we created to stabilize operations and about EUR 239 million of irregularity costs. This means that customer compensation payments and cost of care expenses, they were a drag on unit costs, which were 9.5% higher than in 2019, excluding currency effects. Some of the irregularity costs also related to the strikes of Lufthansa Ground and cockpit personnel, which had an overall profit impact of around EUR 17 million when also considering the lost revenues. In addition, maintenance expenses increased due to the reactivation of additional parts of our fleet. Higher costs, however, were more than offset by better revenues, the huge demand, especially from leisure travelers, limited capacity and passing on of higher fuel costs resulted in higher yields and load factors. As a result, yields were 22.5% above precrisis levels and loads were almost as high as in 2019. Once more, the Transatlantic stood out with strong U.S.-based premium leisure demand being a key driver. By airline, SWISS and Austrian Airlines outperformed with operating margins of 15%, 16%, respectively, with Austrian even generating a record operating profit of EUR 110 million in the third quarter. In total, adjusted EBIT in the Passenger Airlines business amounted to EUR 709 million. Turning to our Aviation Services. Profits in our logistics business exceeded the prior year record level amounting to EUR 331 million. Despite the easing of disruptions in ocean shipping, which had been a big driver of demand in prior quarters, yields continue to be up more than 20% on the prior year. Compared to precrisis levels, they were more than twice as high in the third quarter. Ongoing supply constraints, especially on the Europe-Asia trade lane contributed to this. In addition, companies are focusing on making sure that they have enough inventory in light of the still mindful risks to supply chains. Lufthansa Technik continued to take advantage of the global recovery in air travel and the resulting strong demand for MRO services, which allowed passing through cost inflation in materials and labor to customers. The strong U.S. dollar also supported earnings, which reached EUR 177 million. This was the highest adjusted EBIT in the business ever achieved in the third quarter. The Catering business and -- the Catering business around LSG benefited from its large footprint in the Americas, where business has picked up far more significantly than in Asia. Only the grants under the U.S. Cares Act included in the prior year base meant that the adjusted EBIT was down year-on-year amounting to EUR 6 million. And finally, the results of the other businesses and group functions was minus EUR 69 million below the prior year level because of the end of short-term work benefits, which were still included in the last year's results. On the balance sheet, well, net debt declined to EUR 6.2 billion, EUR 2.8 billion below the level at year-end 2021 as you see on the slide. Our net debt is fixed rate financed at less than 3% per year, with an average maturity of approximately 5 years, and considering current liquidity of EUR 11.8 billion. And our expectations for cash generation also going forward, our refinancing needs are, hence, very limited. The net pension obligation decreased by EUR 4.5 billion to EUR 2.1 billion in the first 9 months of the year because of the increase in the discount rate to now 3.8%. As a result, financial leverage, measured as net financial debt plus net pension obligations over adjusted EBITDA, is down to 2.5% based on results in the first 9 months, demonstrating the progress made towards our goal of regaining an investment grade rating by 2024, which is also part of our midterm targets. Shareholder equity increased to EUR 9.2 billion, with equity in relation to the sum of total equity plus net debt, now amounting to 52%. I will finish with our financial outlook for the rest of the year. We intend to operate around 80% of precrisis capacity in Q4. The average capacity operated by our airlines in the full year will be close to 75% of 2019. Assuming no currently unforeseen deterioration in the operating environment, such as a revival of pandemic-related travel restrictions and escalation of the Ukraine war or events of a similar magnitude, we are confident to generate an adjusted EBIT of more than EUR 1 billion for the full year 2022. This is based on the positive development in the third quarter, record results from Lufthansa Cargo and Lufthansa Technik, as well as the current booking situation. Adjusted free cash flow is expected to reach more than EUR 2 billion with the exact outcome dependent on booking levels at our year-end. With these results, we are on track for the achievement of our 2024 targets, which are -- an adjusted EBIT margin of more than 8% and a capital return of more than 10%, pending formal 2023 guidance, which we intend to publish in March next year. We expect further progress in 2023, meaning a further increase of profits compared to the current year level. And with this, I'll end the short presentation, and move into Q&A.

Okay. So the question is, how have you been impacted by rising fuel cost? And are you seeing a rebound in business travel demand? I'll begin with the second part of the question first, which is rebound in business travel demand. We have seen it pick up quite strongly. Of course, there is still a lot of duty of care in place. And in terms of Lufthansa Group's performance of business travel demand, we've seen it return to about 60% by end of Q3 in terms of revenue. This is 60% compared to 2019 levels. And for the full year, we expect -- or by the end of the year, we expect it to reach around 70% for 2022 and also expect it to be higher next year. But that we'll have to see much closer to the month of next year because it's still very short-term booking windows. So that shift in booking behavior has not shifted yet in terms of business travel demand, which is what we have to monitor much closely then. And rising fuel costs, of course, we were quite impacted by it. But of course -- but not to a very great extent because of our hedging full hedging in place. And also we managed to pass on this increasing fuel cost on to our customers through increasing prices and channeling the booking classes on our booking platforms. So that's a short answer to your question. Next one is, can you speak to labor relations with pilots and flight attendants? Yes, of course, we've concluded some very important agreements with the unions, with the pilots, which is the pilot union being the [indiscernible] cockpit. We've recently concluded an agreement, which runs until June 2023. And with a no strike action until then, and the condition is such that it's a fixed salary increase of about EUR 500 in 2 steps in August of this year and in April of the next year. What this translates to is about 20% increase for somebody with the starting level salary and then about 5.5% for the top owners. And this agreement covers 5,500 pilots at the German mainline and cargo, and this -- the personnel costs of about EUR 1.1 billion per annum. And with the flight attendants, that's also we've recently concluded an agreement as well a couple of weeks ago with covering about 19,000 flight personnel. And then we also have an agreement with ver.di, which is the ground personnel, and this is an 18-month agreement with fixed in percent rate, salary increases in 3 steps, mainly benefiting the lower income levels to help them cope with high inflation. And this covers about 20,000 ground staff in Germany with the personnel cost of about EUR 1.2 billion per annum. The next question is, what does Lufthansa do to cut carbon emissions over the next 10 years? Well, so we've always been at the forefront of innovation and sustainability. And our key drivers for emission reduction are fleet renewal and then sustainable aviation fuels. The third one is operation and air traffic management efficiency. And then lastly, compensation and offsetting. So with fleet renewal, we expect to, for example, in terms of just achieving 50% less carbon reduction by 2030. We expect 10 to 15 percentage points to come from fleet renewal. That makes it our most important level to cut carbon emissions. And then from sustainable aviation fuels, we expect about 5% to 10%. And from operation air traffic management efficiency, another 5% to 10% and the remaining from compensation offsetting. When it comes to fleet renewal, our technology is by far the greatest driver for a more climate-friendly aviation industry, and technological innovation is part of our DNA. So overall, the group continues to modernize its fleet and increase the share of new generation eco-efficient aircraft in its fleet to over 50% by 2032, so over the next 10 years. And at the same time, we also plan to retire no less denying -- less efficient sub fleets. So just a snapshot of the last year in 2021, we put 13 new aircraft into service in addition to 2 used ones, and including Airbus A220-300, A321neo and Boeing 777F, which are equipped with modern engines, and a total of 55 older aircraft left the group fleet in 2021. So fleet definitely is our most important lever, and we currently also monitor innovation-related technology developments and their implications for the group's strategy and operations. However, at this stage, we do not forecast new models of propulsion, so to speak, to play a meaningful role when it comes to commercial flights with more than 100 passengers, for example, at least in the next 15 years. And then in terms of SAF, which is also going to play a key role to reduce our carbon emissions. The sustainable aviation fuel has been deeply prioritized, and we have several partnerships with producers and key technology providers. Currently, the focus is on advanced biofuels and power to liquid processes and even solar fuels. So we have exclusive SAF agreements. And to ensure the long-term supply of sustainable aviation fuel for the Lufthansa Group, the company has made an issue commitment to purchase SAF to around USD 250 million by 2024, and this is in the spot market. So I think I'll take the last question. Can you speak to a projected passenger travel and cargo demand for 2023? So for 2023, we expect corporates to reach about around close to 80% and then leisure should be around 90% of 2019 levels. And by 2023, we -- and these are IATA projections. We already expect it to be more than 2019 levels and cargo demand for 2023. Well, there's multiple factors in place. So it's a cyclical business. And it's -- what's definitely going to affect the market more than demand is going to be the supply side of things, which is where with more airlines being reactivated and coming back into the market, the belly capacity is going to come back. So the supply would be the more key thing to focus in terms of cargo market for 2023. And I think that was the last question. So I'll close it at that. Thank you for dialing in and listening. And of course, if you have more questions, so if you feel like something was left unaddressed, please feel free to write us an e-mail at [email protected] and happy to speak with you one-on-one and have a nice rest of your week.