German flag carrier Lufthansa needs to further rein in its costs or sell assets to catch up with peers in terms of valuation. Lufthansa has already postponed some spending, is cutting costs at its passenger airlines, and skipped its 2009 dividend. Still, earnings at its core airlines business are set to take another hit this year from losses at carriers it has bought.
Chief Executive Wolfgang Mayrhuber last year completed a shopping spree adding Brussels Airlines, Austrian Airlines and bmi to his stable of carriers to battle Air France-KLM and British Airways for European pole position.
Austrian Airlines and bmi had a combined 2009 operating loss of 109 million euros, and neither expects to make money in 2010. Lufthansa's ratio of enterprise value (EV) to earnings before interest, tax, depreciation and amortisation (EBITDA) is at 4.7, below Air France's 6.3 and BA's 9.1, according to Reuters data.
All three airlines have improved their EV to EBITDA valuations from between 2.1 and 3.1 since 2008, but Lufthansa's peers climbed more quickly than the German flagship carrier.
"Deutsche Lufthansa continues to look cheaper than peers," Deutsche bank analysts said. "This is despite Lufthansa having a stronger balance sheet than peers and having historically achieved higher ROCE (return on capital employed)." Lacking positive catalysts, such as British Airways' $8 billion merger deal with Iberia signed on April 8, Lufthansa's share price has edged up only 6.8 percent so far this year, compared with 8.2 percent for Air France and 22 percent for BA.
"Lufthansa has to cut its costs further, and its capex. But that's difficult because Lufthansa lives from its image of high quality," said UniCredit credit analyst Carmen Hummel.
"Lufthansa has to stop making acquisitions. It has to decide to spend zero euros. And then it would have to say that it might sell some assets," she said. Lufthansa is still seen as one of the world's financially strongest airlines, with an investment grade credit rating at Standard & Poor's. S&P cut its rating on Lufthansa to "BBB-" in August, one notch above junk.
Among the few other carriers that are rated as strong or stronger than Lufthansa are Australia's Qantas and US-based Southwest Airlines.
But Lufthansa's acquisitions and fallout from the global economic crisis already cost it its investment grade credit rating at Moody's last year, leaving the airline with a split rating - one major agency's stance is at investment grade and the other at junk. Analysts say Standard & Poor's is likely to fall in line in the second half of this year as competition among European airlines remains fierce and yields stay stubbornly weak. "If there's an alignment it will likely be downward by S&P for the time being," said LBBW analyst Per-Ola Hellgren.
Airlines face an uphill battle to fix their finances and turn a profit as they struggle with a toxic mixture of soaring fuel costs, increasingly price-sensitive customers and shrinking corporate and private travel budgets.
Lufthansa's capital expenditure (capex) rose almost 12 percent to 2.4 billion euros in 2009, when it posted a 112 million euro full-year net loss. The world's airlines lost about $9.4 billion last year as customers curbed spending during the recession, according to the International Air Transport Association (IATA).
IATA said they stand to lose another $2.8 billion this year on fallout from the downturn - even before a volcanic ash cloud over Europe cost them $1.7 billion in revenue.
Lufthansa has estimated it will take a hit of nearly 200 million euros from the ash cloud. Lufthansa has yet to reveal its strategy for bmi and has said it will hold off any decision on the matter until the carrier returns to profitability in 2012. Analysts say Lufthansa could sell bmi's regional carrier or low-cost unit bmibaby.
Lufthansa could also issue new shares, although shareholders will not want to see prospects for future dividends diluted. "The arrival of the Icelandic ash cloud, together with economic instability in Greece, has brought the potential rights issue back onto the agenda," said Royal Bank of Scotland analyst Andrew Lobbenberg.
For now, analysts are keeping faith in the German carrier, with some putting a positive spin on its cheap valuation. Almost 60 percent of analysts covering Lufthansa recommend that investors buy the carrier's stock, according to Thomson Reuters StarMine.
"It can only get better," Commerzbank said in its preview of Lufthansa's earnings, which are due on May 5, an occasion when the company may comment on the rights issue speculation.
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