Lufthansa: German Taxpayer Will Save The Day
- With only €4.3 billion in cash reserves at the end of March, Lufthansa was not prepared for the current crisis.
- The airline is in dire need of cash and it will likely strike a €10 billion deal with the German government.
- However, the terms of that deal will slow down the company’s growth in the long-term.
- We expect the stock to trade sidelines for years and see no real catalyst that could push it considerably higher in the next 12 to 18 months.
- No position.
Two weeks ago Lufthansa (OTCQX:DLAKF) reported its preliminary results for Q1 and stated that in March alone revenues were down 47% to €1.4B. With 99% of its fleet on the ground, the German carrier faces an unprecedented situation that has never happened to it in the past. The global pandemic that has swept throughout Europe in the last two months, forced the air traffic to go down to unprecedentedly low levels in the region. Currently, Lufthansa faces a liquidity crisis, as every hour it loses around €1 million and at the current burn rate, it will not have any resources to stay afloat if it stays non-operational for any longer. With only €4.3 billion in cash reserves at the end of March, Lufthansa was not prepared for such a severe situation and without state aid, it will not be able to weather the current storm.
Various reports suggest that the German government will bail out the company and provide €10 billion in state aid, but in exchange, it wants to receive a 25% stake in the airline. Such terms, on the one hand, will save the company from bankruptcy, but on the other hand, will expose Lufthansa to political headwinds and increase the already high debt burden. Even though the company trades at a P/E of ~4x, it's not undervalued. And while it's more than likely that German taxpayers will save the company from going broke, the government's equity stake will slow down the growth in the long run. Considering this, we decided not to short Lufthansa, as it'll be foolish to bet against the state, but at the same time, we didn't acquire its shares, as the future looks bleak despite the upcoming relief package.
Brave New World
Problems at Lufthansa started long before COVID-19, as the airline has been struggling for years to create value. Since the beginning of 2018, the company's stock price has been constantly declining and profits were shrinking. To improve the situation, in December it was announced that Lufthansa will become a holding company and give more autonomy to its subsidiaries like Eurowings, Brussels Airlines, Lufthansa Technic, and others. The goal of this move was to rebuild the airline from below by restructuring its subsidiaries one by one and thereby improving the overall performance. However, while Lufthansa was working on the details of this reorganization, the global pandemic hit Europe hard at the beginning of March and didn't leave any time for Lufthansa to prepare for the upcoming storm. As Italy became the epicenter of the spread of COVID-19 at the beginning of March, EU countries one by one started to restrict air travel. At the beginning of April, Europe's air traffic already was down 95% and it continues to be this low to this day.
At the end of March, Lufthansa had only around €4.3 billion in liquidity and at first, it was looking to borrow money from the markets. However, the situation quickly deteriorated. While US airlines were able to receive additional funds in a form of grants and deferred low-interest-rate loans under the CARES Act, Lufthansa was not able to strike any deal with the German government yet. However, a €10 billion in state aid is likely to be approved in the coming days.
The only good thing is that Lufthansa is not the only one that faces this situation. Every airline around the globe greatly suffered and continues to suffer in one way or another. While the comparison table below clearly shows that Lufthansa in undervalued to its peers since its valuation multiples are lower than the industry's median, those numbers right now are meaningless. Nobody knows how things will play out in a week or a month from now.
Source: Capital IQ
There's no denying that Lufthansa will be bailed out by German taxpayers. However, countless risks make it harder for us to justify a long position in the company. At the same time shorting doesn't make sense at all, since betting against the state is a foolish thing to do, especially if it's Germany, which is one of the most advanced economies in the world. We view the chances of the deal not happening to be very low. Lufthansa already had the German government as its shareholder a few decades ago, so a 25% stake in the company should not be seen as something extraordinary. However, new problems will erupt after the deal is signed.
First of all, Lufthansa will be exposed to political risks and headwinds. In addition to its private shareholders, it will need to take the view of the state on corporate governance into an account. Germany has been vocal in fighting climate change in the last few years and is about to increase the climate tax on airlines. The upcoming bailout deal will likely include the improvement of the company's environmental policy. Austria already said that it will help Austrian Airlines with resources, but the airline will need to dramatically cut its carbon footprint in the foreseeable future. The same could be done to Lufthansa. While on the one hand, it's good for society as a whole, but on the other hand, Lufthansa will have a hard time implementing those requirements, if the air travel industry will not recover soon.
Lufthansa already has a poor balance sheet. We don't know how many euros were burned since April, but the figure is going to be staggering. While the relief package will ease the situation, it will broaden Lufthansa's debt burden. The company's interest rate coverage is already at 3% and the state aid will come not only in a form of a grant but also in a form of a loan too, although the rate at this moment is unknown. The decision not to issue any dividends for the time being and borrow and additional debt on its unencumbered aircraft clearly shows that Lufthansa is in a desperate situation and it needs to save every euro it has to live to fight another day.
In addition to political and financial factors, the market environment will also decide how Lufthansa will perform in the upcoming months. While lockdowns all around Europe are beginning to ease, the air travel industry will not be able to recover to its pre-COVID-19 days sometime soon. The reality is that there's too much uncertainty at this point and buying any airline is a risky endeavor, even if the government is involved. We expect the stock to trade sidelines for years and see no real catalyst that could push it considerably higher in the next 12 to 18 months. No position.
The bottom line on Lufthansa:
- Lufthansa was not prepared for the global pandemic and it had only €4.3 billion in cash reserves at the end of March.
- Every hour, the airline loses €1 million and it will require additional assistance form the German government to stay alive and live to fight another day.
- While the German taxpayer will likely save the day, Lufthansa will not be able to show considerable growth in the next 12 to 18 months.
- Currently, there's too much uncertainty in the air and that's why we believe that Lufthansa's stock will trade sidelines in the foreseeable future.
- We have no position in Lufthansa.
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