Lufthansa Stock: Balance Sheet Risk Remains Despite Dilutive Rights Issue
Summary
- Lufthansa has announced the authorization of a €2.1 billion rights issue, mainly to repay debt owed to the German government.
- While net debt will be reduced post-raise, debt levels are still on track to rise further over the upcoming months, depending on the pace of the recovery.
- With further selling pressure also likely to be an additional overhang, I would be cautious at the current valuation.
Alexander Hassenstein/Getty Images News
Major German aviation company Lufthansa's (OTCQX:DLAKF) (OTCQX:DLAKY) latest rights issue has been a long time coming now, so the announced c. €2.1 billion transaction should perhaps not have come as a major surprise. While the expected deal removes uncertainties around the financing, the considerable c. 39% discount to the TERP (theoretical ex-rights price) implies this will be a significant dilution event. Post-rights, Lufthansa's share count will double, which effectively cuts in half the EPS estimates for fiscal 2022 (and beyond). As such, on normalized demand assumptions in fiscal 2024, the valuation does not look compelling, while liquidity also remains tight amid rising debt levels in the upcoming quarters.
Repaying Government Loans via a Rights Issue
Lufthansa has disclosed the authorization of a €2.1 billion rights issue, with the proceeds mainly used to repay the c. €1.5 billion debt to the German government silent stabilization fund I. Notably, the company has also committed to repaying the silent participation II (€1bn), as well as canceling undrawn facilities (€5.5bn) by year-end. In exchange, the German government (via its ESF, Economic Stabilisation Fund), which will hold a c. 16% stake assuming full subscription, will begin selling its stake not earlier than six months following the capital increase. The full divestment is then scheduled to take place no later than 24 months post-issue. The (fully underwritten) rights issue subscription price stands at €3.58 per share, implying a worryingly high c. 39% discount to the TERP. And with each exiting share giving one right, Lufthansa's share count will double to 1,194 million post-issuance, implying a halving in the future EPS.
Source: Lufthansa Capital Raise Presentation Slides
Clearing the Rights Issue Overhang but Liquidity Concerns Remain
On the one hand, Lufthansa's right issue should come as no surprise considering it has been signaled by management and therefore expected by the market. The rights issue amount of c. €2.1 billion is perhaps below initial estimates, however, with net debt now reduced to €8.3 billion on a pro forma basis (still above the €6.7 billion at fiscal 2019). Depending on the pace of demand normalization, debt levels should rise further over the upcoming months, which means future asset disposals (among other tools) may also be necessary to further de-leverage and repair the balance sheet.
Source: Lufthansa Capital Raise Presentation Slides
While the share price has remained resilient on the news (down c. 25% vs. the c. 50% share count dilution), there could still be some delayed overhang from the government selling its stake post the issuance. And even with the repayment of the stabilization fund, Lufthansa's €6-7 billion liquidity range remains below par. While this could be sufficient in a recovery scenario, a more likely "lower for longer" air travel demand scenario could necessitate another capital raise (debt or equity). Following the issuance, which comes at a c. 39% discount to the TERP and implies a doubling of the share count, the company's EPS forecasts from fiscal 2022 onward are set to be revised lower. Yet, on a pro forma basis, Lufthansa trades at higher multiples relative to historical levels, which seems unjustified considering the uncertain backdrop.
Trading Update Reveals Unchanged Targets
Looking ahead, Lufthansa is guiding toward capacity running slightly above the c. 50% guidance for FQ3 '21 as the company is currently flying to c. 85% of pre-pandemic destinations. Although the North Atlantic is set to open from the US side, caution in the EU means the company is still targeting c. 60% of pre-pandemic capacity for FQ4 '21, implying a gradual recovery ahead. September capacity is also guided to be flat relative to August levels, which is a tad disappointing considering the lifting of COVID-19 restrictions since the FQ2 '21 results. Nonetheless, cost-cutting initiatives appear to be taking hold, supporting a higher adj fiscal 2021 EBIT relative to fiscal 2020, with adj FQ3 '21 EBIT also set to be positive (ex-restructuring costs). However, there has been limited visibility into the upcoming disposal process, except that management will only divest once full value can be realized. As long as Lufthansa has time on its side, I see a limited asset value discount as the most likely scenario, although disposals at a "fire sale" price could still happen should we see a COVID-19 resurgence going forward.
Source: Lufthansa Capital Raise Presentation Slides
On balance, the dominant theme for the investment case remains its JVs, which contribute c. 70% of long-haul revenue and most of the airline profitability. Cargo revenue strength also provides welcome support for the company as it looks forward to the upcoming year, although over the longer term, substantial permanent labor productivity improvements will be vital to the post-recovery stage of the investment case. As things stand, however, the key near-term risk is net debt levels, which appear on track to hit a concerning sub-€10 billion by end-2021 (depending on the pace of recovery of forward bookings). Unless Lufthansa succeeds in bringing leverage down to pre-pandemic levels (via asset sales and organic cash flow generation), I continue to believe the group should trade at a discounted P/E multiple.
Final Take
Lufthansa's intention to do a rights issue has been well-signaled for a while now, but the extent of the dilution (entailing a doubling in the number of shares) without sufficiently addressing the liquidity position is a concern. Furthermore, there is selling pressure ahead from the German government via its ESF, which could prove to be an overhang on the valuation multiple relative to peers. As such, I would use any rally in the share price post-rights to sell into strength.
Source: MarketScreener
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Comments (12)
In addition, it is not yet clear who will take over the government after Merkel. But it is already a fact that the Green Party will be given tasks in the government. And it's good to know that this party will then have no say in Lufthansa, because the government will no longer be involved. Conclusion; if you think a little longer than a few weeks, you will certainly be happy with the Lufthansa share.