oWe expect the recovery of global air traffic and business/corporate travel, in particular, will be slower than previously projected due to renewed travel restrictions in response to a spike in COVID-19 cases and increased substitution of face-to-face meetings with virtual gatherings.
oDeutsche Lufthansa AG (Lufthansa) continues to counter the plunge in its revenues by adjusting capacity, containing costs and capital investments, and safeguarding its liquidity position, but these measures will only partly offset the steep decline of up to 80% in air passenger traffic in 2020 (and up to 55% in 2021 versus 2019) and likely significant redundancy payments (subject to negotiations with unions). These developments result in a sharper-than-anticipated deterioration in Lufthansa's EBITDA and credit metrics under our revised base case.
oWe are therefore lowering our ratings on Lufthansa and its senior unsecured debt to 'BB-' from 'BB', and our rating on the junior subordinated debt to 'CCC+' from 'B-'. We affirmed the short-term issuer credit rating at 'B'.
oThe negative outlook reflects our view of persisting material uncertainties about the recovery of Lufthansa's financial metrics and risks of further weakening due to potentially slower-than-expected demand recovery for air passenger travel and insufficient cost-cuttings. We also consider the high uncertainty regarding the COVID-19-related impact on the economy, air traffic demand, and Lufthansa's financial position and liquidity.
FRANKFURT (S&P Global Ratings) --S&P Global Ratings today took the rating actions listed above.
Air passenger demand and consumer confidence look bleak.
There is considerable uncertainty regarding the overall outlook for air travel following a spike in COVID-19 cases and the resulting new round of lockdowns and travel restrictions. We now project that 2020 traffic as measured by revenue passenger kilometers (RPKs) and revenue are likely to be 65%-80% lower than in 2019, versus our previous estimate of 60%-70% lower. We see a weak recovery in 2021, with traffic and revenue still 40%-60% lower than in 2019 (compared with our previous estimate of 30%-40% lower). We also think the subdued demand will carry into 2022, leading us to forecast RPK and revenue 20%-30% lower than in 2019 (compared with 15%-20% previously). Our current estimates incorporate the recent consensus among health experts that a COVID-19 vaccine could be widely available by mid-2021.
Lufthansa cut its flight schedule in response to gloomy demand prospects for the next few quarters.
The group lowered its planned capacity (available seat kilometres [ASK]) guidance for fourth-quarter 2020 to a maximum of 25% of its 2019 ASK, from 50%-55% in early June, resulting in a full-year ASK of at most 30% of 2019 levels. Since the onset of the pandemic, the group's load factors are well below the about 83% recorded in 2019, and we factor into our revised base case that its 2020 passenger numbers will likely be more depressed than we previously forecast. We note Lufthansa's strengthened performance between June and July following a nearly complete halt of air traffic in April-May. Although demand for long-haul flights has remained muted, improved demand for short-haul leisure travel across Europe translated to load factors of more than 65% in June and close to 70% in July. Since September, however, recovery has been side-lined by renewed travel restrictions. Traffic conditions are likely to be bumpy for at least the next few quarters, as local travel constraints, quarantine policies, and COVID-19 testing rules evolve. Furthermore, we anticipate a delayed and sluggish recovery of international long-haul bookings, for example to North America, as well as business and corporate traffic, which are typically Lufthansa's most profitable segments.
Lufthansa will report a marked OCF deficit and accumulate new debt in 2020.
We therefore believe the group's credit metrics will continue to be under considerable pressure over the coming few quarters. We note that Lufthansa is cutting costs, executing operating-efficiency initiatives, and drastically reducing capacity, among other measures, and should benefit from a lower fuel bill (forecast by S&P Global Ratings at EUR2.5 billion-EUR2.7 billion in 2020 versus EUR6.7 billion in 2019). But we think the company will fall short of compensating for the collapse in revenue in 2020. Our fuel-cost forecast includes losses from ineffective fuel hedges (EUR764 million in the first nine months of 2020), which we treat as operating expenses and that were caused by lower fuel prices, and an over-hedged fuel position after a significant cut in capacity. Based on negative EBITDA (after exceptional items) of about EUR3 billion reported for the first nine months of 2020, we estimate that Lufthansa's adjusted EBITDA might deteriorate to between negative EUR3.6 billion and negative EUR3.8 billion this year, compared with a strong EUR4.7 billion in 2019. This dip, aggravated by working capital needs because of ticket refunds (EUR3.0 billion refunded in the first nine months of 2020 to bring the liability from unused flight documents down to a still significant EUR2.7 billion, which, however, includes only a small amount of open or unpaid refunds) and sluggish forward bookings, will result in materially negative OCF this year. We view positively the group's delays or cuts to capital expenditure (capex) for new planes and other discretionary projects (total spending to EUR1.3 billion in 2020 and up to EUR1.3 billion in 2021, from up to EUR3 billion annually scheduled before the pandemic) to restrain cash burn. Still, we forecast that Lufthansa's S&P Global Ratings-adjusted debt will rise significantly to about EUR15.0 billion by end-2020 (at constant pension liability versus end-2019) from about EUR10.8 billion in 2019.
We project that a COVID-19 vaccine, if widely available by mid-2021, could help to restore air traffic demand and contribute to the group's financial recovery in 2021.
We envisage Lufthansa's operating performance improving in 2021, albeit at a slower pace than we projected in June. This is because of a more severe decline in air traffic volumes than we previously forecast, aggravated by the likely large redundancy payments due to the envisaged drastic cutbacks in the airline's global workforce. We now anticipate Lufthansa's EBITDA, as adjusted by S&P Global Ratings, will rebound in 2021 but remain significantly below the EUR2.5 billion-EUR3.0 billion we projected previously. In our base case we assume a substantial recovery in air traffic in second-half 2021, underpinned by our current view that an effective vaccine for COVID-19 will become widely available by the middle of next year, easing or lifting of travel restrictions and restoring passenger confidence in air travel. Our revised base case indicates a weaker recovery in the group's credit metrics. We no longer think that adjusted FFO to debt will recover to above 6% in 2021 (versus our earlier forecasts of 6%-12%). Furthermore, low visibility regarding the pandemic's duration, as well as recessionary trends and their impact on passenger volumes, add a significant degree of uncertainty to our base case.
The EUR9 billion state aid package under the Federal Economic Stabilization Fund strengthened Lufthansa's capital structure and liquidity position.
The stabilization package comprised EUR5.7 billion in silent participation and a EUR3.0 billion state-guaranteed loans. The package also included a 20% stake in Lufthansa's share capital by the German government that was acquired for EUR306 million cash (at a share price of EUR2.56) in third-quarter 2020. We regard the EUR5.7 billion silent participation as akin to debt. This is because we believe that Lufthansa has a material and strong incentive to redeem the silent participation given that the hybrid's documentation includes multiple coupon step-ups until 2027. Furthermore, based on Lufthansa's public communication, we understand that the airline intends to redeem the hybrid instrument as soon as practical. In our view, certain benefits of silent participation, such as no effective maturity date and optionally deferrable coupon features, differentiate it from traditional debt and provide important flexibility to Lufthansa's capital structure. This comparative strength, however, is now offset by our view that the group's actual and forecasted credit metrics are at the weaker end of the highly leveraged financial profile range, combined with our assessment of the business profile remaining at the lower end of satisfactory range because of depressed profitability. Therefore, we removed the one-notch uplift to the anchor to arrive at Lufthansa's stand-alone credit profile (SACP) of 'b+'.
The sizable government support package abated near-term liquidity concerns.
As of Sept. 30, 2020, the group's total liquidity was EUR10.5 billion, comprising EUR4.2 billion of cash, cash equivalents, and liquid securities, as well as EUR6.3 billion of available funds under the EUR9.0 billion state aid package under the Federal Economic Stabilization Fund. Liquidity was further augmented by EUR600 million in cash from the convertible bond issue completed in November 2020, to a pro forma total liquidity position of about EUR11.1 billion. Moreover, we acknowledge Lufthansa's determination and flexibility to defer capex for new planes and suspend dividends, with a focus on preserving cash and restoring its credit measures.
Our view of Lufthansa as a government-related entity supports the group's creditworthiness.
We see a moderate likelihood that, beyond the stabilization package, Lufthansa would receive extraordinary support from the German government under a stress scenario. We base our view on our assessment of Lufthansa's important role for, and limited link with, the German government.
Environmental, social, and governance (ESG) credit factors for this credit rating change:
oHealth and safety
The negative outlook reflects our view that Lufthansa's financial metrics will remain under considerable pressure in the next few quarters amid the extremely difficult trading environment. Furthermore, there is elevated uncertainty regarding the COVID-19 pandemic and economic recession, and the repercussions for air traffic demand and Lufthansa's financial position and liquidity.
We could lower the rating over the next 12 months if we believe the recovery will be more prolonged or weaker than expected, resulting in continued high cash flow burn, thus leading to very weak or even negative FFO generation in 2021. This could occur if COVID-19 cannot be contained, resulting in prolonged lockdowns and travel restrictions, or if passengers remain reluctant to book flights.
We could also lower the rating if industry fundamentals weaken significantly and for a prolonged period, impairing Lufthansa's competitive position and profitability. While we currently don't see liquidity as a near-term risk, we would lower the rating by at least one notch if air traffic does not recover in line with our expectations and management's proactive actions to adjust operating costs and capital investments are insufficient to preserve at least adequate liquidity, such that sources exceed uses by more than 1.2x in the coming 12 months, in the absence of extraordinary government support.
A stable outlook would hinge on greater visibility on more normal demand conditions and that the recovery is robust enough to enable Lufthansa to partly restore its financial strength, such as adjusted FFO to debt recovering to at least 6% over 2021, alongside a stable liquidity position.
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Related Research
oLufthansa Rating Lowered To 'BB' On Increased Leverage; Outlook Negative, July 1, 2020
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