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Rating Action:

Moody's upgrades Lufthansa to Baa3; stable outlook

Global Credit Research - 24 Aug 2017

London, 24 August 2017 -- Moody's Investors Service, ("Moody's") has today assigned a Baa3 long term issuer rating to Deutsche Lufthansa Aktiengesellschaft (Lufthansa) and has withdrawn the Ba1 corporate family rating (CFR) and the Ba1-PD probability of default rating (PDR) of Lufthansa. Concurrently, Moody's has upgraded Lufthansa's senior unsecured instrument rating to Baa3 from Ba1, the short term rating to P-3 from NP, the senior unsecured rating on the company's medium-term notes (MTN) programme to (P)Baa3 from (P)Ba1 and its short-term rating to (P)P-3 from (P)NP. The outlook on all the ratings is stable.

"Our decision to upgrade Lufthansa follows the company's positive evolution of its operating profitability which improved markedly in the first half of 2017 and our expectations that its full-year profits and operating cash flow will continue to strengthen on the back of strong demand and cost reductions," says Sven Reinke, a Moody's Senior Vice President and lead analyst for Lufthansa. "Lufthansa has significantly improved its cost base over the last few years, strengthening its competitive profile. In addition, rising profitability and a one-off cash injection into its pension schemes will reduce year-end leverage materially."

RATINGS RATIONALE

Today's rating action reflects Lufthansa's strongly improved operating profit generation with the company achieving an adjusted EBIT of EUR2,265 million during the last 12 months to June 2017. As a result, Lufthansa's Moody's-adjusted retained cash flow/net debt ratio increased to 25.7% in Q2 2017 from 18.6% at FYE2016. Gross adjusted leverage improved to 4.3x in Q2 2017, from 4.6x at FYE2016 and Moody's expects that it will decrease to approximately 3.5x by the end of 2017, driven by a combination of a lower pension deficit and higher earnings. As a result, both key metrics will be within the previously defined guidance for a Baa3 rating.

The rating upgrade also reflects the substantial strategic progress Lufthansa has made during the last couple of years in terms of (1) strengthening its market position with the acquisition of 100% of Brussels Airlines in January 2017 and the wet-lease transaction with Air Berlin, which was agreed in September 2016; (2) the company's improved cost competitiveness following the transition of its point-to-point traffic to Eurowings, which enables it to better compete with successful low-cost airlines such as EasyJet Plc (Baa1 stable) and Ryanair (not rated); and (3) agreements with the workforce to transition to defined contribution pension schemes for most employees.

Following the likely liquidation of Air Berlin, Moody's expects that Lufthansa's competitive position in its domestic German market will strengthen. Lufthansa confirmed that it is in negotiations to acquire parts of Air Berlin's business in addition to the already in the November 2016 agreed wet-lease transaction that has increased Lufthansa's capacity in Germany considerably. The potential increase in market share would allow Lufthansa to better utilise its capacity and achieve scale effects. However, Moody's does not expect that such a transaction would have a severe adverse effect on its capital structure.

Following the strong results for H1 2017 with an increase of the adjusted EBIT by 97.0% to EUR1,042 million compared with EUR529 million in H1 2016 and much improved operating cash flow generation of EUR 3.2 billion compared with EUR2.2 billion in H1 2016, Moody's expects that Lufthansa's profitability will strengthen further in 2017. Such strong results would affirm the positive trend of the last couple of years when the company was able to substantially improve its profitability compared with the lower level prior to 2015. In addition, Moody's expects the company's gross adjusted leverage to fall to around 3.5x at the end of 2017 driven by rising profitability and a EUR1.6 billion one-off cash injection into the pension schemes. The high pension deficit which increased to EUR8.4 billion in 2016 compared with EUR4.7 billion in 2013 owing to a material decline of the discount rates is the main reason for Lufthansa's relatively high gross adjusted leverage over the last couple of years.

Lufthansa's Baa3 ratings also reflect its leading position in the European airline sector, its diversified route network, the diversity of its business segments and its solid liquidity position. In particular, Lufthansa's maintenance segment, which generates the majority of its revenues from third party customers, provides diversification to the group, distinguishing it from other airlines. This segment partially mitigates the exposure to the more volatile passenger airlines and logistics (cargo) segments. However, Moody's rating also reflects the improved but still relatively low level of operating profitability when compared with other investment grade rated airlines and the exposure to external shock events that are characteristic for the passenger airlines industry.

Moody's considers that Lufthansa's liquidity is solid, with a balance of cash and equivalents and liquid securities of EUR6.1 billion and undrawn committed short-term credit lines of EUR855 million which compares strongly with the low short-term debt of EU659 million as at the end of Q2 2017. The rating agency expects Lufthansa's liquidity to remain solid despite the anticipated decline of the company's liquidity buffer following the upcoming EUR1.6 billion cash injection into the pension schemes. Moody's notes that Lufthansa retains a minimum liquidity target of EUR2.3 billion.

RATIONALE FOR THE STABLE OUTLOOK

The stable outlook on the ratings reflects Moody's view that Lufthansa's financial profile will gradually strengthen further over the next 12 -- 18 months, supported by strong demand in the European airline market and the benefits from Lufthansa's structural progress in terms of cost reductions and the transformation of the point-to-point traffic. The outlook also reflects Moody's expectation that Lufthansa's financial policy will continue to prioritize an investment grade financial profile over shareholder returns.

WHAT COULD CHANGE THE RATING UP/DOWN

Moody's does not expect positive rating pressure over the next 12-18 months as a higher rating would likely require a prolonged period of proven resilience and sustainable performance through the industry cycle. Quantitatively, there could be positive rating pressure for Lufthansa if it strengthens its liquidity and if:

1) gross adjusted leverage falls below 2.5x;

2) the retained cash flow (RCF)/net debt metric increases materially above 30%; and

3) the adjusted EBITDA margin moves towards 20%, indicating resilience to competitive pressures.

The rating could come under negative pressure if Lufthansa fails to continue to make progress towards Moody's expectation of gross adjusted leverage falling towards 3.5x, as a leverage closer to 4.0x would position Lufthansa weakly in the Baa3 rating category. In addition, the rating could come under negative pressure if the RCF/net debt metric were to fall below 25% on a continued basis or if Lufthansa's liquidity weakens materially.

PRINCIPAL METHODOLOGY

The principal methodology used in these ratings was Global Passenger Airlines published in May 2012. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

Deutsche Lufthansa Aktiengesellschaft , headquartered in Cologne, Germany, is the leading European airline in terms of revenues. In FY2016 it reported revenues and an adjusted EBIT of EUR31.7 billion and EUR1,752 million respectively.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Sven Reinke
Senior Vice President
Corporate Finance Group
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Mario Santangelo
Associate Managing Director
Corporate Finance Group
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Releasing Office:
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

No Related Data.
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