Like British Airways and other European airlines, strong financials are being eroded by terrorist action and economic instability. Routes to Europe from South America and Asia showed a particularly weak performance for the first half of 2016. While the European and North American routes remained stable, Europe even saw an increase in its yields excluding currency effects in the second quarter of 2016, something that will be hard to repeat in the third quarter. Lufthansa has today produced H1 2016 results that are very impressive given the climate. Total group revenue for H1 2016 was down 2.1% year on year at €15.0 billion despite higher passenger volumes. Traffic revenue was down 4.5% due to strong pricing pressures in both the airline and the cargo businesses.
In spite of the lower revenues, however, adjusted EBIT increased by €61 million to €529 million, on the back of total costs declining faster than fuel costs. Unit costs excluding fuel costs and currency effects decreased by 1.3% for the period year on year. The fuel cost benefits amounted to €597 million; and the pricing pressure, which is also partly the product of the lower fuel prices, resulted in a 5.2% reduction in unit revenues excluding currency effects. “The Lufthansa Group achieved a solid result for the first half-year,” says Carsten Spohr, Chairman of the Executive Board & CEO of Deutsche Lufthansa. “We are making good progress in implementing our Three-Pillar-Strategy. We see progress in all the areas where we can influence the changes ourselves. And this is particularly true for our cost structures and the growth of Eurowings, the development of which is progressing well.”
The net result for the first half of 2016, standing as it is at €429 million is slightly off the H1 2015 total excluding the €503 million from the early conversion of the JetBlue convertible bond. Tellingly first-half cash flow from operating activities declined 13% to €2.2 billion indicating that forward bookings are rapidly declining, but Lufthansa management was able to offset this in H1 2016 with savings increasing free cash flow in the process to €1.1 billion from €1bn year on year. This is owed largely to an increase in pension fund provisions in response to the decline of the IFRS discount rate to 1.6% from 2.8%. At a comparable discount rate in the first quarter of 2015 (1.7%), the equity ratio of 7.5% was substantially lower than its present level. Lufthansa Passenger Airlines was the only business unit to substantially improve its operating result in both the first and the second quarter. First-half earnings for Lufthansa Passenger Airlines increased by €281 million to €387 million, and the EBIT margin rose accordingly to 5.2%, an improvement of 3.8 percentage points. This is due to strict capacity discipline, among other reasons.
The best margin among the Group’s network airlines remains SWISS at 6.3% although earnings declined by €47 million in the first half-year as a result of the economic effects of the strong Swiss franc. Austrian Airlines improved its result in the first half-year by €16 million, while the cumulative earnings result from the holdings in SunExpress and Brussels Airlines showed a decline of €40 million. Both subsidiaries are currently operating in very difficult markets. The first half-year result for Eurowings was €67 million below its prior-year level, a result attributable mainly to its ramp-up and project costs and to the challenging competitive environment. The biggest decline in first-half earnings – by €95 million – was posted by Lufthansa Cargo. Due to massive market overcapacities, yields in the airfreight sector have now declined to levels last seen during the financial crisis in 2009.
In response, Lufthansa Cargo has embarked on a structural cost reduction program which is intended to save €80 million, twice as much as originally planned. The service companies Lufthansa Technik and LSG Sky Chefs reported first-half results that were €64 million and €2 million below their prior-year levels, respectively. Unit revenues excluding currency effects are expected to fall 8 to 9 per cent in the second half-year. Planned full-year capacity growth is being reduced from 6.0 per cent to 5.4 per cent. On current estimates, second-half fuel costs will be around €350 million below their prior-year levels.
For the year as a whole Lufthansa confirms its previous fuel cost forecast of €4.8 billion. Going forward Lufthansa, like IAG is in a good position to weather the coming storm of slowing passenger traffic, but Lufthansa will also have the added bonus of improving its equity ratio via the UFO flight attendants agreement where the retirement system will be switched from a defined benefit to a defined contribution model. Lufthansa expects EBIT to be above the previous year and several hundred million euros above the Adjusted EBIT for the financial year 2016. What the Lufthansa results do tell us is that a price war in the European air passenger market is gathering momentum and the reducing passenger numbers will compound the effects of this. As such one must wonder about the health of Air France-KLM, Air Berlin and a number of other major airlines going forward. Will European airlines be able to increase fares and stabilise the situation? Not likely if Ryanair, easyJet and Wizz keep growing. Lufthansa is yet to confirm if it will defer any aircraft deliveries in H2 2016, but it is a sure bet that it will.