Thursday, October 30, 2014

Lufthansa Lowers 2015 Earnings Outlook • German Airline Drawing Up Plans in Case Economic Prospects Deteriorate Further

The Wall Street Journal
By Natalia Drozdiak

Updated Oct. 30, 2014 10:07 a.m. ET

FRANKFURT— Deutsche Lufthansa AG on Thursday scaled back its earnings targets for next year and said it was drawing up contingency plans should economic conditions further deteriorate.

The German airline now sees its 2015 operating profit “significantly above the result of 2014,” compared with its previous €2 billion ($2.52 billion) target, while confirming its 2014 operating profit target of €1 billion. The airline blamed the weaker global economic backdrop as well as overcapacity in key markets. In response to the weakness, it said it would curtail capacity growth next year to 3% from 5% to help combat pressure on yields.

“We can see that the economic slowdown and the continuing declines in our passenger yields in the face of such fierce competition will affect our operating scope in the year ahead,” said Chief Financial Officer Simone Menne. She said earnings would also be hit by a sharp rise in pension costs.

The airline also warned that its 2014 dividend payment could be cut because of a change in interest rates and the sale of its IT unit.

Ms. Menne said the carrier’s dividend policy was “under review” and would be discussed when the supervisory board meets in early December. Lufthansa said earlier this month that it would sell its IT infrastructure division to International Business Machines Corp. , a move that will reduce costs in the long run but result in a €240 million charge this year.

Lufthansa also said its 2014 earnings targets remained vulnerable to further labor union strikes this year. It said strikes aren’t factored into the 2015 outlook, so it too could be further impacted if more labor unrest takes place. Labor union strikes have already shaved off €170 million in operating profit this year, Lufthansa said.

“To have conviction in the investment case we need to regain confidence in the stabilization of forecasts, which is difficult at this stage given the challenged operating environment,” Jefferies analyst Mark Irvine-Fortescue said.

Lufthansa’s shares dropped 7% to €11.47 around 1300 GMT.

The airline said the pressure on yields from overcapacity in the industry stemmed from outside Europe and mainly from North America. Lufthansa said it sees stable versus rising yields in 2015 and that capacity growth in North America will likely surpass 3% in 2015.

Like other European airlines, Lufthansa is struggling to compete with discount carriers, which have undermined short-haul operations in Europe, while rapidly growing Middle Eastern carriers are also threatening their long-haul businesses.

Lufthansa said it might have to make more capacity cuts and shrink the size of its fleet if demand declines further. Still, the carrier is so far “satisfied” with next year’s bookings, Chief Executive Carsten Spohr said.

“We are disappointed that management is giving up again on its originally agreed financial target for 2015 without taking further action to preserve the 2015 target,” Citi group analyst Andrew Light said.

The company said its fuel hedging policy was so far unaffected by the low jetfuel costs, adding that its fuel for next year is partly already hedged at 65% for 2015.

The altered 2015 outlook came even as it reported that third-quarter net profit rose 24% to €561 million from €451 million last year. Analysts had expected the airline to post a third-quarter net profit of around €491 million. Sales for the quarter advanced 1.9% to €8.46 billion from €8.3 billion, Lufthansa said.

Lufthansa said it would hold off on a specific 2015 forecast until next year, saying “strong volatility” in issues such as exchange rates and fuel costs made it too difficult to be more precise for now.

The airline said lower restructuring costs and a new aircraft depreciation policy helped offset the cost of the strikes. Its third-quarter operating profit rose 25% to €735 million, compared with €589 million the year before and against analyst estimates of €662 million.

Lufthansa said the cost cuts are outpacing their 2015 Score restructuring target to slash operating costs by €1.5 billion and doesn’t see any other restructuring expenses next year. The airline plans to make the cost reductions and earnings improvements a permanent fixture once the program ends.

Chief Executive Spohr said the airline could cut more administrative staff and implement a hiring freeze in airline operations departments.

Earlier this year, the airline said it is extending the depreciation period for its aircraft from 12 to 20 years, and reducing their residual book value from 15% to 5% of purchase price. Lufthansa said the new policy has already boosted operating results by €260 million in the first nine months of the year.

The airline had already downgraded its outlook in June on weak sales growth and labor unrest, when it was subsequently hit by a number of pilot strikes. Lufthansa and its pilots are at odds over a push by the carrier to raise the early retirement age and the airline’s plans to shift some flying to lower-cost operations.

Mr. Spohr, earlier this year announced a plan to boost the shift of short-haul operations to a discount unit while also moving some long-haul flights to a lower-cost business model. The airline also wants to revamp some Airbus Group NV A340-300 long-haul jets to offer discount flights to leisure travelers. It will brief its board about the lower-cost “Wings” concept in December, Lufthansa said.

European rival Air France-KLM SA in October also announced its second profit warning this year. The unprofitable Franco-Dutch carrier said a two-week-long pilots strike cost the airline about €416 million in lost sales.

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