German airline group Deutsche Lufthansa (FRA:LHA) has recently suffered several blows to its financial performance, with certain headwinds unlikely to abate in the near-term.

Lufthansa posted less-than-stellar earnings results for the first nine months of 2018.

The firm generally blamed higher fuel costs, flight delays and cancellations, as well as merger-related integration expenses and losses at its discount carrier Eurowings, for its downbeat performance.

For the first three quarters of 2018, the Cologne-headquartered company said it earned €2.4bn, a 7.7% drop from the prior-year period, on the back of almost €27bn in total revenues.

(Click on image to enlarge)

Apart from geopolitical risks facing the global aviation industry, including Brexit and Italian government spending and policy, European airliners have generally been hampered by fierce competition and higher oil prices. 

Lufthansa chair and CEO Carsten Spohr said he expects full-year costs to rise by over €1.0bn in 2018, underscored by a fuel bill that had increased by €536m in the first nine months of 2018.

While oil prices have fallen recently, sentiment may very well reverse as U.S. sanctions on Iranian crude are set to come into effect on November 4.

The active crude oil futures contract was last trading at a little above US$66.40 intraday Wednesday, a decline of nearly 12.9% from its 52-week high of US$76.25 set in early October. Crude had risen more than 44.5% over the past year, driven in large part by uncertainties over Iran’s supply contributions, as well as global trade disputes.

Lufthansa anticipates an €850m rise in fuel costs this year compared to 2017 and by a further €900m in 2019.

Traffic control

European airliners face an increasingly congested market, which has spurred a groundswell of consolidation, with rising oil prices attributed to accelerating the recent insolvency of several players, including Primera Air, Switzerland’s Skyworks, and Belgium’s VLM.

Several companies had also collapsed in 2017 under the fierce weight of competition, including Alitalia, Monarch and Air Berlin, which saw certain of its assets purchased by Lufthansa for around €210m.

Fitch Ratings recently noted that further consolidation is “inevitable” in the still-crowded European airline sector due to bankruptcies and through M&A. Fitch analysts Angelina Valavina and Tatiana Kordyukova said they expect five large airline groups to dominate the future of the sector, while medium and small carriers are likely to remain under pressure.

The top five carriers account for about 50% of intra-European seats compared to the domestic market share of almost 80% for the four largest U.S. carriers.

Lufthansa CEO Spohr said the acquisition of Eurowings in 2017 “was the right decision” in strategic terms, even if it promoted “a very challenging 2018.”

In late September, the firm’s board approved a €1.0bn investment in the low-cost carrier, with an aim of making a rapid expansion.

However, for the first three quarters of 2018, Eurowings reported negative earnings of €-65m, a €210m fall from the same year-ago period, which was primarily driven by a €170m integration expense related to parts of the former Air Berlin, as well as to flight delays and cancellations.

Lufthansa canceled roughly 18,000 flights, adversely impacting more than 1.7 million of its passengers, as well as many of its shareholders and long-term creditors.

While the German airliner’s stock was trading up about 2.22% intraday Wednesday to €17.70, it has tumbled around 44.4% since roughly the start of 2018. Also, yields on Lufthansa’s 5.125% bonds due August 2075 have risen close to 210bps year-on-year to a little more than 4.8%.

Overall, Lufthansa’s credit profile remains in positive territory.

Over the first nine months of 2018, the firm shaved 14% off its net financial debt from its 2017 year-end level to €2.5bn, with its debt ratio down 0.2 points to 1.5. However, free cash flow for the period plunged 59% to €1.2bn, given hefty investments on aircraft and reserve engines.

Market perception of Lufthansa’s creditworthiness has generally improved, with the spread on its five-year credit default swap tighter by about 2bps to just north of 230bps.

Higher ticket prices?

While airlines with a fundamentally strong market position can typically withstand higher oil prices for an extended length of time, it is likely that Lufthansa will pass any increased costs to consumers.

(Click on image to enlarge)

However, the potential for higher airline tickets does not appear to have shifted sentiment among most German consumers.

According to GfK, for example, the propensity for Germans to buy increased again in October, offsetting earlier losses.

The agency said that apparently “unfazed by external risks such as trade conflicts and Brexit, consumers are prepared to splash out.” GfK added that there is “little worry of job losses, leading to high planning security. This fuels consumption – in particular larger purchases.”

Against this landscape, Lufthansa boasts that it transported around 108.5 million passengers in the first three quarters of 2018, a new record volume.

German expectations about the country’s broader economic landscape appears to tell a different narrative, as GfK’s indicator slipped 8.1 points from the prior month to 19 in October. The latest level is also more than 35 points down from the start of the year.

GfK added that the “dynamism that was particularly prevalent in the second half of 2017 has proved impossible to maintain. This is primarily due to external factors. The trade conflict between the USA and the EU has not been fully resolved despite a period of calm, while the dispute with China has even escalated. It is also looking more and more likely that a hard Brexit is on the cards. This is highly unlikely to inspire consumer optimism.”

The event risks, including potential higher fuel costs and M&A, does not seem to bode well for Lufthansa financial and operational performance.

All in all, the airline giant said it continues to expect adjusted EBIT for 2018 that is “slightly below the record level seen last year.