Lufthansa's Eurowings Price Cuts to Curb Profit Gain in 2016

  • Discount unit's development set to depress average fares
  • Fuel price helped German carrier post record earnings in 2015

Deutsche Lufthansa AG said the expansion of its Eurowings discount brand will come at a cost this year, with a reduction in average fares eating into gains from lower oil prices.

Operating profit will advance only “slightly” in 2016 amid a deterioration in yields as Eurowings adds flights in the long-haul market, where Lufthansa traditionally makes most of its money, and competition from low-cost rivals intensifies on European routes. The stock dropped the most in more than four months.

Lufthansa damped expectations after reporting that adjusted earnings before interest and tax jumped 55 percent to a record 1.82 billion euros ($2 billion) in 2015. The cautious outlook excludes potential disruption from further strikes over its drive to pare expenses and stem the loss of traffic to Ryanair Holdings Plc and EasyJet Plc, in which the expansion of Eurowings is pivotal.

“We must lower the unit costs at our hub airlines,” Chief Financial Officer Simone Menne said in a statement. “This is and remains the key to maintain our competitiveness. I don’t see the trend for unit revenue declines in Europe ending anytime soon.”

Stock Slides

Lufthansa fell as much as 7.3 percent, the most since Oct. 29, and was trading down 6.9 percent at 14.23 euros as of 11:35 a.m. in Frankfurt. That pushed the stock to a 2.2 percent decline this year.

The group has been expanding Eurowings by bundling its discount operations under the once minor brand and making it a receptacle for all short-haul flights that aren’t routed through Lufthansa’s main Frankfurt and Munich hubs.

Eurowings will start serving Munich in 2017 or 2018, Chief Executive Officer Carsten Spohr told analysts on a conference call. The company is also considering assigning larger Airbus Group SE A340 aircraft to the unit that are being phased out at the Lufthansa brand, in addition to smaller A330 wide-body planes. Costs at Eurowings should come down by 10 percent a year through 2018.

Walkouts over the plan have wiped 500 million euros from earnings over the past two years, including about 100 million euros in the fourth quarter of 2015. Resistance from staff also means the strategy is making slow progress, with route transfers from Lufthansa’s mainline brand proceeding only as crews retire.

The Eurowings fleet is set to expand by 10 aircraft to 98 this year, including wide-body jets that it’s deploying on intercontinental leisure routes that the lower cost base should make viable. Still, just two out of every three seats were filled on European routes in the first two months of 2016, while the long-haul rollout has stuttered amid problems with aircraft.

Fuel Boost

Menne said that forward bookings in some markets have also been held back following a spate over terror attacks over the past year, with people reserving seats later or avoiding some travel until the situation becomes clearer.

Lower kerosene prices spurred earnings across the airline industry last year, proving particularly beneficial to Lufthansa and Air France-KLM Group, Europe’s biggest airline, which has also suffered a spate of strikes over a new short-haul strategy.

Lufthansa said fuel costs will drop by a further 1 billion euros in 2016, 25 percent more than it had suggested in January, matching last year’s reduction. The company typically seeks to retain one-third of fuel-price gains, passing the rest to customers.

Unit costs excluding fuel and currency fluctuations will fall “slightly” as Eurowings grows, after rising 2.4 percent in 2015 following multiple walkouts. The carrier, which also owns the Austrian and Swiss airline brands, may decide in the second quarter about buying full control of Brussels Airlines NV and adding the carrier to its Eurowings operations.

Profit in 2015 was within Lufthansa’s forecast range. The carrier will revive its dividend following the third suspension in six years with a payment of 50 cents a share, matching the average analyst estimate.

Before it's here, it's on the Bloomberg Terminal.