Deutsche Lufthansa Primer

BI Airlines, Europe Dashboard

George Ferguson Ian McFarlane

BI Senior Industry Analyst BI Associate

1. BI Primer: Lufthansa Profit Challenged by Wages and Lower Fares

12/15/16

(Bloomberg Intelligence) -- Deutsche Lufthansa AG is challenged Table of Contents

by wages, lower fares and sharp competition in all markets, Financial Review Topics
especially from low-cost carriers. In the Intra-Europe market, the
Revenue 2017 Yields
airline is trying to use its Eurowings subsidiary to blunt competition, Margins Fuel Prices Rising
though unless pilot unions agree to a two-tiered pay system, costs Profitability Wage Battles NEW
will be too high. Fares in the Americas, its most important overseas Earnings Review
market, are falling as low-cost entrants enter, and in Asia and Africa
on strong capacity additions from government carriers less focused on profit.

Getting labor costs down will be critical to Lufthansa's long-term profitability. Given pilot union strength, this may
be done by introducing a two-tiered pilot pay scale with new hires paid less and relegated to Eurowings. The
current pilot contract includes influence over Lufthansa business decisions.

Key Points:
2017 Yields: Intra-Europe Fares To Fall in 2017 on Ryanair,
Norwegian Growth
Fuel Prices Rising: Futures Show European Airline Margins
Narrower on Fuel in 2017
Wage Battles: Lufthansa, Air France Push for Wage Tiers in Low-
Cost Battle

Financial Review

Revenue Analysis

2. Lufthansa 2017 Revenue to Fall on Capacity, Tough Competition

12/15/16
Lufthansa's revenue will likely continue to fall in 2017 as competition pushes fares lower with capacity adds of 4-
5%. In Europe, capacity additions by low-cost airlines pressure fares as subsidiary Eurowings tacks on 20% in a
battle for market share. Atlantic yields should fall as new long-haul, low-cost entrants such as WOW, Norwegian
and Air Canada Rouge add. Asia fares may fall as Chinese and Middle East airlines expand, though slower
growth at Turkish Air could lift some of the pressure there.

Regions: Europe is Lufthansa's largest market at 65% of passenger revenue. Internationally, the North American
market is most important at 17% of revenue. Asia-Pacific accounts for 12% and suffers from intense competition
from Chinese and Gulf airlines. Africa-Middle East is 5% and Latin America 2%.

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("BFLP") and its subsidiariesin all jurisdictions other than Argentina, Bermuda, China, India, Japan and Korea (the ("BFLP Countries"). BFLP is a wholly-owned subsidiary of Bloomberg LP
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 Lufthansa Passenger Revenue by Region (% YoY)

Margin Analysis

3. Lufthansa Margin to Fall in 2017 on Fares, Wages and Fuel

12/15/16

Lufthansa's 2017 Ebitdar margin is likely to fall as wages and fuel costs rise and revenue slips. Overcapacity in all
markets will pressure fares and likely squeeze revenue. Wages are likely to rise as Lufthansa pilots bring contract
negotiations to a head. That expense could be sizable, as pilots want mid-single-digit raises from the last contract,
which expired in 2012. The futures contract indicates fuel prices will be higher, though Lufthansa is significantly
hedged, slowing the effects.

Peer Comparison: Lufthansa's trailing 12-month Ebitdar margin of 12.9% is behind full-service rival IAG Group at
17.1%, but outperforms Air France-KLM (11.8%) and is similar to SAS (12.9%). Low-cost carriers' margins
significantly outperform Lufthansa, with Ryanair at 30.3% and EasyJet at 22.7%.

European Full-Service Airline Margins (% YoY)

Profitability Analysis

4. Lufthansa 2017 Profit to Fall on Falling Fares, Higher Wages

12/15/16
Lufthansa's 2017 profit will likely fall on lower revenue and higher expenses, as yields slip more than growth in
capacity, and wages and fuel costs rise. Profit growth is unlikely without rising fares, which are falling in all of
Lufthansa's markets amid excess capacity and intense competition. Lufthansa plans capacity growth of 4-5% next
year -- well above GDP growth -- which will likely pressure fares. Absent broad-based cuts, especially from low-
cost carriers, fares probably won't rise.

This report may not be modified or altered in any way. The BLOOMBERG PROFESSIONAL service and BLOOMBERG Data are owned and distributed locally by Bloomberg Finance LP
("BFLP") and its subsidiariesin all jurisdictions other than Argentina, Bermuda, China, India, Japan and Korea (the ("BFLP Countries"). BFLP is a wholly-owned subsidiary of Bloomberg LP
("BLP"). BLP provides BFLP with all the global marketingand operational support and service for the Services and distributes the Services either directly or through a non-BFLP subsidiary in the
BLP Countries. BFLP, BLP and their affiliates do not provide investment advice,and nothing herein shall constitute an offer of financial instruments by BFLP, BLP or their affiliates.
 Segments: The passenger group is Lufthansa's largest segment, comprising 84% of operating profit and driven
by Lufthansa Passenger Airlines, which accounts for 67%. Eurowings only recently turned a profit. The
maintenance, repair and overhaul segment accounts for 15% and catering 4%. Logistics continues to lose.

Lufthansa's Operating Profit by Segment ( MM)

Earnings Review

5. Lufthansa Adjusted Profit Falls on Fares, Oversupply: 3Q Review

12/20/16
Lufthansa's 3Q results confirm its revenue challenges as yields fell in all regions on overcapacity; the most on
Americas routes, which are second largest after intra-European. Lufthansa must focus on bringing costs down to
be more competitive with Ryanair, especially at its low-cost subsidiary Eurowings. During the quarter, wage
expense came down at Lufthansa Passenger Airlines due to one-time gains from moving to a defined contribution
pension, from defined benefit, for flight attendants.

Wage costs will be a focus in 2017 as Lufthansa strives to lower costs and take back full managerial control.
Logistics continues to suffer on global excess capacity and the maintenance business from competition for engine
services.

Key Points:
Yields Fall Most in Americas Markets, Lufthansa's Second-Most
Important | BI
Lufthansa Intra-Europe Yields Fall Only 1% in 3Q on Business
Travel, Not Likely to Persist | BI
Fuel Costs Provide a Boost to Lufthansa's 3Q Results | BI

Additional Resources:
Analyzer | BI
Earnings Release | DOCC
Earnings Call Transcript | DOCC
Company Presentation | DOCC

Topics

2017 Yields

6. Intra-Europe Fares To Fall in 2017 on Ryanair, Norwegian Growth

12/08/16

This report may not be modified or altered in any way. The BLOOMBERG PROFESSIONAL service and BLOOMBERG Data are owned and distributed locally by Bloomberg Finance LP
("BFLP") and its subsidiariesin all jurisdictions other than Argentina, Bermuda, China, India, Japan and Korea (the ("BFLP Countries"). BFLP is a wholly-owned subsidiary of Bloomberg LP
("BLP"). BLP provides BFLP with all the global marketingand operational support and service for the Services and distributes the Services either directly or through a non-BFLP subsidiary in the
BLP Countries. BFLP, BLP and their affiliates do not provide investment advice,and nothing herein shall constitute an offer of financial instruments by BFLP, BLP or their affiliates.
 European airlines' intra-Europe fares will continue to fall in 2017 on excess capacity and weak economic growth,
confirmed by 3Q yields. Most airlines had their worst yield decline in over two years, with a faltering pound
aggravating euro reported yields to the downside. EasyJet's yields were extraordinarily weak, as the soft pound
should have boosted the value of euro bookings. This trend likely will continue in 2017 as low-cost airlines,
especially Ryanair, add capacity at rates well above 2017 GDP growth.

EasyJet, Ryanair and Norwegian plan capacity additions above GDP as they grab market share from full-cost
carriers and their low-cost subsidiaries, including Lufthansa/Eurowings, Air France/Transavia and IAG/Vueling. Air
Berlin routes are likely a focus of expansion given financial weakness.

European Airlines Short-Haul Yields (YoY%)

7. Europe-to-Asia Fares to Fall in 2017 on China, Middle East Adds

12/08/16
European airlines' 3Q Asia yields fell across the board, with the trend likely to continue in 2017 on strong capacity
additions from Asian and Middle East carriers. Most Chinese airlines added long-haul capacity -- though not all to
Europe -- from the mid-teens to about 30% in 2016, and that will likely persist. Air France, Lufthansa and IAG
yields fell mid-single digits in 3Q, even as Lufthansa and Air France significantly cut capacity, showing the depths
of the problem.

Asia is the third-most important market for European airlines and of significant size. Turkish Air is a wild card in
the region as it struggles due to concerns over connecting in Istanbul after the coup attempt. Resumption of
growth in 2017 would add to downward pressure on fares.

European Airlines Asia Pacific Fares (YoY %)

8. Capacity Adds Will Trim European Airlines' 2017 Americas Yields

12/08/16

This report may not be modified or altered in any way. The BLOOMBERG PROFESSIONAL service and BLOOMBERG Data are owned and distributed locally by Bloomberg Finance LP
("BFLP") and its subsidiariesin all jurisdictions other than Argentina, Bermuda, China, India, Japan and Korea (the ("BFLP Countries"). BFLP is a wholly-owned subsidiary of Bloomberg LP
("BLP"). BLP provides BFLP with all the global marketingand operational support and service for the Services and distributes the Services either directly or through a non-BFLP subsidiary in the
BLP Countries. BFLP, BLP and their affiliates do not provide investment advice,and nothing herein shall constitute an offer of financial instruments by BFLP, BLP or their affiliates.
 Americas fares will remain under intense pressure in 2017, continuing the 3Q trend. New entrants, especially low-
cost, long-haul carriers, continue to add significant Atlantic capacity to capture some of the best yields globally.
While Latin markets start to turn the corner economically, their size doesn't allow significant growth without
dilution. Carriers planning significant capacity additions are Air Canada, including its low-cost subsidiary Rouge,
WestJet, WOW Air and Norwegian.

Americas yields are about a third of Air France's revenue and slightly less for Lufthansa. IAG is likely similar, but
doesn't provide details. North Atlantic capacity is controlled by joint ventures within the airline alliances, restricting
Delta, United, American and Air Canada additions.

European Airline's Americas Yields (YoY %)

9. Europe Airlines' Africa Yields May Rise on Turkish Air Travails

12/08/16
Yields to Africa and the Middle East fell in Q3, though could improve for European carriers in 2017 on troubles at
Turkish Air. The carrier had gained from its location, allowing easy connections for fliers between Europe and
Africa/Middle East. Turkish Air's growth slowed into 4Q, coming off a very weak 3Q as fares were likely cut to fill
planes after a coup attempt throttled demand in July. If Turkish Air slows capacity growth and the region remains
stable, yields could be a bright spot.

Full-service European airlines that serve Africa and the Middle East include Air France, Lufthansa and IAG.
Ryanair, EasyJet and Norwegian Air also serve limited numbers of cities, though could expand coverage if yields
rise and security is stable. Middle East/Africa revenue is relatively small.

European Airlines Africa/Middle East Yields (YoY%)

Fuel Prices Rising

This report may not be modified or altered in any way. The BLOOMBERG PROFESSIONAL service and BLOOMBERG Data are owned and distributed locally by Bloomberg Finance LP
("BFLP") and its subsidiariesin all jurisdictions other than Argentina, Bermuda, China, India, Japan and Korea (the ("BFLP Countries"). BFLP is a wholly-owned subsidiary of Bloomberg LP
("BLP"). BLP provides BFLP with all the global marketingand operational support and service for the Services and distributes the Services either directly or through a non-BFLP subsidiary in the
BLP Countries. BFLP, BLP and their affiliates do not provide investment advice,and nothing herein shall constitute an offer of financial instruments by BFLP, BLP or their affiliates.
 10. Futures Show European Airline Margins Narrower on Fuel in 2017
12/13/16
Brent futures indicate European airline margins are at risk to higher fuel costs in 2017 and won't benefit from
lower prices. Airlines which hedged less, including Norwegian, will be hurt the most, though currency hedges may
alleviate some of the pain. Airlines with the largest fuel and currency hedges, including Lufthansa, Air France,
Ryanair and EasyJet, may have it easier. The weakening of the euro and pound against the dollar could
exacerbate the expected increase in oil prices during the year.

The futures curve shows that on an unhedged basis, airline margins may be pressured by fuel costs in 2017. The
average Brent price was 37 euros ($39) a barrel in 1Q. That rose to 43-44 euros on average in 2Q-3Q, and leapt
to 47 euros in 4Q. The curve prices Brent at 49-51 euros in 2017.

Brent Futures Curve in Euros

Wage Battles

11. Lufthansa Pilot Contract Sustains Eurowings' Low-Cost Platform

02/22/17
The mediated agreement between Lufthansa and the pilot union, while increasing costs at Lufthansa and
Germanwings, seems to maintain Eurowings' platform for competition against European low-cost carriers. The
pilots must ultimately agree, but the proposal recommended by the union negotiator would increase wages 2%
retroactively for 2016, 2.3% in 2017, 2.4% in 2018 and 2% in 2019. It also allows 40 aircraft to be operated
outside the group tariff, which presumably is also outside Eurowings.

Eurowings is Lufthansa's answer to low-cost competition from Ryanair, Easyjet, Norwegian, IAG's Vueling and
others. Lufthansa has among the highest cost-per-seat mile of European airlines and needs to lower crew costs
to be competitive on leisure routes or risk ceding market share.

This report may not be modified or altered in any way. The BLOOMBERG PROFESSIONAL service and BLOOMBERG Data are owned and distributed locally by Bloomberg Finance LP
("BFLP") and its subsidiariesin all jurisdictions other than Argentina, Bermuda, China, India, Japan and Korea (the ("BFLP Countries"). BFLP is a wholly-owned subsidiary of Bloomberg LP
("BLP"). BLP provides BFLP with all the global marketingand operational support and service for the Services and distributes the Services either directly or through a non-BFLP subsidiary in the
BLP Countries. BFLP, BLP and their affiliates do not provide investment advice,and nothing herein shall constitute an offer of financial instruments by BFLP, BLP or their affiliates.
 Lufthansa Costs per Seat Kilometer (Ex-Fuel)

12. Lufthansa, Air France Push for Wage Tiers in Low-Cost Battle
12/13/16
Full-service airlines IAG, Lufthansa and Air France must continue to drive down wage costs to become
competitive against low-cost carriers if they want to maintain short-haul market share. European low-cost carriers
are taking share with discount fares, which they're able to do because their wage-per-seat costs are about half
those of full-service carriers. Ryanair, Norwegian and EasyJet have the lowest wage-seat cost of any European
airline. Turkish Airlines is competitive, though it can't fly intra-Europe routes.

Lufthansa is trying to use Eurowings as a low-cost platform, though its pilots union is resisting the addition of a
lower pay tier. Air France pilots have also struck, in part to protest a similar tier at low-cost subsidiary Transavia.

Wage Per Seat Kilometer Costs (Euro Cents)

To contact the analyst for this research:

George Ferguson at gferguson5@bloomberg.net

This report may not be modified or altered in any way. The BLOOMBERG PROFESSIONAL service and BLOOMBERG Data are owned and distributed locally by Bloomberg Finance LP
("BFLP") and its subsidiariesin all jurisdictions other than Argentina, Bermuda, China, India, Japan and Korea (the ("BFLP Countries"). BFLP is a wholly-owned subsidiary of Bloomberg LP
("BLP"). BLP provides BFLP with all the global marketingand operational support and service for the Services and distributes the Services either directly or through a non-BFLP subsidiary in the
BLP Countries. BFLP, BLP and their affiliates do not provide investment advice,and nothing herein shall constitute an offer of financial instruments by BFLP, BLP or their affiliates.