Lufthansa can fly higher

First-quarter results for 2013 were solid enough and triggered a round of earnings upgrades. Revenue was static and operating losses in the traditionally weak period were flat at €359m (£307m), despite strikes and €64m of restructuring costs. Average fares rose and, crucially, management still thinks full-year operating profit will beat the €524m Lufthansa made in 2012 - analysts think it will double.

If all goes to plan, Lufthansa will make €2.3bn in 2015 and its operating profit margin will nudge 8 per cent compared with just 2.8 per cent last year. That might sound ambitious, but airlines run with lots of fixed costs and, meanwhile, some major drivers are all rapidly moving in the right direction.

Much is being pinned on a massive restructuring programme, dubbed 'SCORE'. Lufthansa Italia has been shut down and loss-making British Midland (BMI) sold to International Consolidated Airlines (IAG), which operates British Airways. Taking over all Lufthansa's short-haul routes not operated from hubs at Frankfurt and Munich from July will boost profits at budget subsidiary Germanwings this year, and radical action at both SWISS and Austrian Airlines will chip in, too.

About 3,500 jobs will also disappear, but angry unions, who had walked out over pay, have agreed a new pay deal, which ends the threat of further action. Plenty of back-office and procurement initiatives are under way, too. Yes, Lufthansa will incur €170m of costs and there is so-called 'execution risk', but the airline's bosses found €618m-worth of savings last year and expect to make another €740m in 2013.

There will be a big tailwind from fuel costs, too. The price of jet fuel has tumbled from $1,100 per metric tonne to less than $900, which should cap Lufthansa's annual fuel bill at €7bn, lower than expected. Of course, prices could rise again, but, if they don't, Lufthansa will spend about €400m less on fuel this year and analysts' profit estimates should rise further. Indeed, those high fixed costs mean that most of the fall in fuel costs will drop straight into profits.

And Lufthansa finally looks to have got a grip on growth in its capacity. After years of ramping up too fast, short-haul capacity is being cut by 2.9 per cent this summer to improve revenue per seat and boost 'load factor' (the proportion of seats sold), which rose two points to 76 per cent in 2013's first quarter. That decision has gone down well with analysts. An increase in more lucrative long-haul capacity should further boost yields.

Of course, Lufthansa has been rewarded for its actions - its share price has doubled over the past 12 months - but forecasts have been ramped up, too, so the shares still trade on just eight times 2014's earnings estimates. IAG's shares trade on 12 times earnings. And a multiple of five times enterprise value to cash profits, including aircraft rent and ownership costs, is unjustified, according to Gerald Khoo, an analyst at broker Espirito Santo. Even Air France-KLM limps in at six times, in line with the sector average.

The current valuation still gives insufficient credit for Lufthansa's clearer focus and better capital allocation, or the likelihood of it hitting restructuring and profit targets, argues Mr Khoo. What's more, adjusted return on capital has averaged about 10 per cent over the past decade, which analysts at broker Goodbody reckon justifies a rating in line with rival flag carriers.