Finnair Oyj – Interim report – 30 June 2022
16. IMPAIRMENT TESTING
Fleet and other non-current assets subject to depreciation, including the right-of-use assets, are stated at historical cost less accumulated depreciation and impairment loss, when applicable. The Group reviews the assets for impairment at each reporting date or whenever there is any indication of impairment. Goodwill and intangible assets with indefinite useful life are not subject to depreciation but to annual impairment review at each reporting date. An impairment loss is recognized if the recoverable amount of an asset is below its carrying amount. The recoverable amount is determined as the higher of the asset’s fair value less costs to sell or its value in use. Finnair applies the value in use model as its primary method for determining the recoverable amount of the assets. Finnair’s impairment testing based on the value in use model is described in more detail in the consolidated financial statements 2021 and below.
Finnair considers the various adverse economic and business implications relating to the COVID-19 pandemic and the closure of the Russian airspace following the war in Ukraine as indications of possible impairment, and therefore, impairment test has been carried out as of 30 June 2022. Such indicators include the unprecedented global market disruptions caused by the pandemic and the war in Ukraine as well as their negative impacts on the Group’s operating environment, financial performance, and lower capacity utilization rates. The impairment review based on value in use approach is carried out at the level of a cash generating unit (‘CGU’) and is based on Finnair’s current business model and fleet as at the reporting date. Finnair is a network carrier with highly integrated fleet operations and considers all its fleet and other closely related assets as one CGU. The intangible assets with indefinite useful life have been identified to belong to the CGU for impairment testing purposes. The intangible assets with indefinite useful life amount to 1.4 million euros (31 March 2022: 1.4). Assets that are held for sale are excluded from the CGU and reviewed separately for impairment.
The cash generating unit has been tested for impairment using value in use model based on which the recoverable amount of the CGU exceeds its carrying value at the balance sheet date. The recoverable amount of the CGU on 30 June 2022 was 1,800.5 million euros (31 March 2022: 1,950.3) and the carrying amount of the assets 1,551.0 million euros (31 March 2022: 1,807.3).
The value in use measurement is based on a discounted cash flow model where the cash flow projections are based on the latest business plan approved by the Board of Directors and a management forecast covering a five-year period. The cash flows beyond the five-year period are projected to increase in line with management’s long-term growth assumptions. In order to consider the increased uncertainty caused by the war in Ukraine and the COVID-19 pandemic on the future outlook, Finnair is utilizing the expected cash flow approach, which is using multiple, probability-weighted cash flow projections based on the different forecast scenarios prepared by the management. The scenarios and probabilities allocated to each scenario have been reviewed and approved by the Board of Directors in connection with the preparation of the interim financial report. In determining the probabilities of the scenarios, the management has considered, in particular, the heightened uncertainty surrounding the duration of the airspace closure in Russia, but also the uncertainty of the pace of the post-pandemic recovery.
The modelling of cash flows is based on the latest forecast scenarios prepared by the management which are described in note 4. The Board of Directors’ assessment of Finnair as a going concern. The scenarios differ mainly in the duration of the Russian airspace closure which is, under the optimistic scenario, estimated to last around 3 years and under the more pessimistic scenarios the closure is expected to last until foreseeable future. In the optimistic scenario, which is considered to have a probability of 40%, the operations are expected to return to the pre-pandemic levels of 2019 in 2025. Under the two more pessimistic scenarios, each of which are considered to have a 30% probability, the 2025 annual operational capacity is expected to be ca. 84% of the of the 2019 levels.
The preparation of the calculations used for impairment testing requires significant management judgement and the use of management estimates. These estimates are based on budgets and forecasts, which already inherently contain some degree of uncertainty. Uncertainty and related management judgement are described in more detail in the consolidated financial statements 2021 and in this interim report’s note 3. Critical accounting estimates and uncertainties. The main factors requiring significant management judgement include, in particular, estimating a duration for the Russian airspace closure as well as the speed of the post-pandemic demand recovery and unit revenue development. It is especially difficult to predict the duration of the Russian airspace closure. Finnair has considered the impact of these management estimates on the impairment testing by using the abovementioned forecast scenarios and expected cash flow approach in the testing. Additionally, the value in use calculation is sensitive to changes in the EBITDA margin, the cost of jet fuel, the terminal growth rate, and changes in the discount rate, which are the key assumptions used in the calculation.
The estimated business growth and EBITDA are based on the management’s best assessment of the duration of the Russian airspace closure, the pace of recovery from the pandemic as well as the development of market demand and environment. The estimates are benchmarked against external information sources when available, such as long-term average growth estimates for the industry. The increased uncertainty related to the COVID-19 is considered through the multiple scenarios and the expected cash flow approach used in impairment testing as well as in the discount rate. The discount rate used is based on the weighted average cost of capital (WACC), which reflects the market assessment of the time value of money and the risks specific in Finnair’s business. Fuel price is based on hedge-weighted fuel price based on the forward curve, estimated fuel consumption based on planned flights and the historical data of fuel consumption for each aircraft type.
Due to increased uncertainties related to the use of key assumptions and management estimates, Finnair has prepared a sensitivity analysis to reflect how the result of the impairment testing would react to the changes in key assumptions. The sensitivity analysis considers changes in one assumption at the time, whereby the other assumptions are kept unchanged. The result of the sensitivity analysis reflects the sensitivity of the recoverable amount based on expected cash flow model.
4. THE BOARD OF DIRECTORS’ ASSESSMENT OF FINNAIR AS A GOING CONCERN
The consolidated half-year financial report for the period ending 30 June 2022 has been prepared based on the going concern assumption. The Finnair Board of Directors has assessed the Group’s ability to continue as a going concern based on the Group’s ability to meet its obligations as they fall due at least 12 months after the half-year financial report is issued. The Board of Directors’ assessment is based on the latest business plan approved by the Board of Directors which also considers impacts of the Russian airspace closure and the COVID-19 pandemic on the Group’s financial situation. Due to the uncertainty embedded in the economic environment and the difficulty of forecasting its duration, the Board of Directors has considered three different forecast scenarios prepared by the management that cover a period of 30 months from July 2022 until December 2024. The scenarios have been sensitized to reflect differences in the duration of the Russian airspace closure and its impact on the company’s scope of business, network and fleet as well as profitability. The main identified uncertainties and management assumptions relating to the forecast scenarios and the going concern assessment are described in more detail in the consolidated financial statements 2021 and in the above note 3. Critical accounting estimates and sources of uncertainty.
Revenue and profitability are expected to improve slower in 2022 and in the following years than what was estimated at the time of the preparation of the 2021 financial statements, which is caused by the closure of the Russian airspace and increased jet fuel prices. According to the optimistic scenario updated in connection with the half-year report, the airspace would open in three years, while in connection with this year’s first interim report, the airspace was estimated to open in two years. Correspondingly, under the two more pessimistic scenarios, the Russian airspace would remain closed for the foreseeable future whereas in connection with the earlier interim report, the Russian airspace was estimated to be closed for three or four years. Under the two more pessimistic scenarios, the company expects to optimize its capacity and network taking into account the effects of the Russian airspace closure, and to be able to materially streamline its operations during the years 2022-2024. Under the optimistic scenario, Finnair expects to operate at ca. 70% capacity in 2022 and ca. 89% capacity in 2023 (measured in annual available seat kilometres) as compared to the pre-pandemic levels of 2019. Under the two more pessimistic scenarios, Finnair expects to operate at 69% capacity in 2022 and at 81% capacity in 2023. In the optimistic scenario, the operations are expected to return to the pre-pandemic levels of 2019 in 2025, while under the more pessimistic scenarios, the 2025 annual operational capacity is expected to remain around 84% of the 2019 levels. Finnair will be able to meet its obligations as they fall due at least 12 months after the date that the consolidated half-year report is issued under all scenarios.
While the duration of the Russian airspace closure or COVID-19 pandemic is not in the sphere of Finnair’s influence, Finnair continues to adjust its operational capacity and reducing costs. Finnair is also preparing a new strategy to improve its weak profitability and to strengthen its financial position. The company’s target is to complete the strategy work during the autumn of 2022.
Considering the circumstances and uncertainties mentioned in the consolidated financial statements 2021 and above, as well as the already realized and planned measures to mitigate the impacts of the closure of the Russian airspace and COVID-19-pandemic, the Board of Directors has concluded that the assessment does not cast significant doubt on the Group’s ability to continue as a going concern and that consequently, the Group continues to adopt the going concern basis of accounting in preparing the consolidated half-year report. The Board of Director’s conclusion is based on the information available as at the date of the issuance of the half-year financial report and an assessment conducted based on the information assuming, that the company is able to conduct its adjusted business operations according to the plan and to maintain sufficient financing for a period of at least 12 months after the date that the consolidated half-year report is issued. The management and the Board of Directors have also considered events and developments taking place after the balance sheet date and concluded that there is no material impact on the scenarios approved by the Board of Directors and the going concern assessment of the Group.
Despite the various mitigating measures implemented by Finnair, its financial performance in the upcoming months will be significantly affected by the closure of Russian airspace, the pandemic, and high jet fuel prices, leading to weaker financial performance as compared to the pre-pandemic levels, for a duration that is currently uncertain. Should future events or conditions cause the Group to be unable to continue its operations in accordance with the Board of Director’s current assessment, using the going concern principle may prove to be no longer justified and the carrying values as well as the classification of the Group’s assets and liabilities would have to be adjusted accordingly.