TUI AG – Annual report – 30 September 2022
Principles and Methods underlying the Consolidated Financial Statements (extract)
Key judgements, assumptions and estimates (extract)
ASSUMPTIONS AND ESTIMATES (extracts)
Assumptions and estimates that may have a material impact on the amounts reported as assets and liabilities in TUI Group are mainly related to the following balance sheet-related facts and circumstances:
- Determination of assumptions for use in impairment tests, in particular for goodwill and property, plant and equipment
- Effect of climate-related risks on the measurement of assets
- Determination of the fair values for acquisitions of companies and determination of the useful lives of acquired intangible assets
- Determination of useful lives and residual carrying amounts of property, plant and equipment
- Determination of actuarial assumptions to measure pension obligations
- Recognition and measurement of other provisions
- Determination of the incremental borrowing rate used to measure lease liabilities
- Recoverability of future tax savings from tax losses carried forward and tax-deductible temporary differences
- Measurement of tax risks
- Recoverable amounts of touristic prepayments
- Determination that the package holiday represents a performance obligation due to the significant integration service
- Determination of period-related revenue recognition on a straight-line basis over the duration of the trip
- Determination of the ECL of financial instruments
DETERMINING ASSUMPTIONS FOR USE IN IMPAIRMENT TESTS, IN PARTICULAR FOR GOODWILL AND PROPERTY, PLANT AND EQUIPMENT
The impairment tests are performed on the basis of future discounted cash inflows derived from medium-term corporate planning. Both the derivation of future cash inflows and the determination of the interest rate are heavily influenced by assumptions and estimates and are associated with uncertainties, in particular due to the strong general increase in prices and interest rates, which could lead to a decline in demand for tourism products, due to long-lasting price increases for fuel and other input factors and as a result of climate related risks.
While TUI’s Winter 2021 / 22 business was still adversely affected by travel restrictions in response to the COVID-19 pandemic, all segments fully resumed their operations after these restrictions were gradually lifted. From April 2022, the Cruises segment again operated its entire fleet. From Summer 2022, Hotels & Resorts offered their entire product portfolio. Demand showed a very robust recovery, which, however started later than assumed in the prior year’s planning due to the travel restrictions in place at the beginning of the financial year. In the Cruises segment, demand recovered later than in other segments. A shorter-term booking pattern continues to be observed. The unprecedented restart of business operations resulted in business disruptions in aviation, in particular in the UK and the Netherlands, but also in other source markets, causing an adverse impact on Group earnings. The price increases recorded in the course of the financial year under review, in particular for fuels, and the fluctuations in exchange rates were not fully offset by higher travel prices and placed an additional burden on earnings in the completed financial year. For financial year 2023, it is expected that travel restrictions will no longer have a material impact on TUI’s business and that TUI’s business will return to 2019 levels. However, in financial year 2023, fuel costs are expected to remain high as well as energy and food prices. The cost-saving initiatives already implemented, especially in Markets & Airlines and the segment Musement, will have a positive effect. For the subsequent financial years 2024 and 2025, the cost-saving initiatives already implemented, the further digitalisation of our business and the expansion of existing and new business areas are expected to take largely effect. These factors together will lead to customer volumes which will expectedly exceed 2019 levels. Fuel prices are expected to decline in those years though remain at higher levels. Below we describe the key assumptions underlying medium-term business planning in the segments.
In its business plan, Hotels & Resorts expects to improve performance versus 2022, in particular as travel restrictions are no longer expected. This development is expected to benefit from TUI’s high level of direct distribution, enabling the segment to steer customers to its own hotels. In the medium term, the segment is expected to deliver further earnings growth due to capacity expansion, demand growth and increases in average selling prices.
In the Cruises segment, Marella and TUI Cruises are expected to operate their entire fleets and achieve occupancy rates close to 2019 levels in financial year 2023. However, earnings will be adversely impacted by increased prices for bunker oil in 2023. Post-2023, prices for bunker oil are expected to decline, initially to levels 23 % and then to 16.5 % above the assumed price levels for fuel of prior year’s planning. In Summer 2023, Marella will already be expanding its fleet by an additional cruise ship. TUI Cruises will transfer that vessel in Summer 2023 and expand its fleet to eight ships (excluding the Hapag Lloyd Kreuzfahrten brand) in the following years to 2025. The fleet expansion and the associated assumptions about occupancy rates are subject to elevated uncertainty.
The future development of TUI Musement depends in part on the development of customer numbers in Markets & Airlines. TUI Musement will also generate growth through the sale of tours, activities and tickets due to the expansion of its own / direct distribution via the internet and the app.
In Markets & Airlines, financial year 2023 is expected to see a return of customer numbers to 2019 levels, partly driven by market consolidation. The implemented cost-savings initiatives will cushion the adverse earnings impact from higher fuel prices and other higher costs. The operational flight disruption encountered in financial year 2022 is not expected to recur in 2023 to that extent, partly due to measures initiated by TUI itself, partly because airports will adjust their capacity to higher load factors. Wider use of online distribution, the provision of dynamic production capacities for flights and accommodation and the investments in digitalisation are expected to take effect in financial years 2024 and 2025. Moreover, kerosene prices are expected to decline initially to 49.6 % and then 41.0 % above the assumed price niveau of prior year’s planning. These planning assumptions are subject to elevated uncertainty.
Other key factors are the weighted average cost of capital after income taxes (WACC), on which discounting is based, the sustainable growth rate and the growth in perpetuity. Changes in these assumptions may have a significant impact on the recoverable amount and the amount of any impairment loss. The increase in the general interest rate level in financial year 2022 also resulted in an increase in WACC as at 30 September 2022.
The weighted average cost of capital after income taxes (WACC), on which discounting is based, was derived from external capital market information about comparable companies. The cost of capital to Markets & Airlines was increased by an additional risk premium of 1.9 % (previous year 3.4 %). This additional risk premium was based on an analysis of internal and external market expectations and reflects the elevated uncertainty with regard to medium- and long-term market developments as well as existing risks regarding a general price inflation which could lead to a decline in demand for tourism products and increased prices for fuel and other input factors. Additional country-specific risk premiums are included, in particular, in the measurement of individual hotels. On the determination of WACC we refer to the section Goodwill.
The increased discount factor and the general price inflation, in particular, triggered the implementation of a risk assessment for the Group’s assets in the light of indications suggesting impairments as at 30 September 2022. Where an increased risk was identified for a cash-generating unit, its assets were tested for impairment. Moreover, where additional indications such as planned closures, divestments or restructurings were observed, the assets were also tested for impairment. All previously impaired assets were tested for reversals of impairments and all goodwills were tested for impairments.
Finally we have implemented sensitivity analyses to estimate the uncertainty associated with the assumptions on which the impairment tests are based. The sensitivities and their impact on the fair value result exclusively from the adjustment of individual parameters. Possible compensatory measures were not taken into account. Sensitivities have been calculated for changes of the WACC and the sustainable growth in perpetuity. In addition, sensitivity analyses have been carried out for a general increase or decrease of future cash flows, a long-lasting increase or decrease of prices for fuel, risks or chances related to demand and fuel prices in the financial year 2023 and for material climate related risks. For further details we refer to the section ‘Goodwill’.
EFFECT OF CLIMATE-RELATED RISKS ON THE MEASUREMENT OF ASSETS
Climate-related risks can have an impact on the recoverability of the Group’s assets in various ways. These risks include the increasing occurrence of natural disasters and the resulting damage, e. g. to hotels, or the disruption to travel activity. TUI addresses risks from natural disasters, e. g. hurricanes, by taking out insurance policies. In addition TUI has well-established crisis management procedures in place which are focused on the welfare of the customers in such situations. The related expenses are included in the business plans. In total the aforementioned physical risks do not have a material financial impact. Accordingly these risks are not comprised in the sensitivity analysis described in the section ‘Goodwill’.
Climate-related risks with an impact on the recoverability of assets can additionally occur if the demand for the services of TUI declines because they do not meet the standards in relation to emissions and adaptation to climate change. TUI counteracts these risks with its strategy to reduce climate-damaging emissions and increasing the sustainability of our services. These so called transitional risks are subsumed under SBTi risks.
Moreover, the future cash inflows used in impairment tests for individual assets may also be affected by higher future expenses due to regulatory or voluntary measures to reduce climate-damaging emissions. In 2022, TUI joined the Science Based Target intitiative (SBTi), committing to implement emission reductions until 2030. Detailed emission reduction roadmaps have been developed for TUI’s airlines, cruises and hotels which represent 99 % of the Groups’s own emissions. The estimates of the impact on future cash inflows from these roadmaps are subject to substantial uncertainty. This uncertainty is especially related to changes in the regulatory framework, the development of new technologies and changes in customer behaviour. The impact is different between the segments. The following SBTi risks are taken into account in the sensitivity analysis in the section ‘Goodwill’.
In Markets & Airlines, these risks primarily concern the airlines. They will be impacted by higher aircraft fuel taxes, emissions trading and the consumption of low-carbon aviation fuel. These expenses will partially be offset by cost savings from reduced aviation fuel consumption and lower costs of emissions trading in the wake of an increasing use of low-carbon aviation fuels. Overall we expect an increase of the flight expenses. Given the comparable young and efficient fleet of TUI we expect that we will occur less additional costs than other airlines. Therefore it is our assumption that these increases are in a range that made it possible to cover them by corresponding price increases. However, at the current point in time, the future regulatory framework for aircraft fuel tax and emissions trading is not yet known and there is as yet insufficient production capacity for low-carbon aviation fuel. In addition the willingness to pay of our customers might not be sufficient to cover the cost increases. The estimates are therefore subject to elevated uncertainty.
TUI assumes that expenses from measures to reduce climate-damaging emissions in the Hotels & Resorts segment will relate in particular to efforts to reduce energy consumption, to establish own energy generation units, e. g. through the use of solar installations, and to purchase energy which has been produced without climate-damaging emissions. Estimates show that energy-saving measures as well as the Group’s own generation of energy may lead to savings that exceed the initial expenses.
In the Cruises segment, the measures to reduce climate-damaging emissions include investments, leading, for instance, to a more efficient use of the ships and the installation of shore power connections. These investments are already included in planned capital expenditure. However, in the Cruises segment, too, a big proportion of future expenses will relate to the use of low-carbon fuels, bunker oil taxes and emissions trading. As in Markets & Airlines, the estimates of these expenses and the willingness to pay of our customers are subject to substantial uncertainty.
Overall, TUI does not consider climate-related risks as a triggering event to test assets for impairment as at 30 September 2022. However, we have implemented sensitivity analyses for all relevant cash generating units to estimate the uncertainty associated with the assumptions, presented in the section ‘Goodwill.’ The sensitivity analyses for these SBTi risks are calculated for an increase or decrease of the expenses related to the reduction of climate-damaging emissions until 2030 without taking into account a compensation by changes of the travel prices.
PROPERTY, PLANT AND EQUIPMENT
The measurement of wear-and-tear to property, plant and equipment items entails estimates. In addition material assumptions and estimates are the determination of useful lives and residual carrying amounts of property, plant and equipment. The carrying amount of property, plant and equipment as at 30 September 2022 totals € 3,400.9 m (previous year € 3,159.3 m). In order to review the amounts carried, an evaluation is carried out on a regular basis to assess whether there are any indications of a potential impairment. These indications relate to a number of areas and factors, e. g. the market-related or technical environment but also physical condition. If any such indication exists, management must estimate the recoverable amount on the basis of expected cash flows and appropriate interest rates.
More detailed information on the useful lives and residual values of property, plant and equipment items is provided in the section ‘Property, plant and equipment’ in the section ‘Accounting and measurement methods’.
In accordance with the provisions of IAS 21, goodwill allocated to the individual segments and sectors was recognised in the functional currency of the subsidiaries and subsequently translated when preparing the consolidated financial statements. Similar to the treatment of other differences from the translation of annual financial statements of foreign subsidiaries, differences due to exchange rate fluctuations between the exchange rate at the date of acquisition of the subsidiary and the exchange rate at the balance sheet date are taken directly to equity outside profit and loss and disclosed as a separate item. In financial year 2022, a reduction in the carrying amount of goodwill of € 22.5 m (previous year increase of € 78.6 m) resulted from foreign exchange differences.
The following table presents a breakdown of goodwill by cash-generating unit (CGU) at carrying amounts. Other exclusively consists of the two cash-generating units Robinson and Blue Diamond, which belong to the Hotels & Resorts segment.
As at 30 September 2022, an impairment test of capitalised goodwill was performed at the level of cash-generating units. No impairments of capitalised goodwill were identified.
For all CGUs, the recoverable amount was determined on the basis of fair value less costs of disposal, being the higher value compared to the value in use. The fair value was calculated by discounting the expected cashflows. This was based on the medium-term plan for the respective entity as at 30 September 2022. Budgeted revenues and EBIT margins are based on expectations with regard to the future business performance. We refer to the section ‘Key judgements, assumptions and estimates’.
The discount rates are calculated as the weighted average cost of capital, taking account of country-specific risks of the CGU and based on external capital market information. The unchanged high weighted average cost of capital reflects the current market situation and in particular the increase in beta factors and debt capital.
The table below provides an overview of the parameters versus the previous financial year, underlying the determination of the fair values per CGU. Due to a growth phase in the first three planning years, the planning period for TUI Musement was extended to five years in order to represent a normalised business. At Marella Cruises, the higher growth rate in revenues in the previous financial year is mainly due to an expected addition of a new ship in the planning year 2024. As in the previous year, the EBIT margin has been adjusted for deductions of centrally incurred costs The table lists the CGUs to which goodwill has been allocated:
In view of the existing uncertainties regarding future business development, an analysis of sensitivities for the main planning parameters was carried out. In the sector Markets & Airlines a risk premium of 1.9 % (previous year 3.4 %) was added to the cost of capital. For further information we refer to ‘Key judgements, assumptions and estimates’. The following table shows the effects of potential deviations in fair value in financial year 2022:
The fair values determined in the sensitivity analysis would have led to an impairment requirement of € 36.0 m in the Hotels & Resorts segment (CGU Robinson) if the WACC had increased by 100 basis points. The reduction in the Cash inflow by 10 % would result in an impairment requirement of € 28.8 m in the Hotels & Resorts segment (CGU Robinson). With the exception of the impairments presented in the Hotels & Resorts segment, the sensitivity analysis did not reveal any further indications of an additional need for impairment losses.
Due to existing uncertainties regarding the general increase in prices and interest rated, which could lead to a decline in demand for travel services, in connection with possible significantly higher costs for fuel and other input factors in the short term, as well as the SBTi risks, which have been described above, and the associated effects on the tourism business, an extended analysis of sensitivities was carried out for cash-generating units with goodwill. For information on these uncertainties, please refer to the section ‘Key judgements, assumptions and estimates’. The sensitivity of the effects of the Science Based Target initiative (SBTi) is based on the assumption of additional negative effects on earnings or lower costs as expected from the planned measures necessary to reach the climate targets. Existing uncertainties for financial year 2023 as a result of the general increase in prices and the associated fall in demand, the USD development and in relation to fuel costs are reflected in the sensitivity of demand and price risks. In addition a corresponding positive development in 2023 has been considered. The sensitivities relating to fuel costs are based on the assumptions of cost increases or cost reductions for aircraft and cruise ships, considered equally for all plan periods. The shown sensitivities and their impact on the fair value result exclusively from the adjustment of the individual parameters. Possible compensatory measures such as using derivative financial instruments to limit price risks or cost saving measures were not taken into account in the determination.
Only the increase in fuel prices by 10 % would have led to an impairment of € 9.5 m in the segment Region West. The following table provides the effects of the sensitivities on the fair value in the financial year 2022.