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IAG - Fuller planes flying further

Nicholas Hyett | 29 July 2016 | A A A
IAG - Fuller planes flying further

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No news or research item is a personal recommendation to deal. All investments can fall as well as rise in value so you could get back less than you invest.

International Consolidated Airlines CDI

Sell: 131.82 | Buy: 131.96 | Change -22.92 (-14.85%)
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International Consolidation Airlines Group (IAG) have reported a 4.1% increase in first half revenues, at EUR10.8bn, with operating profits up 27.9% to EUR710m. IAG shares opened rose 2% in early trading.

The group has seen a softer than expected second quarter, as terrorism, the EU referendum, Spain's political situation and weakness in Latin American economies all impacted demand. Operations have also been disrupted by 22 strikes across Europe so far this year.

Despite the weaker backdrop, the group has kept its planes fuller and flown further this year, with seat factor up 0.7 percentage points to 80% and available seat kilometres (ASK) up 12.3%. That has helped to offset weaker pricing (passenger unit revenue per ASK is down 7.2%) with non-fuel costs flat.

IAG's balance sheet position has is improving with adjusted gearing has falling by one percentage point to 53% with cash increasing 12% to EUR6.6bn.

Outlook:

The UK group continues to target cost savings, expecting reductions in underlying non-fuel unit costs of around 1% at constant currency for the full year (in line with previous guidance). Planned capacity growth for the second half of the year has been reduced with capacity growth and capex for 2017 under review.

Visibility for Q4 revenue remains low, although 74% of expected revenues for Q3 have already been booked. Given current fuel prices and currency levels, the group expects low double digit percentage growth in pre-exceptional operating profit in 2016.

Equity free cash flow is expected to be with the EUR1.5bn - EUR2.5bn range.

Our view:

Despite terrorist attacks and strikes, IAG seems to be dealing well with the drop off in demand that is plaguing the sector. Increased passenger numbers are making up for falling pricing while the group is starting to make head way on cutting costs.

The group has played down the impact of Brexit, although as a Euro reporter with 36% of revenues generated in the UK, lower sterling has dramatically hit reported profits. However, if the UK were to enter a recession BA would be among the first in the firing line.

First and Business class passengers contribute hugely to profits, and their custom turns off and on like a switch as the economy rises and falls. The current weakness being seen in premium cabins could be a warnings sign of things to come.

The problem for any airline is that all those aircraft have to be paid for, whether anyone is sitting in them or not. Deep recessions or global panics empty the plane, but the leases and the bank debts have to be serviced all the same. Seat factor, essentially how full the airline has managed to keep the plane, will be a closely watched figure going forwards.

On price to book measures, a more conservative way of looking at the valuation of intensely cyclical, asset-heavy businesses like airlines, IAG is trading at 1.4x. That's a lot lower than it was before the shares dropped 30% following the referendum but historically, the rule of thumb is that below 1x is the safety zone.

If economic conditions significantly deteriorate and weakness in premium demand worsens further, the market will punish airlines. BA's focus on premium, long haul flights leaves IAG particularly vulnerable. However, for today at least IAG is enjoying the benefits of the benefits of flying fuller planes further.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.