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International Consolidated Airways Group - Flying steady

Nicholas Hyett | 5 May 2017 | A A A
International Consolidated Airways Group - Flying steady

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International Consolidated Airlines CDI

Sell: 204.30 | Buy: 204.60 | Change -8.90 (-4.17%)
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IAG delivered a 9.7% increase in operating profits in the first quarter, at EUR170m it's a record first quarter performance, with a substantial fall in passenger and cargo revenues offset by improvements in ancillary services and lower fuel costs.

Shares rose 4.8% following the announcement.

Our View

Lower fuel prices have helped to boost IAG's profits of late, but they're also contributing to the supply problems that are plaguing the industry. Surging capacity (up around 6.2% in 2016) mean that airlines are having to cut prices to fill their seats. That would normally drive the weaker players out of the market, but lower fuel prices mean they are hanging on in there.

The group is offsetting the lower prices by increasing the numbers of passengers it flies, and cutting operating costs. Progress is slow, it takes time to put new planes into service, but the group is making headway. Cost control is proving particularly impressive.

There's potential for turbulence ahead though. Negative economic fallout in UK from the vote to leave the EU is a worry. First and Business class passengers contribute hugely to profits, and their custom turns off and on like a tap as the economy rises and falls. There's no update on how the segment is faring today, but the decision to launch a budget long haul carrier flying out of Spain rather than the UK might be an indication of which way the wind is blowing.

The problem for any airline is that deep recessions or global panics empty the plane, but leases and 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 a forward price to book measure, a more conservative way of looking at valuation in intensely cyclical, asset-heavy businesses like airlines, IAG is trading at 2.1x. That's actually above where it was before the referendum and historically the rule of thumb has been that something closer to 1x is the safety zone.

First Quarter Results

Passenger Revenue fell 4.2% to EUR4.3bn, contributing to a 2.8% fall in total revenue to EUR4.9bn. The fall came despite improvements in both journeys flown and the number of empty seats, and reflects continuing pricing pressure and the timing of Easter.

As well as benefiting from lower fuel prices, fuel costs were down over 10%, the group saw employee costs fall 6% thanks to efficiencies achieved across all airlines. Total reported non-fuel costs were down 3.9%, although rose 1.4% at constant exchange rate.

In March IAG launched LEVEL, a new low cost airline offering flights between Barcelona and Los Angeles, San Francisco, Buenos Aires and Punta Cana. Early sales are running ahead of expectations.

The group saw a 16.6% increase in cash held on the balance sheet compared to the year end, hitting EUR7.5bn. Adjusted net debt to EBITDAR (earnings before interest, taxes, depreciation, amortisation and Rent) fell to 1.5 times.

At current fuel prices IAG expects 2017 operating profits to be ahead of last year, with second quarter revenue per available seat kilometre (ASK) to be ahead of the same period in 2016 at constant exchange rates.

Unless otherwise stated, all estimated figures, including prospective dividend yields, are taken from a consensus of analyst forecasts compiled by Thomson Reuters. These estimates should not be taken as a reliable indicator of future performance.

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 disclosure for more information.