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IAG - Profits soar as fuel costs plummet and revenues climb

Nicholas Hyett | 28 July 2017 | A A A
IAG - Profits soar as fuel costs plummet and revenues climb

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International Consolidated Airlines CDI

Sell: 204.30 | Buy: 204.60 | Change -8.90 (-4.17%)
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Operating profits at British Airways and Iberia owner International Consolidated Airlines Group rose 45% in the second quarter to EUR805m. The improved performance was driven by a 4% increase in passenger unit revenues and 13.2% fall in fuel costs, partially offset by a 3.5% increase in non-fuel costs.

The shares rose 1% following the announcement.

Our View

Airline capacity is surging (up around 6.2% in 2016), particularly at the budget end of the market. With more planes in the air, prices have slid as airlines scramble to keep their planes full. This kind of price war would normally drive the weaker players out of the market, but lower fuel prices mean they're hanging on in there and pricing just gets tougher.

However, while rival airlines burn through the fuel price savings by cutting prices, IAG has manged to stay clear of the brawl. The focus on long haul destinations and more premium brands seem to have helped it keep prices up, and as a result lower fuel costs are feeding through to the bottom line.

The group isn't being complacent though. Planes are fuller than they were and the group is cutting operating costs. Since it takes time to put new planes into service, growth is slow, but the group is making headway. Cost control is proving particularly impressive and would have been even better were it not for May's unfortunate power outage.

However, 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 times. That's actually above where it was before the referendum and historically the rule of thumb has been that something closer to 1 is the comfort zone.

The shares are currently offering a prospective yield of 4.5%.

Second Quarter Results

A 4.4% increase in second quarter revenues, which stood at EUR6bn, reflects the benefits of a later Easter and weak comparables. The group saw growth in passenger numbers, up 5.1%, and a small improvement in revenue per available seat kilometre (ASK).

Lower fuel costs continue to dominate the cost environment. Non-fuel costs for the quarter include EUR65m of costs associated with the power failure at British Airways over the second May bank holiday weekend.

LEVEL, IAG's new low cost long-haul carrier, began operating in June, flying two Airbus A330s from Barcelona. Initial trading has reportedly been positive.

Net debt of EUR7bn is EUR1.1bn lower than last year. Adjusted net debt to EBITDAR (earnings before interest, tax, depreciation, amortisation and aircraft operating leases) improved 0.4 percentage points to 1.4 times.

IAG now expects full year operating profits to show a double digit percentage improvement year-on-year, with second half passenger revenue, as measured by revenue per ASK, set to increase versus last year.

Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

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.