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IAG - a game of two halves on costs

George Salmon | 3 August 2018 | A A A
IAG - a game of two halves on costs

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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: 113.12 | Buy: 113.22 | Change -6.06 (-5.11%)
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IAG has delivered half year profits slightly behind prior analysts expectations.

The shares fell 3% on the news.

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Our view

The dominant theme amongst airlines recently has been a relentless increase in capacity, which is raising competition and forcing prices down.

Not at IAG though. A focus on long-haul destinations, plus the extra prestige attached to its flagship brands, have helped it stay clear of the brawl. We've seen eye-catching operating profit growth, with lower fuel costs boosting returns.

However, the upward trend in oil prices means that tailwind is fading fast. This has put the emphasis on IAG to limit increases in non-fuel operating costs. The last couple of updates have brought good news on this front, and the group is confident of driving costs down further over the year.

While IAG delivered a stellar performance last year, investors should remember that demand for First and Business class berths turns off and on like a tap as the economy rises and falls. That makes uncertainty following the vote to leave the EU a worry. Regardless of whether the planes are full or not, the group will have to service its lease and debt obligations.

Perhaps with the inherent cyclicality of running a premium airline in mind, IAG is exploring building out lower-cost services. LEVEL and Vueling are growing, while transatlantic flights from Barcelona have kicked off its first foray into the low-cost long-haul market.

We wouldn't be surprised if the group uses M&A to quicken the pace of change. It has already taken a near 5% stake in rival operator Norwegian. IAG has seen two approaches rebuffed, but Willie Walsh hasn't ruled out trying for third time lucky. A deal makes sense, but only if the price is right.

At present, the group is trading at 2.3 times book value, a more conservative way of valuing intensely cyclical and asset-heavy businesses like airlines. That's marginally ahead of the longer-term average.

This year's prospective yield is 3.8%.

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First half trading details

IAG's passenger revenue rose 3.6% to EUR9.9bn, boosted by a 5% increase in total kilometres flown. Including cargo revenue, total revenue rose 3.1% to EUR11.2bn.

At constant exchange rates, revenue per available kilometre flown rose 2.9%, as a result of a higher yield from customers and, with seat factor rising 1.5 percentage points to 82.4, slightly fuller planes.

Adjusted operating profit rose 17.4% to EUR1.1bn. Within the different airlines, British Airways and Iberia both delivered 17.3% increases, with profits of EUR868m and EUR102m respectively. Aer Lingus profits nigh-on doubled to EUR104m but losses at Vueling increased from EUR7m to EUR11m.

With Q2 profits rising 5.7% to EUR835m, the increase was driven by a strong first quarter. While a non-fuel costs before exceptional items fell 4.5%, a 12.9% increase in fuel costs limited Q2 profit growth. Some of that is driven by increased capacity, but fuel costs still rose 6.7% on a per kilometre basis.

IAG's CEO Willie Walsh also highlighted the impact of French Air Traffic Control strikes, with Vueling incurring EUR20m of disruption costs.

Adjusted net debt fell EUR826m to EUR6.2bn. That helped net debt to EBITDAR (earnings before interest, tax, depreciation, amortisation and rental costs) improve from 1.5 to 1.2 times

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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 for more information.