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IAG - underlying cost improvements boost profits

George Salmon | 26 October 2018 | A A A
IAG - underlying cost improvements boost profits

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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: 120.18 | Buy: 120.28 | Change 2.48 (2.10%)
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International Consolidated Airlines (IAG) has reported underlying third quarter operating profit of EUR1.5bn. That's flat on last year, but slightly ahead of prior analyst forecasts.

The shares rose 1.8% on the news.

The third quarter interim dividend is 14.5 euro cents per share, up from 12.5 cents last year.

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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 puts the emphasis on IAG to limit increases in non-fuel operating costs. Recent 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 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's 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's trading at 1.9 times book value, a more conservative way of valuing intensely cyclical and asset-heavy businesses like airlines. That's around the longer-term average.

This year's prospective yield is 4.9%.

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Third quarter trading details

Total revenue rose 8.5% to EUR7.1bn, as cargo and other revenues rose 12.7% to EUR752m and passenger revenue increased 8% to EUR6.4bn.

The rise in passenger revenue is a function of seat factor (a measure of how full the planes are) rising from 86.2 to 86.5 year on year, a 6.6% increase in capacity and a marginal rise in average prices. On a per available seat basis, revenue rose 2.7%.

Operating costs rose 10.7% to EUR5.7bn, with fuel costs up 21.8% to EUR1.5bn.

Unit costs rose 3.8%, meaning it costs on average 6.33 euro cents to fly one available seat one kilometre. Non-fuel unit costs rose 0.5% to 4.66 euro cent, although after stripping out exchange rate movements, this represents a decline of 0.7%.

IAG's adjusted net debt increased by EUR292m to EUR7.5bn as capital expenditure increased. Adjusted net debt to EBITDAR (Earnings before interest, tax, depreciation, amortisation and rental costs) was flat at 1.4 times.

Looking ahead, IAG says both passenger unit revenue and non-fuel unit costs are expected to improve at constant currency for the full year.

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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.


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