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IAG - resilient showing in a tough quarter

George Salmon | 10 May 2019 | A A A
IAG - resilient showing in a tough quarter

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International Consolidated Airlines CDI

Sell: 204.30 | Buy: 204.60 | Change -8.90 (-4.17%)
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Higher fuel prices have impacted IAG's first quarter results, although unlike many others in the sector the group has still recorded a profit, albeit sharply lower.

Looking ahead, the group says it expects both passenger revenue per available seat kilometre (ASK) and non-fuel costs per ASK to improve over the year, such that full year operating profits will be broadly flat on 2018.

The shares rose 4.2% on the news.

View the latest share price and how to deal

Our view

Low fuel prices have meant it's been the best of times and the worst of times for airlines these last few years.

That's because they've helped keep running costs low, but have also encouraged a flood of extra capacity and competition, which has forced prices down.

However, that extra capacity has impacted low-cost carriers the most. A focus on long-haul destinations, plus its more upmarket flagship brands, have helped IAG steer clear of much of the trouble that has plagued rivals like now defunct Monarch. The net effect has been eye-catching profit growth and some healthy dividend increases, and chunky share buybacks.

However, the upward trend in oil prices means that tailwind is running out of puff. For IAG to sustain its current altitude, it'll need to improve efficiency elsewhere. Recent updates have brought good news on this front, and the group is confident it can reduce costs and increase revenue per seat for the remainder of this year.

While that's encouraging to hear, investors should remember demand for First and Business class berths turns off and on like a tap as the economy rises and falls. IAG hasn't seen any change in behaviour yet, but potentially variable revenues and a large fixed cost base make the unknowns around the UK's impending exit from the EU a worry.

That probably explains why the group's trading at 1.6 times book value, a more conservative way of valuing intensely cyclical and asset-heavy businesses like airlines, and on just 4.9 times expected earnings. That's below the longer-term average on both measures.

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.

IAG had wanted to bolster its offering by acquiring rival operator Norwegian, but after at least two failed approaches decided the price wasn't going to be right. With leverage well within the target range, IAG instead plans to pay out EUR700m as a special dividend.

Looking beyond this year, the shares are priced to yield 5.8% in 2020.

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First quarter trading details

IAG continues to add capacity, with total ASKs rising 6.1% to 75.4bn. A slight increase in seat factor, to 80.7, shows its 582 planes were slightly fuller than at this time a year ago, but pressure on pricing, the timing of Easter and a slight fall in cargo revenue ensured group revenue increases rose just 5.9% to EUR 5.3bn.

However, with operating costs rising 10.7%, underlying operating profit fell 60.3% to EUR135m. After excluding the impact of a stronger dollar and other currency moves, that still represents a 51.6% fall.

While non-fuel costs rose 6.9%, that represents a slight decline at constant exchange rates on a per ASK basis. The main driver of the extra costs was a 22.8% increase in fuel oil and emission charges, which rose to EUR1.4bn, or 11.1% at constant exchange rates on a per ASK basis.

IAG's adjusted net debt at the end of the quarter was EUR5.2bn, which equates to a net debt to EBITDA ratio of 1.

Find out more about IAG shares including how to invest

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.