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IAG - profits ahead of forecasts

George Salmon | 2 August 2019 | A A A
IAG - profits ahead of forecasts

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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: 204.30 | Buy: 204.60 | Change -8.90 (-4.17%)
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Second quarter revenues and operating profits at International Consolidated Airlines (IAG) are ahead of analysts' prior forecasts.

The shares rose 1.7% on the news.

View the latest share price and how to deal

Our view

A £183m fine from the Information Commissioner's Office for data loss is an unwelcome distraction, but IAG should be able to withstand the impact. It's a one-off hit, is less than 10% of next year's expected profits and could yet be reduced on appeal. However, that's not to say improvements aren't required. The ICO could levy up to 4% of a business' turnover - and in British Airways' case that would have been closer to £500m.

A repeat could be even more painful if the worries around a disorderly Brexit turn to reality. 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.

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

For now though, the focus remains on the core, premium brands. 2018 profitability was boosted by low fuel prices, which has in turn led to healthy dividend increases and chunky share buybacks. The shares offer a prospective yield of 6.9%.

But that fuel tailwind is running out of puff. If IAG is to keep profits up, it'll need to improve efficiency elsewhere. Recent updates have brought good news on this front, and the group is growing revenue per seat ahead of non-fuel costs. We think that's encouraging to hear.

However the shares have been weighed down by the potential uncertainties ahead, which means they trade at 1.4 times book value, a more conservative way of valuing intensely cyclical and asset-heavy businesses like airlines. The PE ratio is just 4 times expected earnings. Both measures are well below the longer-term average.

That could look attractive to investors willing to stomach the macro risks.

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Second quarter and half year results

Second quarter revenue was EUR6,8bn, up 9.5% on last year. That was driven by passenger revenue, which rose to EUR6bn on account of a 5.4% increase in available seat kilometres, a measure of capacity, and a rise in seat factor from 84 to 85, which is a measure of how full the planes are.

Quarterly underlying operating profit rose 6.7% to EUR960m, with increased fuel and aircraft costs driving operating costs up 10%. That's an improvement from a weaker first quarter, but isn't enough to stop profits for the half as a whole falling 11.7% to EUR1.1bn.

On a per seat basis, and at constant exchange rates, passenger revenue rose 1.1%, while non-fuel costs rose 0.4%.

Net debt of EUR4.8bn represents an underlying fall of 25.7% (after excluding the impact of accounting rule changes that impact how debt is calculated). That means leverage as measured by net debt to EBITDA (earnings before interest, tax, depreciation and amortisation) fell to 0.9, from a ratio of 1.2 last year.

Looking ahead, at current fuel prices and exchange rates, IAG expects 2019 underlying operating profit to be in line with 2018. Passenger revenue per available seat is expected to be flat, with non-fuel costs per available seat expected to improve.

IAG has announced plans to order eight new aircraft from airbus, and intends to purchase 200 from 737s from Boeing. These planes should join the fleet from 2023.

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.