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IAG -new merger terms to preserve cash

Nicholas Hyett, Equity Analyst | 20 January 2021 | A A A
IAG -new merger terms to preserve cash

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International Consolidated Airlines CDI

Sell: 120.90 | Buy: 121.02 | Change 0.24 (0.20%)
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IAG has revised terms of its deal to buy Spanish airline Air Europa through its subsidiary, Iberia. Under the new agreement, Iberia will pay €500m instead of €1bn to acquire Air Europa.

Payment will be deferred until 6 years after the acquisition's completion, expected during the second half of this year.

Assuming the deal goes to plan, IAG expects the transaction to have a "minimal" impact on cash outflows until 2026, at which time management believes the benefits of the merger will be fully realized.

The shares rose 2.1% following the announcement.

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Our view

Demand for flights was starting to recover as travel restrictions were relaxed over the summer. But a second wave of virus outbreaks and accompanying travel restrictions have undone much of that progress.

As a result, IAG and its peers have had to push their plans for increasing capacity further into the future.

The biggest question on our minds now is whether the vaccine will open the door for a busy summer travel season. While IAG can likely last through the latest wave of lockdowns, the group needs a profitable summer in 2021. We think long-haul travel will be last to recover, putting IAG in a precarious position if a return to normalcy is further delayed.

The prolonged disruption means more pressure on IAG's balance sheet, making the group's capital raise seem prudent even if it diluted existing shareholders. By pushing the cost of its Air Europa merger further into the future, the group should reduce the chance of a near-term cash crunch.

The good news is that from a balance sheet perspective IAG in a stronger position than some of its peers, and this is its main attraction in our view. If IAG can weather the storm where others fail, its competitive landscape will be much improved. Additionally, management has done a good job limiting the group's weekly cash burn so far.

While the vaccine has offered a light at the end of the tunnel, investors shouldn't lose sight of how much damage has been inflicted. Capacity cuts and the severe cost reduction programme mean IAG will be a significantly smaller company when it emerges from this crisis. The risks to all airlines have been increased dramatically by COVID-19.

IAG key facts

  • Price/Book Ratio: 0.2
  • 10 year average Price/Book ratio: 0.4
  • Prospective yield: 0.2%

All ratios are sourced from Refinitiv. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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Q3 Trading details

IAG's third quarter revenue fell 83% to €1.2bn, and the group made an operating loss of €1.3bn compared with a €1.4bn profit last year. Including exceptional items, including restructuring costs at British Airways, IAG's operating loss was €1.9bn.

As a result of weaker than anticipated bookings IAG no longer expects to break even on a cash flow basis in Q4.

Third quarter passenger capacity fell 78.6%, and only 48.9% of seats were filled. As a result passenger revenue fell 88.6% to €737m and other revenue fell 60.4% to €200m. Cargo revenue increased 12.3% to €302m as the group flew 1,115 additional cargo flights, driven by demand for medical equipment and supplies.

Employee costs fell 42% to €708m, although the group incurred €275m in exceptional costs as it reduced headcount by 10,000 at British Airways and Aer Lingus. Fuel costs fell 77.3% to €370m, reflecting lower prices and lower fuel requirements due to the lighter flying schedule. Weekly cash costs were 54% lower than originally anticipated at €205m.

Despite cutting capacity in September, bookings have not held up as well as expected. Additional government restrictions, quarantine requirements and a lack of airport testing have contributed to the shortfall. As a result IAG now plans to fly no more than 30% of 2019 capacity in Q4.

As of 30 September IAG had €6.6bn in available liquidity, comprised of €5.0bn in cash and €1.6bn in available credit. In addition €2.74bn was received in early October, after the end of the quarter, as gross proceeds from the group's recent capital raise. Including this, total liquidity is around €9.3bn. Net debt, including lease liabilities, was €11.1bn, up from €7.6bn at the end of 2019.

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This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. 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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