IAG: strong first half sees profits jump higher

IAG’s first-half revenue rose by 8% to €15.9bn, with growth being driven by higher average ticket prices and increased capacity. Sales growth across all regions was positive.

Operating profit jumped 44% higher to €1.9bn. This was driven by the uplift in revenue and lower fuel costs, which was partially offset by rising operational costs.

Free cash flow fell from €3.2bn to €2.1bn, partly due to a payment to HMRC for an ongoing tax dispute. Net debt improved from €7.5bn to €5.5bn.

Full-year guidance points to capacity growth of around 2.5%. Both fuel and non-fuel costs are expected to be lower than previous guidance, and markets are now forecasting full-year operating profit growth of 2% to €4.5bn.

The shares rose 2.2% in early trading.

Our view

British Airways owner IAG had a great start to the year, with profits rising at high double-digit rates over the first half. Despite beating profit expectations by a hefty margin, some slight weakness in pricing for the second half has weighed on sentiment, causing an underwhelming share price reaction on the day.

IAG’s market-leading networks, strong brands, and fierce operational focus continue to drive performance skyward. Tariffs had been weighing on the travel sector, given their potential to increase aircraft prices and cause a global economic slowdown. But for now, near-term demand remains strong, with around 57% of seats for the second half already booked up.

Its largest airline, British Airways, accounts for around 45% of the group’s operating profits. The airline is based in London, where the market is particularly constrained and new flight slots are among the most scarce in the world. Given that British Airways owns such a large proportion of these slots, it has strong pricing power and looks well-positioned to keep benefiting more than its peers from these dynamics.

Due to the high fixed costs associated with flying planes, squeezing more passengers onto each flight is key to increasing profitability. Easing fuel costs has also helped the bottom line. But keep in mind that external shocks could send fuel prices higher again. That risk looks well hedged in the short term, but the group will always be at the mercy of external factors.

Strong operational performance is resulting in healthy free cash flows, strengthening the balance sheet. There’s also plenty of cash left over to hand to shareholders through dividend payments and share buybacks. As always, though, shareholder returns are never guaranteed.

There are some things to keep in mind, though. While pent-up travel demand still has room to run, it can't go on forever. IAG’s also investing heavily in the business. This includes expanding its fleet, upgrading its digital infrastructure and leveraging data in a bid to improve the customer experience. While we support the strategy, if these investments fail to deliver the required return, sentiment may sour.

The market is only forecasting operating profits to rise around 2% this year. But with its recent history of outperformance, strong demand and lower fuel costs, we see upside to that number. The valuation looks attractive relative to the long-term average on an EV/EBITDA basis (a measurement of company worth relative to its cash profits). But the cyclical nature of the industry, as well as the sensitivity of demand to macro-events, shouldn’t be overlooked. Ups and downs along the way can’t be ruled out.