International Consolidated Airlines Group's [IAG] share price bounced back from a two-and-a-half-year low following the announcement of better-than-expected interim results.
The British Airways owner posted a profit rise of more than 6% from the same quarter a year earlier, generating €960m during the second quarter thanks to steady ticket pricing and non-fuel cost cutting.
Revenue per customer was up 3.1%, a significant uptick form the first quarter when it was down 1.4%, with overall passenger revenue climbing 7.2% from the same quarter last year to hit €10.6bn.
“Despite fuel cost headwinds, we delivered a good performance. At constant currency, fuel unit costs were up 6.3% while passenger unit revenue increased 1.1%, benefitting from the timing of Easter,” IAG CEO Willie Walsh said.
The positive news sent IAG’s share price up 8.3% on 2 August, but since then shares have traded sideways, up just 0.1% having opened lower this week. Due to the lower open on Monday, the stock is 1.2% below its 50-day moving average of 454.3p.
What’s propelling IAG’s profits?
Low cost airlines are struggling, both Ryanair [RYA] and Lufthansa [LHA] for instance announced profit warnings in the three months preceding IAG’s results. Whereas premium brands such as Virgin Atlantic and American Airlines [AAL] appear to be faring better, with the latter posting better-than-expected profit for Q2 on 25 July.
For IAG, its limited exposure to European short-haul flights has meant it is performing better than its competitors and has been remarkably unscathed by the bloc’s airline price war.
And despite the difficult outlook for aviation companies, IAG’s operating margin of 15.07 (TTM) outperforms the industry’s average of 7.18, leading JP Morgan analysts to believe it is significantly undervalued. They also suggest the carrier’s fortification against the wider industry’s headwinds leave the firm with “levers it can pull” in the event of a hard Brexit.
“It could immediately retire older wide body aircraft that are close to fully depreciated; it could return short haul aircraft on lease; and it points out that circa 50% of revenue is not denominated in sterling,” JP Morgan said.
“We also believe that in a hard Brexit IAG’s peers would pull capacity and so the industry supply-demand equation might be better than some fear.”
“We also believe that in a hard Brexit IAG’s peers would pull capacity and so the industry supply-demand equation might be better than some fear.” - JPMorgan Cazenove
JPM continues to rate the stock as ‘overweight’, with a price target of 802p, which represents a near of 80% upside from the 12 Aug closing price of 448.8p. Elsewhere, The Wall Street Journal reports a consensus ‘buy’ rating with an average price target of 692p.
Brexit casts a dark cloud
IAG’s dependence on UK flyers – whose appetite for international travel is expected to diminish if an economic downturn or weaker pound were the result of a hard Brexit – is an ongoing headwind for analysts.
Indeed, the company’s British Airways business dominates the group, as it brought in more than 60% of its €10.64bn in first-half revenue. While Ireland’s Aer Lingus as well as Spain’s Iberia and Vueling, made up a cumulative 36% of its remaining revenue.
British Airways' contribution to group revenue in H1
Despite Austrian, Irish and Spanish regulators giving IAG the go-ahead to pursue its undisclosed local ownership and control plans on 2 August, shareholders are still concerned about IAG’s ability to meet the EU’s obligations that more than half of its shareholders must come from the bloc, after Britain leaves.
At current fuel prices and exchange rates, IAG expects full-year operating profit to be in line with 2018, and is forecasting relatively flat passenger unit revenue. However, the company did not disclose a specific guidance range.
|PE ratio (TTM)||2.75|
|Return on equity (TTM)||31.31%|
IAG share price vitals, Yahoo finance, 13 August 2019
“Holding guidance for 2019 illustrates resilience at a time when market confidence is low,” Credit Suisse said on IAG’s outlook. However, looking at IAG’s (TTM) PE ratio – which currently sits well below the industry’s average at 7.72 – others appear to be concerned that growth will not materialise.
Indeed, the stock is trading at 3.9 times consensus forecast earnings per share for the next 12 months, according to data from Refinitiv, which is lower than Lufthansa and perennial laggard Air France-KLM [AF] for the first time in five years.
One hinderance on the company’s full-year results could be the record £183m fine from the Information Commissioner’s Office, the result of a data breach. However, Hargreaves Lansdown’s George Salmon believes the fine’s impact will be minimal, given that it’s less than 10% of next year’s expected profits.
“If IAG is to keep profits up, it'll need to improve efficiency elsewhere,” Salmon wrote in a note to clients. “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.”