IAG shares look shaky despite the travel recovery – one to avoid

IAG, owner of British Airways, looks to be getting back on track, and hopes to turn a profit in the next quarter. But don't think that makes IAG shares a buy, says Rupert Hargreaves. Here's why.

The IAG (LSE: IAG) share price is a bellwether for the global travel industry.

Shares in the airline group, which owns British Airways and Aer Lingus among others, have jumped around over the past two years as investors have tried to second-guess when the travel market will recover from the pandemic.

After more than two years, it looks as if IAG is finally starting to get back on track. It’s aiming to fly at 80% of pre-pandemic capacity this year (assuming demand holds up), according to its latest trading update.

What’s more, management reckons the company will turn a profit in the second quarter, a huge step in the right direction. If IAG returns to profit, it should remove any question marks over its ability to continue as a going concern – for the time being at least.

IAG’s North American routes are its cash cows

IAG’s portfolio of airline brands gives it scale, while it also has a strong foothold in the key North Atlantic travel market.

The transatlantic route between London Heathrow and JFK New York is the jewel in IAG’s crown. It is the fourth-most active route in the world, and the most profitable. However, over the past two years, stop-start travel restrictions have hammered demand.

Management plans to ramp up capacity to 100% on the route by the third quarter, indicating that demand is returning faster than in other areas. A “strong” return in business travel is helping power the recovery.

As IAG’s main focus is North America and other long-haul destinations, the war in Ukraine has not affected it directly, although it is reporting significantly higher fuel costs as a result of higher oil prices.

The optimistic outlook implies that IAG is starting to draw a line under two years of losses and uncertainty. But it’s not all good news.

IAG is carrying a heavy debt burden

Capacity issues at Heathrow are forcing management to slow its growth plans. The firm was planning to fly 85% of capacity this year; its target is now 80% – not for lack of demand, but for lack of infrastructure. Instead of increasing capacity as fast as possible, management is now focusing on “enhancing operational resilience”.

And while IAG expects to return to profit in the second quarter, it lost money in the first. It recorded a loss of €800m in the first three months of 2022, slightly better than the €1.1bn recorded for the same period last year.

It also ended the period with interest-bearing debt of €20bn, a huge drag on the balance sheet. The cost of sustaining borrowings totalled €233m in the first quarter alone.

The airline industry has some major structural challenges

IAG’s size and transatlantic routes are solid competitive advantages, but the company is not immune to the general issues that plague aviation.

The sector is highly competitive and beholden to volatile fuel prices. That latter point is probably more important today than it has been for decades. Airlines can and do hedge their fuel costs, but they can only hedge so much and for so long.

Even the best hedging programmes cannot help them compete against state-owned carriers such as Etihad Airways. With their almost bottomless pockets, these carriers can keep ticket prices low and absorb high costs during periods of uncertainty. IAG can’t do that, especially with its weakened balance sheet.

Then there’s the cyclical nature of the airline business. Most European airlines make money in the holiday season and lose it over the winter period. A series of bad winters can really hit a firm’s ability to compete in the lucrative summer months. IAG is, to a certain extent, insulated from this by its transatlantic routes. Still, profits have historically (pre-pandemic) dropped substantially over the winter period.

So, while the business might be projecting a return to profit in the second quarter, investors need to be prepared for losses to return in the second half.

Unpredictability makes it hard to analyse IAG

All of this means that it’s impossible for me to try and project where IAG will be in five or ten years from now, and that makes the business pretty much uninvestable. Yes, the airline might perform better this year than it did last year – that wouldn’t be very hard – but that growth might not be sustainable.

As well as all the factors above, the big unknown is the global economic environment. If global growth slows, even IAG’s transatlantic routes won’t help it avoid the fallout.

Even though the stock might surprise to the upside in 2022, it’s unclear how or if the business will grow sustainably from here while paying down debt, fending off the competition and dealing with growing economic risks. I’d avoid it.

SEE ALSO:

Two of the best airline stocks to invest in as the travel industry rebounds

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