International Consolidated Airlines: a buy for the brave

The airline industry has borne the brunt of the financial fallout from the coronavirus. Countries around the world have imposed various degrees of restrictions on flights, from screening and quarantines to outright bans; even where planes are still allowed to fly, demand has fallen so far that airlines have voluntarily cancelled flights. 

The industry seems to be facing a crisis much worse than the 2003 outbreak of Sars or the global financial crisis of 2008/2009. Indeed, some experts are predicting that, unless things improve, the entire industry could find itself bankrupt by May.

A nosedive too far

It is no surprise, then, that shares in International Consolidated Airlines Group (LSE: IAG), the parent company of British Airways, have fallen by nearly 60% from the peak of 646p in January to the current level of 259p. However, this is an overreaction. Firstly, it’s still very unlikely that this crisis could force IAG into bankruptcy. While some of its costs are fixed irrespective of how many flights it operates, others, such as fuel, can be drastically cut back under a nightmare scenario of a prolonged grounding, or at least deferred until normal service has been resumed. The company could also save money by suspending the dividend.

Russ Mould of AJ Bell estimates that even if it were to operate at 20% capacity for the next 12 months, a far longer period of disruption that most experts are predicting, it would still only lose around £5bn. While this is a huge amount, IAG has more than £9bn of liquidity, enabling it to survive even an 18-month shutdown. 

The fact that CEO Willie Walsh has said IAG will not be seeking government support, in contrast to most other airlines around the world, suggests that the management is confident that it will be able to survive the coming crisis.

If IAG does manage to pull through, it looks extremely cheap. According to the official estimates it is trading at only three times 2021 earnings. While next year’s earnings-per-share estimates are now clearly out of date, they do give an idea of what will happen when things return to normal. Mould also points out that the fact that IAG is in a better financial position than its rivals, especially those in Europe, means that it could benefit from a reduction in the number of competitors, something that Mould thinks is needed to cut the industry’s overcapacity.

I suggest that you go long on IAG at the current price of 227p at £16 per 1p. With a stop loss of 96p, this gives you a downside of £2,096. This is a much wider and deeper stop loss than I normally recommend. However, it reflects the extremely volatile market and the short bias of my portfolio: it has leeway for potential losses on IAG, thanks to current gains from shorting other stocks such as Uber and Boeing. Meanwhile, take profits from shorting Wayfair, which has fallen by 70% since I tipped it in issue 969.