Shares in International Consolidated Airlines Group (LSE:IAG) have been doing well lately. Over the last six months, the IAG share price has increased by 8%.
Compared to a decline of around 1% for the FTSE 100, that’s a pretty decent return. But should I be looking to buy IAG shares at the moment?
Investing like Warren Buffett
According to Warren Buffett, investing in businesses is about buying an ownership stake in a business when it’s selling below its intrinsic value. In Buffett’s words:
If you attempt to assess intrinsic value, it all relates to cash flows. The only reason for putting cash into any kind of investment now is because you expect to take cash out. Not by selling it to someone else, because that’s just a game of who beats who, but by, in a sense, what the asset itself produces. That’s true if you’re buying a farm, it’s true if you’re buying a business.
In other words, whether or not a company’s stock is cheap from an investment perspective depends on the free cash it will produce in the future. It’s not about where its share price is going to go.
This is important. It means that the question of whether or not IAG shares are a bargain comes down to whether the cash it will produce in future represents a good return on the current share price.
IAG shares
So, how do IAG shares stack up relative to the company’s future prospects? I have some concerns.
Today’s share price values the entire business of IAG at £6.65bn. This means that for an investment to produce an 8% annual return, the company will need to generate an average of £532m per year over the next decade.
I have three major reasons for thinking that this is unlikely. That’s why I don’t intend to buy the stock any time soon.
First, the company hasn’t generated free cash flow in excess of £500m in the last five years. That makes me doubtful that it can achieve this consistently for the next 10 years.
Second, the company has around £8.6bn of debt on its balance sheet. Over the next decade, IAG will have to make interest payments on this as well as paying it down, which I think will inhibit cash flow.
Third, the company’s costs are high and, in my view, likely to increase. IAG’s biggest cost is fuel, and oil prices don’t seem to me to be showing signs of coming down in the near future.
A bargain?
I’m not saying that IAG is going to go bankrupt, though I wouldn’t be surprised if it did. But I’m looking for more from an investment than just something that isn’t about to go bust.
The company’s share price could also go anywhere in the future. But as Warren Buffett says, investing isn’t about predicting what share prices will do, it’s about assessing the price of a company relative to its future prospects.
From this perspective, I don’t like the look of IAG stock as an investment. The IAG share price doesn’t look like a bargain to me, which is why I won’t be buying it for my portfolio any time soon.
