At first glance, the valuation of International Consolidated Airlines (LSE: IAG) looks modest and the shares appear cheap.
With the stock near 158p, the forward-looking earnings multiple is just below six for 2024.
City analysts expect a three-digit percentage resurgence in earnings this year followed by a further increase of more than 30% next year.
But such estimates are not nailed-on certainties. And it’s possible for the airline company’s earnings to miss expectations. Indeed, the industry is particularly vulnerable to economic shocks.
We saw the weaknesses of the business exposed during the pandemic. And going forward the enterprise is sensitive to varying consumer demand and volatile fuel prices among other things.
One of the consequences of the difficulties caused by the pandemic was that IAG took on more debt. And it also diluted existing shareholders with an almost €3bn capital raising event.
Back to profits
But despite the financial trauma, at least the business survived. However, I’d argue that the valuation is not as cheap as it seems right now because of the big pile of debt on the balance sheet.
Nevertheless, it’s encouraging that passenger demand has returned to the business. In May’s first-quarter results report, the firm said it scored a profit “for the first time since the first quarter of 2019”.
As well as steady increases in passenger numbers, lower fuel prices helped to get rid of the red ink from the accounts. And the directors even upgraded their expectations for operating profit for the full year 2023.
Chief executive Luis Gallego said its airlines had recovered capacity to “close to pre-pandemic levels”.
Meanwhile, the share price has performed well since October last year. It’s up almost 70%. And over the past year the rise is about 25%, which reveals the volatility the stock often suffers.
And much of that volatility is driven by investor sentiment. Although there are good reasons for investors to become twitchy about the company’s prospects – the airline industry is a tough one. And it’s difficult for any player in the sector to remain consistently profitable for long.
The business is flying again
However, the IAG business appears to be in good health right now. But rather than that situation making me consider the stock a screaming ‘buy’, it makes me nervous instead.
Indeed, fuel prices have eased, passenger numbers are up, profits are recovering… maybe this is as good as it gets for the business. And like all cyclical enterprises, when the going is good, the risks of some kind of downturn always seem to be elevated.
But on top of that, IAG appears to be aiming to consolidate the airline sector. And it has a history of acquiring other operators.
But rather than investing in the sprawling mainstream operator, I like to target nimble companies that challenge the goliaths. Often, such smaller outfits can put in impressive growth spurts that can make for a satisfactory investment outcome.
So, for me, IAG shares are not attractive right now. Although it’s possible the business and the stock will perform well in the years ahead, I’ll be watching from the sidelines.
