The conditions are just right for this airline owner to soar
Even after soaring by 107pc since our initial 'buy' recommendation in February 2021, shares in British Airways owner IAG continue to trade on a dirt-cheap valuation. The FTSE 100-listed company, which also owns several other airlines including Iberia, Vueling and Aer Lingus, has a price-to-earnings ratio of just 7.1 at a time when the UK's large-cap index trades very close to a record high.
The firm's near-term financial forecasts do little to help justify its bargain basement price level. While investors may naturally expect such a lowly-valued stock to have a deteriorating bottom line, its earnings per share are set to rise by 12pc this year and by a further 8pc next year.
Indeed, as a highly cyclical firm, IAG is well placed to benefit from the full effect of sustained monetary policy easing across its key markets of the US, Eurozone and the UK.
Due to the existence of time lags, interest rate cuts enacted thus far by central banks in all three geographies are yet to have their maximum impact on economic growth or wage increases. And with sticky inflation widely expected to dissipate over the medium term, a likely continuation of recent monetary policy easing could lead to rising spending power among consumers that prompts higher demand for international air travel.
In fact, passenger numbers for the global airline industry are forecast to rise by 5.8pc this year. They are also expected to double from their pre-pandemic level of four billion people per year to roughly eight billion people per year by 2040.
With IAG having a well-diversified business model, it is in a relatively strong position to capitalise on an upbeat long-term industry outlook. Its portfolio of airlines equates to a greater variety of geographies covered and, perhaps more importantly, a wider range of price points vis-à-vis its rivals. For example, it is not limited to European budget short-haul operations as per some of its sector peers.
A diverse range of operations could prove particularly useful should an uncertain outlook caused by the global trade war lead to temporary economic difficulties. Given that the firm had total liquidity of around €12.4bn (£10.5 bn) at the end of March this year, while net interest costs were covered more than eight times by operating profits last year, it is well placed to overcome the inherent ups-and-downs of the economic cycle.
The company's latest quarterly results, meanwhile, showed that it continues to reinvest for long-term growth. As well as reporting a first-quarter rise in sales of 9.6pc and an operating profit of €198m, versus just €68m in the same period from the prior year, the firm announced that it has ordered 53 new wide-body aeroplanes.
It also confirmed that it is making progress with a €1bn share buyback programme that was announced earlier this year. Share repurchases that are set to take place over the coming months should have a positive impact on the company's share price.
Given its dirt-cheap market valuation, a share buyback programme appears to be a highly logical use of excess cash. While a dividend yield of just 2.2pc, alongside the company's highly cyclical status, means its income appeal is somewhat limited, fast-paced earnings growth could lead to a brisk pace of increase in shareholder payouts over the coming years.
As mentioned, IAG's share price has more than doubled since our initial 'buy' tip in February 2021. In doing so, it has outperformed the FTSE 100 index by 82 percentage points.
In the short run, the company's cyclical status means its shares could be severely affected by news updates regarding the ongoing global trade war. While this may equate to elevated volatility, Questor remains highly upbeat about the stock's long-term capital growth potential.
This is largely due to the vast margin of safety offered by its shares. Investors appear to be materially undervaluing the firm's growth prospects as the impact of falling interest rates, as well as modest inflation, become more evident. With IAG having a solid financial position through which to overcome potential near-term challenges, and it reinvesting heavily ahead of a likely continued improvement in its industry outlook, the stock remains a worthwhile purchase.
Questor says: buy
Ticker: IAG
Share price at close: 343.1p
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