The airline industry was dealt one of the hardest punches by the pandemic, but the pain hasn’t been evenly felt. International Consolidated Airlines Group is a giant that has struggled to get back on its feet. Its shares are still less than half their pre-Covid level, bruised by the heavy shareholder dilution that resulted from the €2.7 billion rights issue in October 2020. Wizz Air, an upstart valued more highly now than it was pre-Covid, is pursuing an aggressive expansion plan as rivals falter. Both carriers have been boosted by a further relaxation of travel restrictions and hopes that the Omicron variant is less severe than initially feared.
IAG and Wizz Air represent the worst and the best performers within the London-listed airline sector over the past two years. You might think that the magnitude of IAG’s fall would leave it looking like a bargain, but you’d be wrong. An enterprise value of almost five times forecast earnings before taxes and other charges for 2023, when capacity is expected to return to 2019 levels — at the earliest — is in the same ballpark as during the three years before the February 2020 market crash.
A greater reliance on long-haul and business travel than budget players such as Ryanair or Wizz means that restrictions have dealt a greater blow to the owner of British Airways. Capacity has been slower to recover, still standing at just over 43 per cent of 2019 levels during the third quarter of last year, from 21.9 per cent over the previous three months. Admittedly, the reopening of the transatlantic travel corridor in November was a key moment and the company expects capacity to have risen to 60 per cent during the fourth quarter.
Yet some investors are sceptical that increased travel between Britain and America will be enough to reflate the group’s share price. Short interest in IAG’s shares might have fallen since a September 2020 peak, but it has risen since November, standing at 4.14 per cent of outstanding share capital, according to data published by the Financial Conduct Authority.
Liquidity to ride out subdued passenger numbers shouldn’t be an issue, at €10.6 billion at the end of September thanks to a fundraising spree since disruption took hold. Yet that’s also meant net debt has spiralled from €7.6 billion at the end of 2019 to a hefty €12.4 billion. The bulk of that debt doesn’t mature until 2026, but a heavy debt burden will place more demands on the group’s earnings eventually.
Does IAG tap the market again for cash to cut leverage quicker? An eventual equity-raising to cut leverage back towards around 1.8 times 2023 earnings for 2023 is likely, according to analysts at Berenberg, although that would still be at the upper end of the range during the 2015-19 period. IAG has stated that it has no plans for another fundraising.
What about business travel? True, corporate revenue accounted for only 13 per cent of the group’s total in 2019, but it is expected to remain 10 per cent to 15 per cent below the pre-pandemic level until 2023, according to Luis Gallego, the group’s chief executive. More fundamentally, will business travel ever fully recover? If not, that puts more pressure on other revenue, such as premium leisure, to plug the gap.
IAG has cut operating costs and trimmed the size of its fleet by 11.5 per cent since 2019, which should alleviate some of the pressure on returns as it emerges from the pandemic. Convincing investors that it is a recovery story worth backing will be a tougher task.
Wizz Air: a safer bet?
Getting the market on board has been much less of a challenge for the budget airline. Its shares trade just over a quarter higher than they did two years ago, equivalent to a more optimistic enterprise value of 6.2 times forecast earnings before taxes and other charges in 2023.
What are investors buying into? An ambitious expansion strategy beyond its eastern European roots, which included an approach for easyJet last year, and a sharper rebound in revenues. A bias towards short-haul flights has helped passenger numbers to recover more quickly and in August the load factor — the percentage of available seating capacity that had been filled — increased to 84 per cent, while overall capacity reached 98 per cent of the 2019 level.
A relatively lower degree of leverage entering the pandemic and a lower-cost operating model prevented the need to tap equity markets for funds, although €500 million was raised via a three-year eurobond and new debt facilities entered into. Analysts at Berenberg reckon that net debt, which was €1.86 billion at the end of September, will reduce to 1.5 times earnings before taxes and other charges by March 2023.
Wizz plans to increase the size of its fleet to 170 by the end of September and to 500 by the end of this decade, from 144 last year. The airline hopes to expand into the vacuum left in the market by weaker operators forced into retreat by the pandemic. Increased investment and quieter winter months led management to point towards a higher operating loss of €200 million over its third quarter, against €121 million during the first half.
It’s got the resources to fund expansion, with available cash of €1.7 billion, but that doesn’t mean growth is without risk. State aid and furlough has kept airlines on life support. It is still uncertain just how much capacity will come out of the market more permanently, or whether airlines will be forced into a price war. Wizz’s average fares over the six months to September missed forecasts by some analysts as it tried to increase demand with more attractive prices.
Stephen Furlong, an analyst at Davy, the broker, argues that the stock performance will depend on whether margins can remain stable over the medium term and “you can only do that if your unit cost is flat or declining”. Expanding bases into western European airports, which typically incur higher operating costs, might make that a tougher task. It also raises the question of whether Wizz’s workforce will remain non-unionised.
Wizz Air is a safer proposition than IAG in the short term, but the easiest gains are behind it.
ADVICE Avoid IAG, hold Wizz
WHY IAG’s valuation is not compelling given the high debt burden and uncertainty hanging over business travel. Further re-rating in Wizz might be harder as costs and potential pressure on fares pose a risk to margins.
