Relief has come much later for International Consolidated Airlines Group than its budget rivals, which capitalised on the bounceback in short-haul travel. The question is whether pent-up demand could provide fuel for a greater recovery in the shares next year.
After edging into profit during the summer, IAG reported figures that were way ahead of market expectations in the third quarter. The return of transatlantic travel as pandemic restrictions were lifted and a reduction in capacity within the market, pushed revenue ahead of the 2019 level.
Years of expansion gave way to airlines pulling back as planes were grounded in 2020. The result has been pricing power and better fares, which for IAG, increased revenue per passenger more than 20 per cent higher than the 2019 level.
There are several potential catalysts for revenue increasing next year. Capacity is expected to recover further to about 87 per cent of 2019 levels during the final quarter of this year and amount to about 78 per cent for the year as a whole. Over the first quarter of next year, capacity is expected to improve to 95 per cent of the pre-pandemic level.
Filling more of the capacity gap could provide a natural fillip to the top line, if fares remain elevated. A better recovery in capacity towards pre-pandemic levels won’t happen any time soon, say analysts at the Irish brokerage Davy, which should keep pricing firm. China reopening — and staying restriction-free — could also spur a recovery in passenger numbers within the Asia Pacific region. Before the pandemic, Asia accounted for 8 per cent of available seat kilometres — a measure of an airline’s capacity to generate revenue.
The state of IAG’s balance sheet remains the biggest challenge to the shares moving sustainably higher. Funding daily operations and expenditure needed to upgrade the fleet shouldn’t be an issue. Cash and available debt facilities stood at almost €13.5 billion at the end of September. The business is also back to generating, rather than simply draining, cash. But a hefty debt pile of about €11.1 billion, remains a dead weight. The bulk of that debt doesn’t mature until 2026, but it will eventually place more demands on the group’s earnings.
From IAG’s chief executive Luis Gallego’s point of view that doesn’t mean that acquisitions are off the table as smaller and less well-funded regional airlines struggle. In August, a loan to Air Europa was converted into a 20 per cent stake in the Spanish airline. The ambition is to agree a full takeover, establishing Madrid as a key hub for IAG and securing a gateway to Latin America from Europe. But funding that could add yet more debt, which analysts at HSBC think could include another rights issue.
A toppy leverage multiple is one reason for IAG’s discount to rivals such as Ryanair and Wizz Air, less ambitious expansion plans is another. Both those peers are expanding their fleets to cash in on capacity that has come out of the market since 2020. But relative to IAG’s own history, the shares aren’t exactly cheap. An enterprise value of 5.9 times forecast earnings before interest, taxes and other charges next year, when capacity is expected to recover fully, is higher than the pre-pandemic level.
A dive in consumer spending is another risk that could unseat IAG’s rehabilitation, particularly since holidaymakers have led the increase in revenue. Further caps on passenger numbers at Heathrow, and airport chaos in general, could also stymie progress.
IAG’s prospects are sunnier than this time last year or even six months ago. Bets against the stock by hedge funds have fallen substantially since the start of this year, with short interest standing at 2.1 per cent of outstanding share capital. That’s almost half the level in January. But for investors wanting to bet on a rebound in the travel market, there are more appealing options.
ADVICE Hold
WHY High debt and limited fleet expansion plans could slow recovery in the shares
F&C Investment Trust
F&C Investment Trust offers a lesson in the power of compound returns. The value of the fund’s assets has risen 204 per cent over the past decade, while the shares have delivered a total return of 253 per cent, outpacing the 158 per cent generated by the FTSE All-World Index.
The trust, which re-entered the FTSE 100 earlier this year, invests across global markets as well as in private equity, with strategies ranging from sustainability to emerging markets to North American technology companies. The portfolio numbers more than 400 companies.
The trust’s top ten holdings include big US tech names such as Microsoft, Apple, and Google-parent Alphabet, which together account for 5.8 per cent of assets. That has naturally resulted in a greater challenge to returns this year. Double-digit inflation and the rapid increase in interest rates since the start of the year have caused valuations to falter. But some of the pressures that have held back performance have shown tentative signs of easing. Investors have pared back expectations of future rate increases by the Federal Reserve, which caused US stocks to rally. The same goes for Chinese stocks, which rebounded almost 25 per cent last month as protests gave way to an easing in Covid restrictions.
The result? Asset returns were just over 3 per cent and edged closer to positive territory for the year to date, at a negative 1.6 per cent. That is better than a loss of 3 per cent so far this year. That also means the discount embedded within the share price, versus the value of the trust’s assets, has narrowed to its smallest level since prior to the pandemic, at only 2 per cent.
The trust has paid a dividend of 13.2p a share, which equates to a yield of 1.5 per cent at the current share price. That hardly puts the stock in income territory, but the dividend is reliable, having been increased for 50 consecutive years.
ADVICE Buy
WHY A diversified portfolio may help deliver solid returns
