Is the IAG share price severely undervalued?

The IAG share price has crashed. G A Chester discusses whether the British Airways owner is a bargain buy or a stock to avoid.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

The International Consolidated Airlines Group (LSE: IAG) share price crashed last Friday after it released its half-year results. Yesterday saw a bit of a rally to 173.46p, but with the shares more than 20% below their April high of 217.85p, and far below their pre-pandemic level, is IAG severely undervalued?

Outlook

Clearly, the market didn’t like IAG’s results. This was despite its Q2 operating loss of €1bn being in line with the analyst consensus forecast.

I think investors were disappointed by the company’s forward-looking comments. It said its current passenger capacity plans for Q3 are for around 45% of 2019 capacity. And added that these plans “remain uncertain and subject to ongoing review”.

Capacity of 45% would be a big improvement on Q2’s 22% but is much lower than the plans of fellow London-listed airlines easyJet and Wizz Air. The former is targeting up to 60% of its pre-pandemic capacity. The latter expects to operate at 90% in July and 100% in August. By contrast, IAG “expects that it will take until at least 2023 for passenger demand to reach the levels of 2019.”

IAG’s network is weighted to long-haul flights over the Atlantic. Evidently management expects a full re-opening of the transatlantic travel corridor to take some time and passenger demand to lag behind it.

Debt

Unsurprisingly, IAG’s debt has continued to rise. At the half-year-end, net debt stood at €12.1bn (gross borrowings of €19.8bn and cash of €7.7bn). This compared with net debt of €9.9bn a year ago.

More positively, the €7.7bn cash, together with undrawn borrowing facilities of €2.5bn, give IAG liquidity of €10.2bn. So there’s no risk of a cash crunch anytime soon. Nevertheless, the company has paid €0.7bn over the last 12 months to service its mountain of borrowings, and the cost of debt will continue to weigh heavily on its financial performance for the foreseeable future.

Forget the IAG share price!

Despite the challenging outlook, bullish investors argue that the IAG share price is so far below its pre-pandemic level that the stock is severely undervalued.

Now, according to the great Warren Buffett, I shouldn’t consider buying a single share in a business unless we would be willing to buy the whole company. So let’s look at the valuation of IAG on this basis.

IAG’s market capitalisation was £9.2bn before the FTSE 100‘s crash week of 9-13 March 2020. Its net debt at the time was €7.6bn (£6.4bn at the prevailing exchange rate). Therefore its Enterprise Value (EV) — market capitalisation plus net debt or minus net cash — was £15.6bn. This is how much I’d have had to pay, if I could have bought all the shares and cleared the debt to acquire the entire company debt-free and cash-free.

Due to a fundraising last September, IAG now has many more shares in issue. At the current share price, its market capitalisation is £8.6bn. With net debt at €12.1bn (£10.3bn at the prevailing exchange rate), the EV is £18.9bn. Put another way, I’d need to pay £3.3bn more to buy the whole company today on a debt-free/cash-free basis than I would have done before the pandemic. This makes no sense to me, so I’m avoiding IAG at its current share price.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be considered so you should consider taking independent financial advice.

G A Chester has no position in any of the shares mentioned. The Motley Fool UK has recommended Wizz Air Holdings. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Tanker coming in to dock in calm waters and a clear sunset
Investing Articles

Here’s the Shell dividend forecast through to 2024

The Shell dividend is still nearly 50% below 2019 levels. Will the oil giant use record profits to rebuild its…

Read more »

Warren Buffett at a Berkshire Hathaway AGM
Investing Articles

3 FTSE 100 stocks I think Warren Buffett might love!

Warren Buffett made his fortune thanks to the success of US shares. But here are three FTSE 100 stocks I…

Read more »

Bearded man writing on notepad in front of computer
Investing Articles

Down 75%, has the Deliveroo share price bottomed?

The last 12 months have been torrid for the Deliveroo share price. But does this open an opportunity to grab…

Read more »

Smartly dressed middle-aged black gentleman working at his desk
Investing Articles

Is now FINALLY the time to buy Lloyds shares?

Lloyds shares have leapt in value as market confidence has improved. Should I buy the FTSE 100 bank before it…

Read more »

Black woman using loudspeaker to be heard
Investing Articles

3 high-dividend FTSE 250 stocks to buy right now!

The London Stock Market is packed with top high-dividend stocks to buy. Here are a handful I'm considering buying, despite…

Read more »

Woman using laptop and working from home
Investing Articles

How I’m using my Stocks and Shares ISA to generate lifelong passive income

I’m looking to build a portfolio of assets that will pay me an income in my retirement. Here’s how I’m…

Read more »

Close-up of British bank notes
Investing Articles

Is this the best time in a decade to start buying FTSE 100 dividend shares?

UK dividend yields are rising again. I reckon any time is a good time to start buying dividend shares. But…

Read more »

Smartly dressed middle-aged black gentleman working at his desk
Investing Articles

Director dealings: Rolls-Royce, Admiral, Dunelm

Director dealings can indicate whether a company's doing well. So, here are this week's biggest insider transactions at three FTSE…

Read more »