International Consolidated Airlines Group (LSE: IAG) is the third-largest European airline group. Its carriers include British Airways, Aer Lingus, Iberia, and Vueling. Shares in IAG currently trade at around 33% of their pre-pandemic price, but I don’t think that this by itself means that they’re cheap. After all, a tin of beans reduced from £100 to £33 is still a really expensive tin of beans! For me, the question of whether or not the IAG share price is cheap comes down to what investors have to pay and what they can expect to get from the underlying business in exchange.
IAG’s current share price represents a cost of £8.1bn to buy the entire company. According to the company’s most recent financial statements, the company has £6.35bn in cash, £16.5bn in debt and lost £5.2bn in free cash in 2020. Paying £8.1bn to take on a company with negative cash flows and £16.5bn in debt in exchange for £6.5bn in cash doesn’t seem like a great investment opportunity to me. But investing is about looking past the most recent news to try and figure out what the future might look like, and I think that IAG’s 2020 losses are clearly the result of some temporary headwinds.
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The recent travel restrictions have severely impacted airlines in general, and IAG in particular. Being unable to operate has left it unable to bring in money by selling seats, whilst still having to pay most of its usual costs on things like aircraft, fuel, and staff. As a result, it has had to raise money by taking on debt, issuing shares , and relying on government assistance. But I don’t think that this is going to last forever. The question is how things will look when normality resumes.
Before the pandemic hit, IAG reported positive free cash flows. In 2019, the company generated £448m in free cash. If IAG can return to these levels quickly, I think the investment proposition looks somewhat better. In exchange for paying £8.1bn and taking on £16.5 of debt, an investor would get £6.35bn in cash and a business that generates £448m per year. This would represent an investment return of 2.45% per year. But whether or not this means that IAG shares are cheap, for me comes down to how this return compares to the returns on offer elsewhere.
Applying similar calculations to other companies leads me to think that a 2.45% return is not that high. In the UK, applying the same calculation implies a 6.14% return from Unilever and a 4.67% return from Lockheed Martin. I therefore don’t think that IAG’s shares are cheap compared to other alternatives.
For me to think that shares of IAG are cheap, I would need to think that the company is going to significantly exceed its 2019 cash flow levels. This might happen, but it isn’t obvious to me that it will. Whilst the relaxing of pandemic restrictions might cause the release of some pent-up demand for travel and a sharp upward movement in the share price, I find it hard to see the kind of investment returns from the underlying business that would lead me to think that IAG’s shares are selling cheap, and so I won’t be buying them any time soon.