After a tough few years, the aviation industry has come back strongly in 2022. That is good news for companies like British Airways parent IAG (LSE: IAG). It reported profit after tax and exceptional items in the first nine months of €199m, compared to an equivalent loss of €2.6bn for the same period last year. Yet despite that turnaround, the IAG share price is 6% lower today than it was a year ago.
With an apparently strong improvement in the IAG business, could the shares soar next year? If so, ought I to add some to my portfolio now?
Business outlook is strong
The move into profit from a big loss, after tax and exceptional items, is encouraging.
One of the perennial challenges of the aviation industry is high fixed costs. Planes are expensive to fly – but they also cost a lot just to keep on the ground doing nothing. Higher passenger flying hours mean that the cost base can now be covered by much bigger revenues. Passenger revenue in the first nine months of the year more than quadrupled compared to the same period last year.
What I find interesting is that passenger capacity in miles at the airline for the full year is expected to come in at only 78% of its pre-pandemic 2019 level. That suggests that there is scope for a big jump in miles flown next year. Add in ticket price rises as well as pent-up demand and I think we could see markedly stronger revenues at IAG in 2023. If it manages its cost base well, that could be excellent news for profits.
Unattractive balance sheet
However, in itself that might not make the current IAG share price a bargain.
Net debt at the end of September stood at over €11bn. That was 5% lower than a year before, but it is still substantial. It is bigger than IAG’s market capitalisation, which stands at £6.7bn.
If the company continues to make profits and generate free cash flow, it can pay down those debts. But I expect that to take a long time given the size of the debt on its balance sheet. Meanwhile, rising interest rates could make it more expensive to refinance the debt in future.
Tough industry
In a way, I think IAG’s situation pretty much shows the business challenges involved in running a large passenger airline (or a few airlines, as in the case of IAG). When times are bad, they are really bad. High costs continue even if revenues plummet for reasons outside the business’s control.
Meanwhile, when times are good, covering the costs of those bad times still weigh heavily on financial performance. I think that helps explain why the share price has actually been falling over the past year, despite its improving business trends.
Meanwhile, cost cuts continue to damage the customer experience. My last BA flight experience left me less than impressed (and stranded near Heathrow overnight). In the long term, too much cost-cutting is a risk to revenues.
Ready for take-off?
For that reason, I have my doubts that the IAG share price will soar in 2023 even if the business continues to recover.
The economics of passenger aviation are unattractive to me and I will not be investing.
