Is this under-the-radar value stock a buy this summer?

With passenger numbers returning to near pre-pandemic levels, Gordon Best takes a closer look at a value stock that may have serious potential.

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International Consolidated Airlines Group (LSE:IAG) is one of the world’s largest airline groups. The company owns a number of well-known airlines, including British Airways, Iberia, and Aer Lingus, and its shares have been flying in recent months. But is now the time to buy this value stock?

This recent growth is due to a number of factors, including the easing of travel restrictions following the pandemic, strong demand for air travel, and the company’s cost-cutting measures.

However, there are some risks to consider before investing in IAG shares. The airline industry is highly cyclical, and it is possible that the strong demand for air travel could wane in the future. The company is also vulnerable to other challenges, such as volatile fuel costs, workplace disputes, and the ongoing conflict in Ukraine.

What is it worth?

IAG recently reported that passenger demand is now at 97% of pre-pandemic levels, leading to the company turning a surprise profit in the recent quarter.

The long-term outlook for the airline industry is positive. The global population is growing, and people are increasingly traveling for business and leisure. Additionally, the rise of low-cost airlines is making air travel more affordable for people in developing countries.

IAG is well-positioned to benefit from the growth of the airline industry. The company has a strong brand portfolio, a global network of airlines, and a track record of profitability. Additionally, IAG is taking steps to reduce its costs, such as in IT improvements and supplier negotiations, which will help it to weather any downturns in the industry. As a result, earnings are expected to grow at a 17% rate over the coming years, roughly in line with the sector average of 19%.

Shares are currently trading at a price-to-earnings (P/E) ratio of around 7.8 times. This is slightly below the average P/E ratio for the airline industry, which is around 16.2. The discounted cash flow calculation suggests that shares may be 59% undervalued. Both metrics indicate there is significant potential if the company can return to normal operations.

What are the risks?

Investing in airlines has always been risky. The industry is cyclical, vulnerable to fluctuating fuel costs, and it is possible that the strong demand for air travel could wane in the future, such as during a recession.

My main concern is the company’s high debt load of £20bn. Although this is seemingly coming under control over the long term, the interest payments are still not covered by earnings. The high return on equity (ROE) of 56% is also slightly skewed as a result of these high debt levels. Competition from low-cost airlines and uncertain demand could quickly lead to this debt level worsening if it is not well managed.

Am I buying this value stock?

IAG shares are a risky investment, due to the cyclical nature of the sector, the company’s debt, and external threats. However, with the share price down heavily since the pandemic, IAG could also be a lucrative value stock. The company has a strong track record and is well-positioned for growth in the long term.

I am keeping IAG shares on my radar, but will not be buying until I see sustained economic growth to avoid the debt situation from worsening.

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 assessed. Consider taking independent financial advice.

Gordon Best has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.

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