Since the start of the year, the International Consolidated Airlines (LSE:IAG) share price is up around 17%. But it’s still a long way short of where it was five years ago.
In 2018, the stock reached 450p before falling sharply during the pandemic. But with Covid-related headwinds now in the past, could the share price be at the start of a mighty rally?
Post-Covid
Most airlines have emerged from the pandemic in a weaker position than they were before. Notably, their balance sheets are in worse shape as a result of having to take on debt and issue equity to stay afloat during travel restrictions.
This is true of IAG as much as any other airline. But there’s an argument that says that while the businesses might be worse off, their relative positions might have changed.
In other words, even if all the companies in the sector are worse off, some might have been affected more than others. And IAG arguably has a competitive edge in this regard.
The firm’s status as the UK’s flag carrier gives it an advantage over its rivals. And this could allow it to increase its market share as travel demand normalises again.
There might be further headwinds to come in the form of a recession, but I’m looking further ahead than that. Those that survive might find their competition significantly weakened or more fragmented than it was before.
Lasting damage
The IAG share price has managed to rally from 127p to 150p over the last 12 months – comfortably outperforming the FTSE 100. But I think there are reasons for being sceptical of the idea that it can get back to its pre-pandemic levels any time soon.
One is that the business still has around seven times as much long-term debt as it had in 2018. Sooner or later, all of that will have to be repaid.
Furthermore, the interest on that debt looks to me like it’s going up at an alarming rate. According to the IAG’s most recent financial statements, around 36% of the company’s operating income goes on paying interest on its loans.
The other big issue is that IAG’s share count has more than doubled over the last five years. As a result, it has to make over twice as much profit to generate the same earnings per share as it did five years ago.
I think this is going to be a real struggle. Even with an improved competitive position, the firm is going to need record revenues to justify a 450p per share valuation and investing on the basis that it’s going to achieve this looks dangerous to me.
Warren Buffett
During the pandemic, Warren Buffett sold Berkshire Hathaway’s investments in each of the four major US airlines. The Oracle of Omaha did so at a significant loss and took a lot of criticism for doing it.
In hindsight though, the decision looks like it made sense. Like IAG, the US carriers took on a lot of debt and this seems likely to severely impair their profitability going forward.
I have the same concern about the UK airlines. And while anything is possible in financial markets, that’s why I don’t see the IAG share price getting back to 450p any time soon.
