Still cheap as chips! What’s wrong with the IAG share price?

Harvey Jones can’t believe just how low a value markets are putting on the IAG share price. He wants to buy it, but suspects there must be a catch.

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The IAG (LSE: IAG) share price is one of the biggest mysteries on the FTSE 100. It’s ridiculously cheap, trading at a meagre four times earnings, a third of the average blue-chip valuation. It seems to flash ‘buy, buy, buy’, yet investors resist.

This has been going on for ages. Obviously, the British Airways owner took a hammering from the pandemic as fleets were grounded, forcing it to load up on debt to muddle through.

Yet as aircraft engine maker Rolls-Royce noted in its recent Q1 results, flying is back to pre-pandemic levels. In 2019, the IAG share peaked at more than 400p. Today, it’s idling at 168p. Something still isn’t right.

FTSE 100 bargain?

A few weeks ago, it looked like investors had woken up to the stock’s undervaluation, as the share price rallied with the rest of the FTSE 100. Now it’s falling with the index instead. I see that as a buying opportunity. But first, I want to know what’s wrong.

IAG, which also owns Aer Lingus, Iberia and Vueling, enjoyed 2023 thanks to “strong and sustained demand for travel, in particular in leisure”. Full-year operating profit before exceptional items more than doubled on 2022 to €3.5bn, finally overtaking 2019’s total of €3.25bn.

Operating margins more than doubled year-on-year from 5.4% to 11.9%, while free cash flow was “strong” at €1.3bn

I think the main reason it’s so cheap is that it still carries a heap of debt from the pandemic. That stood at €10.36bn in 2022. It dipped to €9.25bn in 2023, but that’s still higher than IAG’s market cap of £8.28bn.

Debt is on the right trajectory, though, with analysts forecasting it will shrink again to €8.28bn in 2024 and €7.95bn in 2025. But I suspect the share price will struggle to fly until it finally casts off that burden.

Top value stock

2024 has started well, boosted by a strong Easter, with operating profit soaring from €9m to €68m. Summer is coming. IAG is looking forward to it.

Wars in Ukraine and Gaza continue to hit revenues, and sadly, that doesn’t look like changing. British Airways still hasn’t rebuilt its Asia Pacific network since the pandemic. My longstanding worry is that running an airline is capital-intensive with high fixed costs. Management is at the mercy of events beyond its control, such as war, pandemic and the business cycle. As a result, the IAG share price may always be on the cheap side.

Yet I’m encouraged to see travel demand pick up, even though the cost-of-living crisis drags on. People still love their hols. Even better, the dividend has been restored after a three-year hiatus. Analysts forecast a 2.85% yield in 2024, rising to 3.82% in 2025. That’s pretty rapid growth.

IAG may always be one of the riskier blue-chips but today’s low valuation helps to offset this. I’ll add it to more portfolio when I have the cash. Hopefully, that’s before the next leg of the IAG share price rally.

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.

Harvey Jones has no position in any of the shares mentioned. The Motley Fool UK has recommended Rolls-Royce Plc. 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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