Down 7% to under £2, the IAG share price looks 75% undervalued to me right now

IAG’s share price has fallen on geopolitical events outside its control, but the core business seems excellent to me, leaving the stock looking very cheap.

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British Airways-owner International Consolidated Airlines’ (LSE: IAG) share price has fallen 10% from its 30 September 12-month high of £2.12.

It is down 68% from the £6.15 level it held in January 2020 before the widespread onset of Covid.

To me, such numbers will always flag the possibility of a huge bargain to be had.

Why has it dropped so low?

The big part of the drop from £6.15 resulted from the effects of the Covid virus on travel. Airline passenger numbers fell over 90% in 2020 and 2021.

This was compounded the following year when energy prices rose after major oil and gas exporter Russia invaded Ukraine. Jet fuel prices spiked as well, increasing the costs for airlines.

The smaller more recent part of the fall in IAG’s share price has been due to ongoing military conflicts. The Russia-Ukraine war means Western airlines avoid the cheaper routes to several Asian destinations that cross Russian air space.

Other routes to Asia have also been affected since the recent escalation of the conflict in the Middle East. Additionally, winter holiday destinations in the region are likely to be affected if this heightened insecurity persists.

Is the core business strong?

Covid has retreated and the cost-of-living crisis has lessened, although a resurgence of the latter and a recurrence of a similar pandemic remain key risks for IAG.

However, over and above these external factors, the firm itself looks in very good shape to me.

It also eliminated the only major risk over which it has control when it scrapped the takeover of Air Europa on 1 August.

Its full-year 2023 results showed a near-tripling in its operating profits to €3.5bn, while its operating margin more than doubled to 11.9%. Capacity at that stage was almost back to where it was before Covid in most of its core markets.

And its H1 2024, results saw revenue climb 8.4% year on year to €14.274bn, while operating profit rose 3.9% to €1.309bn.

Are the shares undervalued now?

IAG is extremely undervalued on all three key stock valuation measures I look at most.

On the price-to-earnings ratio (P/E) it currently trades at just 4.2. This is the lowest among all its key competitors, which have an average P/E of 7.6.

On the price-to-book ratio (P/B), IAG trades at just 2.4 against a 3.4 competitor average. And on the price-to-sales ratio (P/S), it trades at only 0.4 compared to an average of 0.6 for its competitors.

To nail down exactly how cheap it is in cash terms, I ran a discounted cash flow analysis using other analysts’ figures and my own.

It shows the stock is 75% undervalued at the current price of £1.97. So a fair value for the shares would be £7.88, although it may go lower or higher, given the vagaries of the market.

Will I buy it?

I focus on high-yield shares, so IAG (yielding zero, currently) is not for me. However, if I was looking for a growth stock, I would buy it, given its very strong core business.

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.

Simon Watkins 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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