In general, I try to avoid airlines when it comes to investing. But that’s been to the detriment of my Stocks and Shares ISA in recent years.
International Consolidated Airlines (LSE:IAG), or IAG for short, has seen its share price more than double in the last 12 months. So should I consider buying it in August?
Ups and downs
IAG has benefitted from strong travel demand recently. It’s not just the last 12 months – the firm’s earnings per share (EPS) have grown strongly over the last five years.
| Year | EPS (£) |
|---|---|
| 2024 | 0.47 |
| 2023 | 0.43 |
| 2022 | 0.05 |
| 2021 | -0.51 |
| 2020 | -1.06 |
That’s why the stock has climbed 210% since August 2020. And analysts think this is set to continue – the consensus forecast is for EPS to reach 58p this year and 72p by 2028.
Despite this, the stock trades at a price-to-earnings (P/E) ratio of 7. That suggests to me that the stock market as a whole isn’t convinced by the optimistic outlook.
I think people are right to be wary. While there are some clear opportunities for IAG to keep growing, things can also go quite dramatically wrong for the company.
Travel demand
IAG’s biggest costs are fuel and staff. And these are largely fixed – it takes the same amount of fuel and staff to operate a flight regardless of how many passengers are on board.
In general, airlines offset these costs and break even after selling around 70% of their available seats. As a result, profit margins on anything above this are very high.
That means operating a flight at 80% capacity is about half as profitable as flying 90% full. This is a good thing when travel demand is strong, but a big problem when it’s weak.
There isn’t much IAG – or any airline – can do about this risk. And I think it’s something investors should be paying careful attention to at the moment.
Recession risk
According to the Bank of America Fund Manager Survey, the most likely cause of a stock market crash is a trade war causing a global recession. That would likely weigh on travel demand.
In that situation, I think it’s highly unlikely IAG’s earnings will grow steadily in the next few years in the way analysts are expecting. And the impact could last for more than a year or so.
IAG still has a lot of debt on its balance sheet from the pandemic. While I’m not expecting a repeat of that kind of travel disruption, it does limit the firm’s financial flexibility.
That, I think, exacerbates the risk of a potential recession. And it makes me wary when it comes to thinking about the stock as a potential addition to my ISA portfolio at the moment.
Long-term opportunities
Despite being wrong about IAG over the last few years, the prospect of a recession means I’m still wary about the stock. But there’s a longer-term dynamic that I’m paying attention to.
Ryanair boss Michael O’Leary has referred to the potential for consolidation across the industry, with smaller carriers acquired by larger rivals. And this could make things far more interesting.
In that situation, airlines could have better pricing power and find themselves in a stronger position. So while I’m not looking to buy IAG shares right now, I’m watching the situation closely.
