The IAG or International Consolidated Airlines (LSE:IAG) share price has performed extremely well over the part two years, with the stock up 180% over the period.
Yes, it has given a little bit of those gains back since the beginning of the year. The US’s moves in Venezuela and heightened pressure on Iran pushed oil prices to gain for six straight days.
As jet fuel represents around 25% of operational costs, it’s not entirely surprising that these moves in the oil market have impacted airlines.
Of course, the likelihood of a prolonged conflict around Iran that would materially impact the availability of oil is unlikely. In fact, I perceived it to be so unlikely that I used the opportunity to pick up shares in my preferred airline pick — which is now trading near 50% below fair value.
Anyway, let’s take a closer look at where analysts believe IAG’s fair value to be.
Analysts’ view
Despite the big run up for this stock in recent years, analysts still believe it’s undervalued by around 20%. That’s pretty considerable.
Those of you who follow my work (I’ve been informed that there are a few) will know that I don’t always believe institutional analysts are that good at their jobs.
But it totally depends. And I’m sure the least capable ones are assigned to the smaller and — to some — less important stocks.
Anyway, I do put a fair amount of weight on consensus when it’s supported by clear fundamentals and a sensible valuation framework. In this case, the optimism isn’t coming from heroic assumptions or blue-sky forecasting, but from fairly grounded expectations around cash generation, balance-sheet strength, and long-term demand.
That doesn’t mean the stock is without risk — no investment ever is — but it does suggest the market may still be underappreciating the durability of the underlying business.
What’s more, we can also see that earnings expectations have consistently been increasing over the past 12 months. That’s a really good sign.
The valuation
For me, the valuation is the most important part of any investment thesis. And it’s worth saying that on face value, IAG shares appear to be pretty good value. They currently trade round 6.4 times forward earnings, placing them at a substantial discount to American peers.
The issue, of course, is that the market is often unwilling to assign the same valuations to British companies as American ones. There’s also a modest net debt position to consider. IAG currently has net debt of around $5.5bn — that’s actually quite acceptable compared with the market cap.
There’s also a modest dividend yield, around 2.3% on a forward basis to consider. Margins are industry-leading too.
However, there are risks. Firstly, it may never receive a re-rating. This is a perception change that delivers a rise in the share price without earnings growth. And then there’s the ever-present risks around airlines. Think cyclicality — which is arguably less of an issue today than it used to be — and fuel costs.
I do believe IAG should be considered. It’s just not my top pick in the sector.
