It has been busy on the news front for British Airways (BA) and Iberia owner International Consolidated Airlines (LSE: IAG). On Monday of last week, an agreement by IAG was announced to acquire Air Europa for €1b next year, capacity growth expectations were trimmed along with 2019 profit forecasts, and the CEO confirmed his intention to step down in a couple of years’ time.
The share price has barely budged, because margins are expected to hold up, the capacity issues are not unique to IAG, and the profit-trimming was the result of industrial action, with no further walk-outs planned at the moment.
That acquisition looks cheap at just 2.55 times earnings before interest, tax, depreciation, and amortisation, and will boost IAG’s presence at their Madrid hub, particularly with connections to South America. Plus, IAG has a history of successfully integrating airlines. Successful completion of the deal would mean IAG having close to 700 planes in the air in 2020; only the big American carriers have more.
The world’s favourite airline?
Most of IAG’s profitability comes from BA, which topped Skytrax’s world airline awards in the mid-2000s. An ageing fleet, dated cabins, and cost-cutting measures, like ending free food on short-haul flights, lost BA the top slot and then some, but customers kept flying and so did profits.
Passengers had little choice, as BA has over half of the take-off and landing slots at Heathrow and dominates lucrative transatlantic routes. If a third runway is added, then under the current slot allocation guidelines. BA stands to get most of the new slots.
Leaving the EU could allow a change in the allocation procedure – and hurt revenues – but IAG has deep pockets to deal with, say, an auction process, and also to buy up any slots given to airlines that fail or have to sell up.
And the scrimping and saving at BA is now over with £6.5b earmarked for updating cabins, lounges and meals, and buying new planes, and so far the reception from customers has been positive. BA does, however, need to keep its flight crew onside.
IAG’s group structure, where individual airlines operate separately but compete for capital, and a bit of a cost-saving drive produced a 15% operating margin and 16.6% return on invested capital for 2018, which is great for an airline. A mixed fleet reduces reliance on manufacturers, and plane configurations are consistent across owned airlines, meaning they can swap them around if needed.
IAG caters to premium, low-cost, and value passengers and is well connected across Europe and North America. South America connectivity is being bolstered, but they are a little light in the fast-growing Asian markets which will need addressing,
So in summary, IAG has a good business model with solid operating margins and a strong balance sheet. Forecasts growth (although trimmed) and shares have an ordinary dividend yield of about 5% currently with hefty special dividends paid recently, which shareholders will expect again when indicated.
In terms of total return, IAG has outperformed the FTSE 100 by 5% over 10 years, but with more volatility, so I am happy holding this stock in my portfolio for the long-term as I expect this to continue.
Check with your broker about reclaiming Spanish dividend withholding tax if you own IAG shares.
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James J. McCombie owns shares in International Consolidated Airlines Group SA. 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.