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Tempted by the IAG share price? Here’s what you should know

Image source: British Airways

The collapse of the International Consolidated Airlines Group (LSE: IAG) share price this week was not due to a fresh round of bad news from the firm.

What happened is that on 14 September, shares in the owner of British Airways started to trade without the rights needed to take part in IAG’s €2.75bn equity fundraising. The price we’re seeing now is what the market reckons the stock will be worth after an expected 2.9bn new shares are added to the group’s existing 1.9bn shares.

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In this piece I’m going to explain what happens next and estimate some new valuation metrics for IAG. I’ll also explain whether I think this could be a good time to buy.

Worse than expected?

If you owned IAG shares on Friday 11 September, you’ll have the right to subscribe for three new shares for every two you already own. If you bought the shares from 14 September onwards, your shares won’t have these rights.

The new shares are being sold at €0.92 each, which is why IAG’s share price fell so sharply on Monday. The new share price effectively averages out the price of the old and new shares.

In theory, IAG shares should have fallen to 131p on Monday, based on Friday’s price of around 200p. In reality, the IAG share price has fallen much further since then — as I write, the stock is trading at 114p.

Bad news on Covid and fears of further lockdowns probably aren’t helping. But it’s possible that investors are also taking an increasingly cautious view of how long it will take long-haul airlines to recover.

IAG share price: time to buy?

Despite the short-term gloom, the pandemic will be over at some point. And I suspect that people will still want to fly. IAG’s decision to raise €2.75bn in fresh equity looks sensible to me. I can’t guarantee that it will be enough to fund the group’s recovery, but it should certainly reduce the risk of a cash crunch.

I’ve been taking a look at how this airline group might be valued after the rights issue is finished.

When the new shares are added to the existing ones, IAG will have almost 5bn shares. Using this number, we can calculate revised estimates for earnings per share.

Looking at forecasts for 2021, I estimate that the stock trades on around 47 times earnings. That’s not cheap at all, and I wouldn’t expect a dividend either.

However, this is an extreme cyclical low for airlines, so I’d expect such a high P/E ratio. That could actually be a buying signal! After all, my sums suggest that IAG’s 2019 net profit of €2,387m would price the stock at just 2.6 times earnings. That’s certainly very cheap.

A problem is that I’m not sure if IAG’s profits will ever return to recent highs. Even if they do, I think it will take at least four or five years.

But is IAG’s share price cheap enough to buy? I think it probably is. However, with such an uncertain outlook, I’d prefer to invest in companies with wider exposure to the aviation market. For now, I think IAG is a stock to avoid.

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Roland Head 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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