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Hargreaves Lansdown investors are buying Rolls-Royce shares and IAG. Here’s what I’d do

Image source: Rolls-Royce plc

Rolls-Royce Holdings (LSE: RR) shares were the most popular choice with investors on share trading platform Hargreaves Lansdown last week.

British Airways owner International Consolidated Airlines Group (LSE: IAG) wasn’t far behind, in second place by value.

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Both companies are ‘reopening stocks’, which depend heavily on air travel getting back to normal over the next year. I’ve been wondering whether I should buy one of them for my portfolio, or whether it’s too late to get on board this trade.

What happens next?

The IAG and Roll-Royce share prices have both risen by more than 100% from the lows seen in early October. Vaccine news in November put a rocket under these stocks, as it did with many others.

Despite these gains, both Rolls-Royce and IAG are still trading at share prices 50% lower than in January 2020. At first glance, this might seem cheap. But I don’t think it is.

The reason for this is that both companies have taken on extra debt and issued large numbers of new shares over the last year. They’ve been focused on survival. But as a potential investor, I’m focused on dilution.

What this means is that from 2021 onwards, Rolls’ and IAG’s profits will be split among many more shares than in the past. This means that earnings per share will be much lower, even if profits return to pre-pandemic levels.

The extra debt these companies have taken on also worries me. Debt payments always come ahead of shareholder dividends. These payments will now be bigger than they were before the pandemic.

I think it could be a while before IAG and Rolls-Royce can start to pay attractive dividends again.

Rolls-Royce shares vs IAG: what I’d buy

The other concern I have as a potential buyer is whether these are really good businesses. Airlines have a long history of boom and bust. But before the pandemic, many investors — even Warren Buffett — were starting to think things might be different now.

It turns out they aren’t. Airlines still have high fixed costs that are difficult to manage when demand is disrupted. And they still face very tough competition from multiple rivals.

Mr Buffett ditched his airline stocks early last year when the likely impact of the pandemic became clear.

In my view, Rolls-Royce is a better business than IAG. This is because Rolls-Royce offers essential products with few competitors and a large base of existing customers. These customers are tied into Rolls on long-term maintenance contracts. When flying restarts, airlines will have to start spending money with Rolls-Royce again.

To sum up, I don’t think Rolls-Royce shares or IAG shares look particularly cheap today. But if I did invest, I’d certainly choose Rolls. I think the engine maker is much more likely to deliver attractive long-term returns for shareholders.

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Roland Head has no position in any of the shares mentioned. The Motley Fool UK has recommended Hargreaves Lansdown. 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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