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Here’s why I’ll be avoiding IAG shares

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An airplane on a runway
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Last week, presumably mostly before Portugal came off the green list for travel, customers of stockbroker Hargreaves Lansdown were buying shares in airline IAG (LSE: IAG). It’s not hard to tell why. Hopes of the economy opening up could lead some to think the shares will go up. But will they? And what happens if the economy doesn’t reopen as expected on June 21 as ministers are now signalling it might not?

All up in the air for travel

Already we’ve seen concerns about countries like Portugal coming off the travel green list. It’s quite possible the restrictions and testing required for international travel go on longer than expected. Did anyone in February or March 2021 really think we’d still be in some form of lockdown in mid 2021 because of Covid-19?

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It seems highly feasible that demand for flights after the latest changes could subside even further, which would be bad news for the shares of the airlines. For me, that is reason enough to avoid shares in IAG.

IAG shares and my portfolio

I want to build my portfolio around quality companies that can grow their profits and their dividends – and hopefully by extension their share prices. To do this, I want to see good margins, high return on capital employed, manageable debt, a company not needing to raise funds from shareholders, and I want the company to operate in a growth industry and ideally be a market leader.

I think IAG only really arguably meets the last of these criteria. Owning British Airways as well as some other airlines certainly gives it scale. IAG has a market capitalisation of just over £10bn. That scale, along with its brand value, is one of its positives.

The share price could also do well if travel picks up better than expected. This could be due to vaccine passports and the success of vaccines against new Covid variants. 

The challenges

In the immediate term, besides the pandemic I think IAG could come under pressure from increasing fuel prices and inflation. Both have the potential to hit margins that are already under tremendous pressure in the vital summer season.

Looking longer term I don’t see the shares recovering that strongly. To me the balance sheet looks really weak. A current ratio (measuring if the company can afford to pay bills in the next 12 months) of 0.68 means shareholders may need to give the airline more money, making it even harder to invest profitably in the airline.

The share count, so the number of shares in total, has more than doubled since the pandemic started. IAG was forced to raise money as customers stopped flying and revenues plummeted. 

The increased share circulation means it’ll be much harder for IAG to achieve the same earnings per share as pre-pandemic. There are more shares so more dilution. 

I think that could create challenges for the share price. 

IAG has swung from being hugely profitable pre-pandemic to being loss-making. I fear the recovery may take longer than some investors expect. In turn that could hit the share price. 

Given all these challenges I’m very clear that I’ll be steering well clear of IAG. Indeed, I’ll likely be avoiding all travel-related shares, especially those that have had to raise significant money just to survive up to this point.

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Andy Ross owns no share 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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