Why I believe International Consolidated Airlines could double in the next decade

Over the past 10 years under the stewardship of current CEO Willie Walsh, International Consolidated Airlines (LSE: IAG) has transformed itself. 

The company, which owns the British Airways, Aer Lingus and Iberia airlines, used to be a loss-making, struggling business, but it’s now one of the most attractive stocks in the FTSE 100. Over the past decade, the shares have produced a total annual return of just under 11%, while over the past five years they’ve returned 19.8% per annum for investors, including dividends.

And I believe that the company can continue to perform the broader market as it builds on its successes over the past few years. 

Beating expectations

Today’s first-quarter results are a great example of what IAG could accomplish over the next decade. The group reported an operating profit of €280m for the first three months of 2018, up 75% year-on-year and comfortably ahead of analysts’ expectations by 37%.

Total revenues grew 2.1% to €5bn, of which passenger revenue was €4.4bn, up 3.4%, and passenger numbers rose 8.5% to 23m. Passenger load factor — a measure of how full its flights were — rose to 80.5%.

IAG has been pursuing an aggressive growth strategy in recent years, which has helped it make the most of rising demand for air travel. Analysts believe the number of airline passengers will double over the next 20 years, growing at a compound annual rate of 4.7%.

IAG is well placed to benefit from this market growth. To help the company stay ahead of the competition, management has made several offers for low-cost carrier Norwegian, which would give the business a strong foothold in the budget transatlantic market.  

But despite the opportunities ahead, shares in IAG trade at a depressed valuation of only 6.5 times forward earnings. In comparison, low-cost carrier easyJet (LSE: EZJ) trades at 14 times forward earnings. So IAG, despite its scale, growing profitability and global presence, looks to me to be deeply undervalued compared to its smaller peer.

That said, easyJet is forecast to grow earnings by 32% this year and 21% for 2019. Over the same period, analysts have only pencilled in earnings growth of 10% for IAG. 

A better buy? 

I think easyJet looks more attractive on other metrics as well. For example, the company’s dividend payout to investors is expected to grow by 20% this year and 30% in 2019, giving a 2019 dividend yield of 3.9%, based on current prices. IAG’s distribution is only expected to expand at around 15% per annum for the next two years, although the shares currently support a much more attractive dividend yield of 4.1%.

However, despite the fact that easyJet seems more attractive as an investment on several metrics, I’m worried about the company’s ability to be able to continue to grow as larger players such as IAG try to edge in on its discount offering. 

The market is expecting a lot from easyJet. And the risk is that this growth never materialises, which could lead to a drop in the share price as the market re-evaluates the airline’s prospects. On the other hand, in my view, IAG’s valuation leaves plenty of room for further upside, if the company performs better than expected.