Normally, no airline passenger wants to lose altitude quickly. I think that is probably true when it comes to most airline shareholders too. They prefer to see the value of their investment increase not fall. But British Airways owner IAG (LSE: IAG) has been heading in the wrong direction. The IAG share price has tumbled 33% in the past year. With pent-up travel demand fuelling a return to the skies, could this be a bargain for my portfolio?
Why is the IAG share price falling?
Given an increase in passenger demand, why has the IAG share price been going down?
One key factor is the fuel price. Fuel is a huge expense for airlines even when prices are cheap. So a move upwards can eat into profits even if everything else goes well at the business. In its first quarter, the airline’s fuel costs per available seat kilometre actually declined 4.0% compared to the same period a year ago. But I do not think that will last. Like many airlines, IAG tries to hedge against fuel price rises. But while that can help iron out costs in the short term, over a longer-time period, a jump in fuel prices inevitably means more costs for an airline.
The company said last month that business travel was at its highest level since the pandemic began. But its recovery has been slower than leisure travel. Historically, business travel has been more profitable for airlines like British Airways than leisure trips. So the slow return of business travel – and a fear that the shift to digital working means a lot of it is now lost forever – is adding to concerns about the long-term profit outlook for IAG.
On top of that, the impact of labour shortages at many airports is concerning investors. It could add more costs for airlines, hurting profits.
Sunny skies ahead
Although its share price has fallen, IAG is fairly upbeat about where things are going.
The company expects to generate an operating profit from the current quarter onwards. It forecasts that operating profit and net operating cash flows will be positive this year. That could help support the IAG share price.
IAG owns a number of powerful assets. Its family of brands, including Aer Lingus, Iberia, and Vueling, give it a strong foothold in the western European aviation market. It holds key slots at airports like Heathrow, giving it an advantage over many competitors. Its ruthless cost-cutting over recent years also means that its economics are attractive compared to many rivals.
My next move
With a market capitalisation of £5.9bn, I think IAG looks attractively valued for its long-term business potential.
But potential is the key word here. One concern I have about owning airline shares – and the reason I sold my IAG shares early in the pandemic – is how unpredictable the industry can be. Even competitive airlines with lean cost structures can be brought to their knees by a sudden turn of events totally outside their control, from surging fuel prices to a pandemic.
I think the business outlook for IAG is improving, but the risk of a sudden cost surge hurting its profitability remains high in my view. So I do not see the current IAG share price as a bargain for my portfolio.