Could IAG Be Ready For Takeoff?
- IAG is currently one of the cheapest companies in the FTSE 100
- Currently offers a dividend yield of 3.28% at £7.19 share price
- Started paying a dividend in 2015 and increased it by 17.50% in 2016 and 14.89% in 2017.
International Airlines Group (LSE: IAG) is one of the world’s largest airline groups with 546 aircraft flying to 279 destinations carrying around 105 million passengers a year. It’s currently the third largest airline group in Europe, behind Lufthansa Group and Ryanair (LSE: RYA).
Formed in January 2011, IAG is the parent company of Aer Lingus, British Airways, Iberia, Vueling and LEVEL. The group is registered in Spain with shares traded on both the London Stock Exchange and Spanish Stock Exchange.
The group recently reported on its Q1 results in May and their operating profit increased by a huge amount from €160 million to €280 million! Key metrics such as available seat kilometres and revenue per available seat kilometres also grew with Latin America & Caribbean showing an 8% increase due to LEVEL flying to Buenos Aires in Argentina.
The group is also benefitting from margin increases in all of its airlines and its guidance remains as they’re targetting an average growth rate of 6.8%. I’m excited by the expected capacity growth of Aer Lingus as it’s displaying the highest return on invested capital (ROIC in the images below).
IAG’s Low-cost Strategy Exceeds Expectations
In March 2017, IAG created a low-cost airline brand, LEVEL, in response to increased competition in the long-haul market by low-cost airlines. The company was smart enough to attack the problem on 2 fronts, as they approached Norwegian Air Shuttle in an attempt to acquire them. The plan was stifled though, as Norwegian refused 2 offers citing that it undervalued their company.
The LEVEL brand currently has 2 A330 aircraft with a further 5 ordered that should be delivered some time in the next few months. This will explain the capital expenditure figures I’ll be posting later on, aeroplanes are not cheap! The brand far exceeded IAG’s expectations as they sold out 52,000 tickets on the first day.
The brand is based in the airport hubs of Barcelona, Spain where it will soon have 3 aircraft and Paris-Orly, France that will soon have 4. The first 2 routes out of Barcelona were to California serving Los Angeles (LAX) and Oakland (OAK) airports, though the latter will be changed to San Francisco (SFO) this year. The other 2 routes were to Buenos Aires and Punta Cana. The 4 routes from Paris will be to Montreal, New York, Guadeloupe and Martinique, they will be available as soon as next month in July 2018.
The group’s revenue has been trending upwards as they continue to expand, and this has been fueled by increasing debt. I’m generally not a fan of companies with rising debt levels but while interest rates remain low, its obvious that IAG has been able to benefit from it. We can see from the group’s Income Statement that their operating margins have increased on a yearly basis along with their net income margins to a healthy figure.
|Total Revenue (M)||€18,569||€20,170||€22,858||€22,567||€22,972|
|Net Income Margin||0.66%||4.87%||6.54%||8.56%||8.71%|
|Diluted Earnings Per Share||€0.06||€0.46||€0.70||€0.89||€0.93|
|Free Cash Flow Per Share||-€0.50||-€0.35||-€0.03||-€0.18||€0.93|
|Dividend Per Share||€0.00||€0.00||€0.200||€0.235||€0.270|
|Free Cash Flow Payout Ratio||0.00%||0.00%||-666.67%||-130.56%||29.03%|
Most new investors use easily obtained metrics such as earnings per share and dividend per share, the outcome of this is called the dividend payout ratio. This is where most investors are surprised when a dividend cut occurs because judging by 2015 and 2016, you would be fooled into thinking the group could afford to pay the dividend if you were focusing on the earnings.
|Year||Cap / Flow||CROIC||FCF PS|
The truth is that due to the group’s capital expenditure requirements such as launching LEVEL Airlines and expanding its A330 fleet, the company had to use debt to pay shareholders dividends in 2015 and 2016. This is why cash is king and needs to be a focal point of your research and not earnings.
For every year until 2017, we can see that capital expenditures exceeded what the group generated in cash flow from its business operations. Once again on the Income Statement, the net income would have you believe that the group was generating a profit every year, however, this has only been the case since 2017.
For 2017 IAG generated an impressive 30% cash return on invested capital, meaning for every €1 invested in the group, they generated a €0.30 return.
Now IAG is finally showing huge profits that can cover its capital expenses and pay dividends to its shareholders without needing to increase debt or raise equity by issuing shares.
I like to buy shares when its free cash flow can give me a yield of 10% or higher, and since IAG created €0.93 in free cash for every share it owns, if we convert that to GBP it represents £0.82 per share. With a current share price of £7.19, we’re getting an 11.40% yield on our money, and I would recommend buying shares of IAG up to a maximum share price of £8.20.
With a current dividend yield of 3.28% and the FCF payout ratio of 29.03%, the group can easily afford to continue raising the dividend every year like they did by 14.89% in 2017. This means we will be receiving income that far exceeds inflation of 2.40%, providing us with a meaningful pay rise in the double digits!