A big bet on transatlantic flying has paid off for long-suffering investors in British Airways owner IAG, as a year-long rally lifted the airline group's shares to their highest level since the start of the pandemic.
Shares in IAG, owner of five airlines including BA, Iberia and Aer Lingus, closed last week at just under 316 pence, the highest level since February 2020. The stock fell on Monday, but has more than doubled in the past year to make it the top performer on the index. FTSE 100 in London.
The turnaround in the company's fortunes came as investors cheered a second straight summer of record profits built on profitable transatlantic flying, which has seen particularly strong demand since the end of the pandemic.
“They focused on where they could travel to win,” said Andrew Lobbenberg, head of European transport equity research at Barclays.
This allowed IAG to pay down its debt owed due to the pandemic and redistribute its dividend. It also announced shareholder buybacks worth €350 million late last year, the first since the pandemic.
“Demand remains strong across the Atlantic and within Europe,” said Nicholas Cadbury, IAG's chief financial officer, adding that the group's shares were supported by “significant cash flow and an increasingly strong balance sheet”, leading to increased investor returns.
One of the biggest questions now hanging over IAG is whether a £7bn investment plan in British Airways can improve service and reduce delays and other operational problems at its main source of profits.
The airline has faced criticism in the past – particularly from customers and unions – for apparently prioritizing shareholder returns over customer experience and quality.
Lobernberg said BA's improvement “should be a strong and sustained driver of the group's earnings momentum”, particularly as the airline controlled Heathrow Airport, one of the world's most profitable travel markets.
“They have to make a strong profit. So, recently they have performed very poorly because they have not been invested enough in them.
IAG's business model is geared toward long-haul travel especially business and first class cabins, parts of the industry that were slower to recover post-Covid but are now thriving.
“If you want exposure to transatlantic and premium travel, IAG is the play you want to look at,” said Julian Cook, a partner at ATKA Capital, a London-based hedge fund focused on aviation.
ATKA sold a stake in Ryanair last year to buy IAG, which was a “no brainer” according to Cook.
“We could see that Atlantic was performing well and wanted to play the premium end of the market,” he added.
Even after the rally, IAG shares still only trade at a price-to-earnings ratio of about 6.5 times, lower than Ryanair and easyJet.
IAG's main hubs of London, Dublin and Madrid are located in the far west of Europe, giving it a natural advantage in flying across the North and South Atlantic.
The group has doubled its efforts on these routes since the outbreak of the pandemic at the expense of flights to Asia, where demand has been slow to return and European airlines face the complexity and cost of having to avoid Russian airspace.
Three-quarters of IAG's long-haul flights are to the Americas, more than 53 percent at Lufthansa Group and 54 percent at Air France-KLM, according to analysts at Bernstein.
This focus on the Atlantic has also allowed IAG Airlines to avoid competition from wealthy and expanding rivals in Turkey and the Gulf, where European airlines struggle to compete on costs and prices, as well as service standards.
In contrast, US and European routes have become more profitable compared to pre-pandemic levels since Norwegian's collapse in 2020, which disrupted existing low-cost carriers.
“Flying west rather than east is the better long-haul strategy post-pandemic, especially from London,” said Alex Irving, a transport analyst at Bernstein.
Other questions facing IAG now include whether aviation demand in its key markets can hold up, as well as the potential for increased geopolitical tensions, especially with a second Trump presidency, analysts said.
There is also uncertainty over future mergers and acquisitions, after European competition authorities last year rejected an attempt to grow its position in the Latin American market by purchasing Spain's Air Europe.
IAG's management told investors it is focused on achieving financial targets set in 2023, which include increasing operating margin to between 12 and 15 percent, up from 11.9 percent in 2023.
Its other goals include increasing its flight schedules by between 4 and 5 percent annually, and achieving a return on invested capital of between 13 and 16 percent. Airlines typically generate single-digit ROI, according to Bernstein's Irving.
“In the context of other European airlines, it is not only the most profitable but the most shareholder-friendly, having clear financial targets for each of its units and allocating capacity to those units according to their earnings performance,” Cook said. .
