International Consolidated Airlines’ (LSE: IAG) share price has risen 129% from its 5 March 12-month traded low of £1.41.
However, just because a stock has risen so much does not have to mean there is no value left in it now. It may be that the fundamental business is simply worth more now than it was before. Or the market might just be playing catch up to the true value of the firm.
In fact, in my experience as a former senior investment bank trader, it may be worth even more than the current share price implies. This is certainly true in IAG’s case, I feel.
Has the business fully bounced back from Covid?
Just before the onset of the global pandemic in early 2020, IAG shares were trading around £6.15. So today’s price represents a 47% discount to that.
This discount now looks unjustified to me. In the last full year before Covid struck – January to December 2019 – IAG’s operating margin was 11.9%. Its operating profit in that year was €3.3bn, and its net debt was €6.4bn.
In its full-year 2023 report, its operating margin had returned to 11.9%, and its operating profit was higher (€3.5bn). Its net debt had shrunk from the previous year, but was still higher than 2019’s, at €9.2bn.
Crucial for me was that in the nine-month 2024 report, this net debt figure had shrunk to pre-Covid levels, at just €6.2bn.
Consequently, I see no good reason why this 47% portion of the IAG price discount is still in place.
How undervalued are the shares?
The first part of my pricing assessment focuses on IAG’s price-to-earnings ratio valuation compared to its core competitors. On this, it trades at 6.2 against a peer average of 7.2, so the stock looks undervalued on this basis.
The second part of the evaluation looks at where IAG shares should be, based on future cash flow forecasts. Using other analysts’ figures and my own, this discounted cash flow analysis shows the stock is technically 64% undervalued at £3.23.
Therefore, the fair value of the stock would be £8.97. Market unpredictability may push the shares lower (or perhaps higher) than this. But it strikingly underlines to me how much of a bargain they look right now.
The additional value in the stock above its pre-pandemic £6.15 level is based on future forecast performance.
Over the medium term, IAG projects that it will increase operating margins anywhere up to 15% (from the current 11.9%). It also forecasts capacity growth of 4%-5% to the end of 2026.
A key risk to these is the intense competition on long- and short-haul routes from other carriers, I think.
However, consensus analysts’ expectations are that its earnings will increase by 5.9% a year to the end of 2027.
Will I buy the stock?
I am aged over 50 now and am focused on stocks that pay me high dividends. These should enable me to keep reducing my working commitments.
However, I would buy the stock today if I were at an earlier stage in my investment cycle. Earnings ultimately power a firm’s share price (and dividend) higher, and I think they will do so for IAG.
This post was originally published on Motley Fool
