Could this hurt the IAG share price?

With British Airways owner IAG (LSE: IAG) due to update the market on its third-quarter performance later this week, I’m getting more nervous about the prospects for the IAG share price.

Specifically, there are a couple of costs I think could dampen investor enthusiasm for the shares.

Oil costs

First is the most immediate concern: fuel costs. The oil price has been strengthening in recent months. That has an impact on airlines as aviation fuel is typically derived from oil. It’s one of the biggest costs for most airlines. In 2019, before flying demand was hit by the pandemic, fuel, oil costs and emissions charges were IAG’s biggest expense. They accounted for 27% of operating expenditure. So I expect the rising oil cost to be bad news for the company’s profit outlook.

Already, overseas operators such as United Airlines have pointed to the possible impact of fuel price rises. The CEO of large American carrier Delta warned recently that “the recent rise in fuel prices will pressure our ability to remain profitable for the December quarter”. Oil trades in a global market, so I expect similar fuel cost pressures to threaten IAG’s financial performance in the coming quarter and beyond. If that emerges in this Friday’s update, I think it could lead to a downwards move in the IAG share price.

One way for an airline to protect against rising fuel prices is to hedge them. That basically means paying a premium today to lock in future prices. But that can actually end up costing money, as the premiums have to be paid, but in the end the fuel may not be required.

Plummeting passenger demand last year cost IAG dearly in fuel hedging. So earlier this year it announced it would reduce its hedging. Up to 60% of requirements for the next year can now be hedged (up to 75% for IAG’s low-cost carriers), a reduction from previous levels. That still means the company is somewhat insulated from the impact of rising fuel costs. But it will have to swallow more than it did historically. That extra cost could hurt profitability, including in the third quarter.

Airport costs

Added to that is the prospect of higher usage costs for airports. Most notably, the owners of BA’s hub airport at Heathrow plan to increase passenger charges by up to 56%. Given that Heathrow is already the world’s costliest hub airport, that’s an eye-watering amount. Such charges are typically paid by passengers, so could dent demand. That could be bad for BA’s passenger numbers at Heathrow in coming years, threatening IAG’s revenue and profits.

I see oil prices as a more immediate challenge to profitability. But airport costs are also a mounting concern. While much attention has been focussed on Heathrow’s demands, airports around the world are also likely to raise costs as they seek to recover from the pandemic.

Bearish on the IAG share price

There could well be good news on Friday too. Passenger numbers are recovering, which could boost profitability. Pent-up demand for travel could also provide a boost to revenue. If there’s better than expected news, that could boost IAG shares.

But I’m expecting concerning news about the cost outlook. I think that could hurt the IAG share price. 

Christopher Ruane has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.