International Consolidated Airlines Group SA (IAG) Ord EUR0.10 (CDI)

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IAG’s second-quarter revenue rose 7.8% to €8.3bn, largely driven by increased capacity and planes being more full on average.

Operating profit remained broadly flat at €1.2bn, which was well ahead of market expectations. Increased revenues were offset by rising fuel and staff costs.

Free cash flow grew from €2.7bn to €3.2bn in the first half. Net debt fell from €9.2bn to €6.4bn year-on-year.

For the full year, capacity is still expected to grow by 7% while generating “significant” free cash flow.

IAG has pulled out of plans to acquire Air Europa, citing that “it would not be in the best interest of shareholders” amidst the “current regulatory environment”. IAG will retain its current 20% stake but must pay a €50mn fee for pulling out of the transaction.

Dividends have been reinstated, with an interim payment of €0.03 announced.

The shares rose 4.3% following the announcement.

Our view

British Airways owner IAG beat profit expectations in the second quarter. But focus was on the reinstatement of dividends as it scrapped plans to buy Air Europa – more on this later.

Turning to everyday operations, we’re pleased to see that planes are flying with more passengers on board, despite the group’s increased capacity. That shows there’s still strong demand for the group’s routes, even though there’s considerable pressure on consumers’ incomes.

Given the high fixed costs associated with flying planes, squeezing more passengers onto each flight increases profitability. However, this benefit is currently being offset by higher fuel costs. That’s part and parcel of running an airline, you’re always at the mercy of this external factor. But we’re happy with the underlying picture, and profitability should get an extra boost when fuel prices ease.

Something else to consider is that the airline industry is drastically different from pre-COVID. A handful of smaller carriers have gone out of business, meaning there’s plenty of sky up for grabs. We view that as a helpful dynamic, and IAG’s strong, trusted brands should help it expand its capacity.

For now though, acquiring new brands seems unlikely. IAG pulled out of plans to buy the remaining 80% of Air Europa, saying that the challenging regulatory environment meant it wouldn’t be in the best interests of shareholders.

We’re inclined to agree given the distractions and headaches that wrestling with regulators over anti-competitive concerns would bring. IAG will cut its losses by paying a €50mn fee for abandoning the deal. On the flip side, it means there’s plenty of cash available, and dividends have been reinstated as a result. As always though, shareholder returns are variable and never guaranteed.

There are some things to keep in mind, though. While pent-up travel demand still has room to run, it can't go on forever. The group's also more exposed to business travel than other short-haul-focused carriers, and that corner of the market would take more of a hit should business consumers avoid departure gates.

IAG’s also set to spend heavily on upgrading its digital infrastructure. This includes upgrading the website and leveraging data to reduce disruption and improve the customer experience. These are great targets, but the pace of delivery is far from guaranteed.

For now, it seems the worst is over for IAG and the current risks to demand look more like turbulence than a complete grounding. We're a lot more positive than we've been for some time. But at current valuations, we prefer other names in the sector.

Environmental, social and governance (ESG) risk

The transport industry is medium risk in terms of ESG, with European firms managing them better than others. Carbon emissions, product governance, and quality & safety are the biggest risk drivers. Other key areas are emissions, effluents & waste, labour relations, and employee health & safety.

According to Sustainalytics, IAG’s management of ESG risk is strong.

The group has sustainability, environmental and social programmes integrated into its core business strategies. Executive compensation is also linked to ESG performance targets. However, its disclosures and reporting of ESG issues falls short of best practice.

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views may have changed since then. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

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