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IAG (LSE: IAG) shares were hit hard in 2020, along with the wider airline sector. And although the stock has risen over 27% in the past 12 months, it’s still down over sharply from pre-pandemic levels.
Given this huge discount, is now an opportunity to grab some cheap shares? Better yet, could this stock be on the brink of a significant rebound? Let’s investigate.
Near-term headwinds
I see multiple signs of worry for IAG, many of which are linked to the current tricky macroeconomic climate. Interest rates remain high across the continent, in order to keep pressure on high inflation.
Inflation raises operating costs for airlines, impacting their profits. It also drives up expenses related to fuel, labour, and maintenance, putting pressure on budgets and profitability.
Rising prices also tend to decrease consumer discretionary spending, such as holidays, potentially reducing customer demand.
The surge in fuel prices specifically has put huge pressure on airline companies like IAG. Unfortunately, this trend shows no sign of slowing down. Analysts have predicted that the ongoing conflict between Hamas and Israel could cause a near 10% increase in crude oil prices compared to their September levels.
High interest rates add further fuel to the fire, as they lead to higher borrowing expenses for airlines. This makes it costly for them to fund expansion and upgrade infrastructure.
IAG currently has over €19.6bn of debt on its balance sheet. After taking into account the company’s €12bn cash balance, this leaves it with a net deficit of €7.6bn. Such a large debt load does worry me, considering high interest rates.
Enticing valuation
IAG shares currently trade on a low price-to-earnings (P/E) ratio of just 4.8. For context, the FTSE 100 average usually hovers around the 12 to 14 mark. In addition to this, competitors Lufthansa and Ryanair trade on higher P/E ratios of 5.6 and 15, respectively. This certainly signifies values in my eyes.
In addition to this, as mentioned, the stock is still trading far below its pre-pandemic levels. Currently priced at 147p, the shares are over 66% lower than their February 2020 levels. This shows me that investors have previously priced the stock much higher, signifying potential room for growth.
Alongside its low valuation, IAG has delivered some encouraging results. Total revenue for the first six months of 2023 topped €13.5bn, up from €9.3bn in the same period last year. More importantly, the company delivered a healthy €921m profit after tax, compared to a €654m loss the year before. These results seem to indicate that the airline is moving in the right direction.
Ready for lift-off?
IAG shares seem like good value to me, and the recent positive results do fill me with confidence. But do I think the stock is about to take off? Unfortunately, no. For me, there are too many short-term hurdles for the stock to make a sudden upward move.
However, as a Fool, I invest with a long-term outlook. Given the current valuation, and large discount to pre-pandemic prices, I like the look of IAG as a long-term play. For this reason, I’d add IAG shares to my portfolio today, if I had some spare cash.
