IAG at 574p – the influence of profits, the pound and oil prices

The International Consolidated Airlines (IAG) share price has turned south in recent weeks but is still showing on the radar as being within the flight path fluctuations around the powerful share price up-trend. There is potential trend support just below the current share price (have a look). Will it bounce there, to continue the established share price up trend (making it a buy) or is it going to continue crashing south through that share price support just below 570p? If it does it has plenty of downside. The IAG share price even now, is up 38% over the year, making it one of the biggest capital gainers. So what now, we wonder? Reach for the sky or periscopes down?

The factors which could propel it earthwards into a new down-trend, include the basic primeval stock broking instinct to make money on the back of a profit (“it’s never wrong to take a profit!”). In the case of IAG it’s a pretty big profit in an operationally and financially geared company. When that gearing works in reverse, it provides a corresponding dramatic fall and a very volatile share price. Moreover, IAG has no dividend to help govern the degree of a share price fall. No wonder it has a beta rating of about 1.7.

Considerations at work are as follows: first, the uncertainty of the almost certain uncertainty of the outcome of the UK general election next month and what that might mean for the exchange rate of the pound, leading to a further strengthening of the dollar; second, withdrawal of quantitative easing (pushing up US interest rates and the attraction of the dollar to international Treasurers) contributing to the cost of fuel for IAG.

There is also the growing bullish sentiment towards the value of oil to consider. The oil price, as we know from filling the car, has been creeping up. A chart of the Brent Crude price I saw recently looked supportive to a bullish view of oil prices, suggesting that it had bottomed and was now staging a recovery. Higher fuel costs, and a stronger dollar (in which oil is valued and traded) are construed as bad news for a share that has had such a dramatic rise.

Counter arguments and observations include the belief that whatever has caused the recent firming of the oil price, it is not real supply and demand fundamentals. OPEC is still pumping oil significantly in excess of demand and oil inventories are historically large in consequence. On that basis, some estimate that oil will fall again. Some have put a figure of $35 as an estimated fair price for a barrel of Brent. Furthermore, a stronger dollar to the pound should not be all bad. The important BA North Atlantic business reportedly constituted about 40% of IAG profits last year. Sterling weakness should, after all, provide IAG with a competitive price advantage over US carriers. Moreover, IAG accounts in Euros, an already weak currency. Thus dollar income from BA, translated into Euros should provide a second dose of currency translation profit, unless the pound also weakens against the Euro.

Given the size of capital gains from IAG shares and the weeks of uncertainty that lie ahead for the UK governmental situation, there has to be a strong chance that IAG shares will not bounce and instead break down. My instinct is that observers will soon settle down to a new politically pragmatic style of parliamentary politics in the UK and that all the parties will find a modus operandi to keep the UK show on the road.

A Labour-led government would be the best for markets because it will kill off the even greater business uncertainty of the UK potentially pulling out of the EEC. Referendum blight could paralyse things for a number of years. A referendum is splendid in constitutional terms in the long term, but in the short term it is likely to be economically petrifying.

If the IAG shares do fall, in the quieter markets of summer, I think that there will be buy back conditions as and when the fundamental oil market supply and demand conditions assert themselves – unless of course, Saudi Arabia signals a change of domestic oil policy. No one knows the motivation of the Saudi government, but whether it is a plan to keep fracked oil in the ground or its belief that an oil driven world economy is being replaced by a non-carbon one, neither suggests a return to former OPEC custom and practice.