Still Flying High at IAG

I have taken another look at International Consolidated Airlines Group, which has come down 15% from 619p last December to 529p last seen. The fundamentals look highly encouraging for seekers of dividends and I believe the shares look extremely good value. They are denominated in Euros, and if the Euro was to weaken on a Brexit vote, they would start to look enticingly cheap to strong dollar investors.

The scope of IAG operations and assets

International Consolidated Airlines Group, S.A. (IAG) is a holding company, which holds the interests of airline and ancillary operations. Its businesses include British Airways, Iberia, Vueling and now Aer Lingus. IAG combines the airlines of the United Kingdom, Spain and Ireland. It has approximately 530 aircraft flying to over 280 destinations. It operates a range of aircraft fleet services, including Airbus A318, Airbus A319, Boeing 787-900, Embraer E190 and Boeing 777-200, among others. IAG, through its subsidiaries, is engaged in providing airline operations, insurance, aircraft maintenance, air freight operations and cargo transport services. It offers services in cities, including London, Madrid, Barcelona, Rome and Dublin. Its subsidiaries include British Airways Capital Limited, AERL Holding Limited, ALG Trustee Limited, Bealine Plc and others.

The recent share price history

The share price was 529p last seen. It has several times assailed the line of share price resistance at just above 600p a share (the peak being 614p). Will it make an attempt to break through again and will it succeed? The market consensus estimates of what IAG may be capable of in terms of earnings and dividend growth this year and next suggest that we shall see the share price enter new territory in due course.

But first, one has to acknowledge the success of the strategy which led to the creation of a culturally differentiated, internationally diversified airline company out of the merger of British Airways, Iberia and, most recently, Aer Lingus, making it an Englishman, an Irishman and a Spaniard’s sort of airline company. Willy Walsh and his team have succeeded in doing it in the midst of a seriously difficult period of economics. That of course may have assisted in knocking heads together over labour practices, first in the UK and then in Spain.

Fortunately, the share price does not need to go beyond its previous share price peak to make this a share to buy, if it can rapidly grow its dividend in line with consensus market estimates. A prospective dividend yield of 4% (for the current year) will do that, and a prospective dividend yield of 4.7% (for FY17) will do more than that, if achieved.

Progress

The progress of this company goes from top line to bottom. It is pretty impressive. Five years ago the reported top line sales revenue was 16.1 billion euros; last year sales revenue had reached 22.8 billion euros. That is compound annual growth of 9% per annum. Of course, that is not organic growth but it does give the company both critical mass and diversity in a hugely competitive industry. It also provides its management with the opportunity to improve margins through cost recovery and the cash flow with which to invest and to pay dividends.

Much of that was apparent in the last set of annual accounts made up to the 31^st of December last. In the light of the strong increase in sales revenue – which had grown by nearly 23% from the 2013 sales revenue figure of 18.6 billion euros to 22.85 billion euros last year – reported gross margins over the same period increased from 59% to 70%. Lower down at the operating cost level, the managers had been able to slow the rise in the operating cost base, which increased by 13% over two years, from 18 billion euros in 2013 to 20.5 billion euros – enough to raise the 2013 operating margin from 3% to 11.4% last year.

Naturally, the bottom line was the beneficiary of these improvements. Attributable earnings, which had been a modest 126 million euros, were nearly a reported 1.5 billion euros last year – a more than tenfold increase, expanding the company’s net margin from 0.8% to 6.5%. All of that of course had a big impact on cash flow, which has dividend paying implications.

Cash Flow

Despite increasing working capital in the business last year, with around 1.2 billion euros of  operating cash flow, net annual operating cash flow was still at nearly 2 billion euros, an increase of 7%. The sources of this cash were, primarily, net income, and the depreciation charge gave it reliability in contributing two thirds of the near 2 billion euros of net annual operational cash flowing through the business.

Dividend outlook

A dividend was paid for the first time, costing 163 million euros. That was covered twelve times by operating cash flow and over seventeen times by year end cash in the balance sheet. Altogether, this showed the considerable scope that the company has to increase dividend payouts by a considerable amount. It is worth buttering the parsnips of this message by pointing out that whereas the actual cash figure shown in the cash flow account was 2.9 billion euros, the cash and ‘near’ cash figure of liquid assets shown in last December’s balance sheet was an even more impressive 5.86 billion euros.

Other measures of value

Testing for other measures of value, I point out that the shares at 529p (last seen) are valued at 6.6 times reported operating cash flow, 2.2 times the cash and ‘near’ cash figure and 1.75 times sales revenue. The estimated net asset figure attributable to ordinary shares is about 210p or around an estimated 40% of the share price.

My apologies for the next bit of arithmetic, which attempts to accurately translate euro earnings forecasts into pound sterling figures.

The consensus historic earnings per share figure is a reported 73.5 cents which at an exchange rate of 0.8 euros to a pound gives a sterling earnings per share figure of 58.8p. That indicates a historic earnings yield (sterling earnings per share divided by the share price) of 11%. Similarly, estimated forecast earnings per share of 110.4 cents translates on that basis to forecast sterling earnings for this year of an estimated 88p and a prospective estimated earnings yield of 16.6%. That is another indication of the scope for a large increase in dividends per share that seems to more than underwrite the consensus forecasts. In consequence, I am happy to rely on the dividend increases contained in the consensus forecasts.

Last Trading Statement

The February 2016 Group traffic and capacity statistics showed that recently the company has been trading strongly. That is to say Group traffic in February, measured in Revenue Passenger Kilometres, increased by 15.8% versus February 2015 (up 9.5% on a pro-forma basis); Group capacity measured in Available Seat Kilometres rose by 14% (up 7.2% on a pro-forma basis); and Group premium traffic, in the month of February increased by 7% on a like for like basis.