BABWF - International Consolidated Airlines Group Stock Outperforms As It Grows Prudently

2023-11-29 15:20:51 ET

Summary

• International Consolidated Airlines Group hosted its Capital Markets Day, providing insight into the company's long-term trajectory.
• IAG has market-leading margins among legacy carriers and emphasizes the importance of hubs to its business.
• Each airline within the group targets a different customer base, and IAG plans to grow its fleet while improving fuel efficiency.

On the 21st of November, International Consolidated Airlines Group S.A. (ICAGY) hosted its Capital Markets Day. I can't deny that I am a big fan of Capital Markets and Investor Days. The reason is quite simple. Wall Street has an obsession with quarterly earnings and preferably meeting and exceeding estimates every quarter and that forces company leadership in a difficult spot where one might forget that in order to realize sustained growth in financial results, a long-term focus is required. That is what Investor Days and Capital Markets Days provide.

In this report, I will be looking at what stood out to me during the IAG Capital Markets Day. The entire presentation is 137 slides, so it is not quite productive to go through all of them one by one. I studied them one by one, but I also have to say that while Capital Markets Days provide a lot of insight into the longer-term trajectory, there is also some noise that has to be filtered out.

How Did International Airlines Group Stock Perform?

When providing new reports on names that I have covered before, one of the first things I do is look at how the stock has performed since my last report. That is not to pound myself on the chest as I already am aware that our core aerospace portfolio can outperform on a flat market and frankly, sometimes my calls also don't work out, and I am not too afraid to admit that. The buy rating on International Airlines Group has worked out well. Since my buy rating for ICAGY stock was issued in July 2022, the stock has gained 36% compared to an 11% gain for the broader markets and since my report in October, the stock has gained nearly 12% compared to a 4.4% gain for the broader markets and I think there is more to come as I put a $2.50 price target on the stock.

IAG Has Market Leading Margins

The slide above was a striking one to me as it showed that IAG has industry-leading margins among legacy carriers and low leverage. Interestingly, on both ends, they are doing better than Delta Air Lines, Inc. ( DAL ) which by many is considered the gold standard for airline management and investment. These 12-month trailing results are not any guarantee for outsized performance going forward, but they do show that IAG is an airline that might be worth keeping on your watch list.

IAG Underlines The Importance Of Hubs To The Business

In a previous report covering the cancelled capacity reductions at Schiphol Airport, I pointed out the importance of the hub function. That is nothing new, but what the IAG slide quite clearly shows is the significant revenue generation in European hubs and how well IAG is positioned there. IAG has the big benefit of the London Heathrow hub for British Airways which is used to serve North America among other regions and the hub in Madrid where Iberia has its hub focuses on Latin America for the long haul. So, the hub function of airports is of vital importance for airlines.

On the routes to North America (excluding Mexico), IAG has a 46% market share serving destinations from Heathrow, Madrid, Barcelona, Gatwick, and Dublin. On the LatAm market, IAG has a 32% market share where flights from Madrid pull the cart. The next step in strengthening those markets is the planned acquisition of Air Europa.

A Diverse Customer Base Targeted By Each Airline

The slide above is probably one of my most favorite slides from the Capital Markets Day as it shows how each airline is targeting slightly different customers with each airline. Level is focused on the long haul cost-conscious traveler, while Vueling does the same but for short-haul routes. Aer Lingus is mostly positioned as a leisure carrier while British Airways is focused on what I would say is the traditional set of travelers which are leisure travelers and business travelers. Iberia looks like a very interesting airline as its primary and secondary targeted demand space covers everything from trade-down back cabins to premium front cabins.

A Fleet To Deliver On Ambitions And Target Demand Space

Currently, there is a significant shortage of airplanes as Boeing and Airbus cannot build airplanes fast enough. So, the fleet plans we are currently seeing most likely might suffer from some delays. However, what we do see is that the IAG commitments to take airplanes allow for slight growth compared to pre-pandemic levels allowing for a 4-5 percent growth rate while transforming the fuel efficiency of the fleet. The short-haul fleet will see the share of fuel-efficient airplanes go up from 24 currently to 37% by 2026 and for long-haul airplanes, the increase will be from 42% to 52%. That change is important as new single-aisle jets are 20% more efficient than previous generation airplanes and for wide-body airplanes, this can even be up to 40%.

Next to that, changes in cabin segmentation to make use of leisure travelers increasingly booking premium cabin seats also have a positive impact on profitability. As an example, the change from a Boeing 757 to an Airbus A321XLR will feature seven seats less, but the per seat costs will see an 18% reduction while an improved premium mix adds another two points increase in margins.

Translating the Product and Demand Environment To Results

The first slide I showed in this report showed the margins and leverage and those margins are compliant with the medium-term ambition of IAG to have an operating margin of 12 to 15 percent on organic growth of 4 to 5 percent with leverage of 1.8x or better. The company sees opportunities for a combination of ordinary and special dividend and share repurchases to drive shareholder value and returns while EPS growth should translate into fundamentally driven higher stock prices.

Conclusion: IAG Has Long-Term Levers To Keep Growing

The Capital Markets Day did not make me go ecstatic about what IAG presented. One reason is that it is always the question of whether the longer-term targets can be achieved, and another is that what the company presented was not something that was significantly out of line with what one should be expecting.

What I can appreciate is the company's strong positioning with its Heathrow hub for the US and Canada flights and for Latin America from the Madrid hub and each airline within the group capitalizes on a different type of passenger from cost-conscious to premium. The company also recognizes the strength of cabin segmentation where premium seating can drive value, which can be introduced on new airplane deliveries making new airplane deliveries transformative in terms of cabin product, cost, and environmental footprint.

The Capital Markets Day presentation gave me no reason to change my buy rating in a positive or negative direction. It is good to see that the company is aiming for modest capacity growth and sees opportunities to drive margins higher on fleet and product transformation.

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