Does IAG, owner of British Airways, have a favorable purchase price?

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In January 2020, shortly before the onset of the Covid-19 nightmare, the Consolidated international airlines (LSE:IAG) The share price hit a 52-week high of 671p. As I write, it languishes at just 131p – 80% below that pre-pandemic level.

And yet, in the FTSE100 On the group’s recent first quarter results, Chief Executive Luis Gallego said: “Demand is recovering strongly in line with our previous expectations. We expect to be profitable from the second quarter and for the full year.

With the effects of the pandemic waning and demand recovering strongly, is there any reason why IAG shares shouldn’t follow the growing number of its planes headed for the skies? Indeed, could shares return to that pre-pandemic price of 671p, offering buyers a profit of 412% today?

Ready to take off

IAG is a diversified airline. In addition to British Airwaysit owns the spanish flag carrier Iberia and Ireland Aer Lingus. It also owns a European short-haul low-cost brand Vueling and low-cost long-haul brand LEVELas well as operating a global air cargo network through its IAG Cargo division.

The group’s diversification hasn’t helped much during the pandemic. The company recorded losses of €6.9 billion in 2020 and €2.9 billion in 2021. While management expects recovery and a return to profitability this year, IAG faces a number of headwinds and potential headwinds.

Turbulence on the horizon

Here are some of the challenges that IAG is facing or could face during the year:

  • Management will need to execute well in what is the biggest surge in global travel industry operations in history.
  • High oil prices could hamper earnings growth, as fuel is one of the biggest costs for airlines.
  • Labor is another major cost and wage inflation could be an additional hurdle.
  • The crisis in the cost of living and the high risk of recession could cause companies to reduce their travel expenditures and leisure travelers to take fewer vacations.
  • IAG’s debt has risen significantly during the pandemic, as has the cost of its profit-sapping service: pre-pandemic interest expense of 561 million euros is now up 46% to 817 million euros.

These headwinds/potential headwinds could dampen IAG’s profitability and market sentiment towards the stock. But there is another factor that I think makes the share price very unlikely to return to the aforementioned 671p pre-pandemic level.

Look in the hold

Not only has IAG’s debt (and the cost of servicing it) increased significantly, but also its number of shares outstanding has more than doubled. In October 2020, the company achieved a fundraising of 2.74 billion euros. As a result, while he entered the pandemic with 2 billion shares outstanding, he now has 5 billion.

The vast changes in the company’s debt level and stock count make comparing the stock price before the pandemic with the stock price today essentially meaningless.

Radar

However, there is a tool that can help us see through the fog. Namely, enterprise value (EV). It is a company’s market capitalization (stock price multiplied by the number of shares outstanding), plus net borrowings (or minus net cash, if the company has more cash than debt ).

This is the theoretical price at which an acquirer could purchase the entire business without debt or cash. This is a common valuation benchmark from which a company or private equity house considering making an acquisition will operate.

Altitude loss

At IAG’s pre-pandemic share price of 671p, its market capitalization was £13.37 billion. His net debt was €6.18bn (£5.28bn), bringing his EV to £18.65bn.

Today, at a price of 131p, its market capitalization is £6.51 billion. Net debt stands at €11.59bn (£9.91bn), bringing its EV to £16.42bn.

So while each individual share is 80% lower than its pre-pandemic level, the value of the whole company is only 12% lower.

How high can the IAG gain?

I can see IAG’s 12% EV discount closing in due course. And maybe even switch to a pre-pandemic EV premium, if and when favorable industry conditions emerge.

However, the idea that the share price could revert to 671p, for a profit of over 400%, seems to me quite fanciful. That would make the EV – theoretical cost to buy the whole business – a staggering £43.27bn, up from £18.65bn pre-pandemic.

In summary, there are times when comparing the current stock price with the price in the past can be perfectly reasonable. But there are times – like in this case, I would say – when it can lead us astray.