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Why I think the IAG share price is a better buy than this aviation business

Alan Oscroft
Dice engraved with the words buy and sell

When airline Flybe was struggling and was taken over by the Connect Airways consortium in January 2019, I wasn’t too surprised to see Virgin Atlantic as one of the partners, but Stobart Group (LSE: STOB) did strike me as a little more surprising.

The group’s Stobart Aviation division does operate a number of airports and offers air services, and I see that as a sensible ‘picks and shovels’ business. But running an airline itself (particularly one that was for sale only because it was struggling financially) can be a risky move.

I pondered whether Stobart Group could be a way in to the aviation business with less risk (thanks to its diversified nature) than that faced by individual airlines or by holiday operators like Thomas Cook.

Trouble?

But according to Sky News, Flybe, having continued to make losses, is under threat of collapse and has been engaging in rescue talks with the government. The airline itself has deflected such claims, but Stobart shares fell 8.3% in morning trading.

The share price had collapsed by mid-year 2019 after several years of impressive earnings growth came to a halt, and the dividend was slashed, but was I seeing a growth opportunity?

At the interim stage, the firm said it was seeking “new long-term debt to fund its growth programme,” and I’m wary of debt-led growth. And now that Flybe looks like it’s in trouble, I’m not sure I’m seeing a joined-up business here, but rather a collection of different divisions that don’t share much synergy.

Big airline

The share price of British Airways owner International Consolidated Airlines (LSE: IAG) has had a flat couple of years, while Stobart’s has fallen nearly 60%.

IAG shares are up 23% over the past five years too, which is a respectable performance — and over 10 years, we’ve seen a rise of 220%, which is definitely impressive. The airline operator (which also owns Spain’s Iberia) has been paying decent dividends too, yielding around 4%.

So why wouldn’t I buy? Well, we’ve had a very strong decade for sure, but those have been cheap-oil years, and any further rises in the price of a barrel could have a seriously adverse effect. Airlines are hostage to the oil price and work on razor-thin margins.

The past year or so has actually been pretty volatile for the IAG share price, and it’s taken a rapid recovery since August to achieve the current result — the shares were 35% below their current price before that happened.

Bear case

My Motley Fool colleague Divyansh Awasthi has listed a number of reasons to be bearish about IAG going into 2020, and they tend to make a lot of sense to me too.

The shares might look decent value, but there was net debt of €6.2bn on the books at Q3 time at 30 September. That’s only a relatively modest 1.2 times EBITDA, which looks fine. But if we’re in a positive phase of a cycle for the aviation industry right now, and higher future oil prices could result in the next five years being tougher, that could become a problem.

I think IAG is clearly a better buy than Stobart, but I still think airlines are too risky.

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Alan Oscroft has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Motley Fool UK 2020