Questor: a recovery built on rising consumer spending can lift British Airways owner IAG

Travel restrictions imposed in response to Covid-19 have had a devastating effect on the airline industry. Indeed, British Airways owner IAG reported an 88pc decline in passenger traffic in its recent third-quarter update. This contributed to a £1.1bn operating loss versus a £1.2bn operating profit in the same period of the previous year.

The company is likely to reveal further financial pain when it releases its full-year results on Friday. Ongoing lockdown measures in the UK, as well as across Europe, equate to low passenger numbers and weak financial performance.

Despite this, Questor believes the prospect of a post-coronavirus economic recovery provides a turnaround opportunity for the carrier. Successful vaccine rollouts have contributed to growing optimism regarding the UK’s economic outlook.

It is now forecast to deliver GDP growth of 5.9pc this year and 3.2pc next year, according to the IMF. Even in Europe, where the vaccine rollout has been much slower than in the UK, the IMF predicts that GDP growth will be 4.7pc in 2021 and 3.1pc in 2022.

The company’s performance could be further catalysed by the release of pent-up consumer demand that is likely to have grown in size during the pandemic.

For example, the UK household saving ratio measures the proportion of an average household’s disposable income that is deposited into savings accounts each quarter. It stood at under 10pc in the first quarter of 2020. However, as lockdown measures came into force it increased to an all-time high of 27pc in the second quarter of 2020.

This suggests that consumers may be holding back on spending during the current lockdown. It could be unleashed as containment measures abate. This was the case in the third quarter of 2020, when a lifting of some lockdown measures led to a surge in consumer spending.

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At least some of this extra cash could be spent on air travel as lockdown measures are gradually lifted. The novelty of holidaying abroad may prove irresistible to many after what has been a very challenging period.

Of course, there is great uncertainty as to when travel restrictions will be lifted. In the meantime, IAG is not providing earnings guidance. It believes that global passenger numbers will not return to their 2019 levels until at least 2023.

However, seeking to judge the path that Covid-19 lockdown measures will take is fraught with difficulty. More relevant to investors is the action taken by the firm to improve its financial position in the meantime. It suggests that IAG has the means to overcome more coronavirus-related uncertainty.

Since the start of the pandemic, it has slashed operating costs to reduce cash burn, cancelled dividend payments and scaled back capital expenditure plans. It also conducted a rights issue in October 2020 that raised £2.4bn. This will have boosted a cash position that stood at £4.4bn at the end of the third quarter. When borrowing facilities are included, the company had total liquidity of £8.2bn at the end of October 2020.

The company’s financial prospects may be further improved by its market position. It owns a variety of brands that operate in short-haul and long-haul markets. This may allow it to share costs between its operations to become more efficient compared with sector peers. Its diverse customer base may also equate to greater growth opportunities versus airlines that focus on one group or a narrower price point.

As with any recovery stock, the risk of investing in IAG is relatively high. As well as short-term challenges posed by Covid-19, threats to its future financial performance include behavioural changes prompted by successive lockdowns. For instance, business travel may be superseded by video calls in some cases. Likewise, increasing environmental concerns may dissuade some consumers from holidaying abroad.

However, the potential rewards on offer appear to be sufficiently high to merit investment. An economic recovery built on rising consumer spending following a period of record saving could catalyse the airline industry. The firm’s financial position suggests it has the means to survive in order to enjoy a turnaround as travel restrictions are rescinded.

Questor says: buy

Ticker: IAG

Share price at close: 165.75p

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