November 29, 2020

The IAG share price just dropped 30% in a day. Is it now too cheap to ignore?

The IAG (LSE: IAG) share price has plunged nearly 80% this year, making it one of the worst performers on the London Stock Exchange. A further decline of 30% yesterday has taken the shares back to prices not seen since 2009. So with the airline owner priced at just 135p, is it now the perfect time to buy?

What caused the 30% fall?

In order to strengthen its balance sheet, reduce leverage and enhance liquidity, IAG decided to issue nearly 3bn new shares. This meant that the company was able to raise €2.7bn in extra cash. In theory, this does sound very positive. However, by issuing more shares, it leads to stock dilution and this decreases shareholders’ ownership in the company. This subsequently led to the drop in the share price.

In the case of IAG, the share dilution was severe. In fact, for every two shares currently held, three new shares could be subscribed for under the rights issue. The new shares were also priced at 92 cents, which is a 36% discount to the theoretical ex-rights price. By pricing the new shares at such a significant discount, it demonstrates IAG’s desperation to raise more cash. It also explains the sharp drop in the IAG share price.

But there are also plenty of positives to take from this new rights issue. For example, as of 30 June, net-debt-to-underlying-EBITDA stood at 4.2x. This is extremely high and the equity placing should be able to reduce this. It will also provide the company with extra cash in order to increase its resilience and ensure that it can emerge from the crisis in a decent position. As a result, in the long term, there are plenty of positives to take away.

What does the future hold for the IAG share price?

Unfortunately for IAG, I can’t see a quick recovery. Although bookings have improved since April and May, they’re still down 40% from last year. Ultimately, this led to a miserable first-half trading update in which the company saw an operating loss of over €4bn. With many travel restrictions still in place, I believe that there will be a very long road ahead before it can start making a profit again.

Even so, an extended period of pain for the company does look priced in, and many may argue that the IAG share price has now reached the bottom. This is backed up by the estimation that the company should reach break-even in terms of net cash flows during the fourth quarter. Although this does seem fairly optimistic, it still gives some hope for the future of the company. 

Would I buy?

For the risk-tolerant investor, the IAG share price does look very tempting in the long term. In fact, using 2019 earnings, the airline has a price-to-earnings ratio of less than 2. This implies an incredibly cheap valuation.

Nevertheless, I’m personally not buying. IAG’s incredibly large debt pile, along with the significant uncertainty surrounding airline travel, makes the stock too much of a risk for me. I’d prefer to go for another value stock, which seems a far safer bet. 

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Stuart Blair 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.

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