At first blush, the valuation of British Airways’ mother or father  IAG (LSE: IAG) seems to be very low-cost. The IAG share price is lower than 4 instances final yr’s earnings per share. A price-to-earnings ratio of beneath 4 can definitely counsel an organization is in cut price territory.

Is that the case for IAG – and ought I so as to add it to my portfolio?

Extremely variable earnings

Though the P/E ratio primarily based on final yr’s earnings was lower than 4, that mirrored an unusually robust revenue efficiency from the airline firm. Primary earnings per share jumped over sixfold from the prior yr. The 2 years earlier than that had seen IAG report sizeable losses.

Variable earnings are half and parcel of the airline trade. Value components corresponding to gas costs can have an enormous impact however are mainly exterior airways’ management, although carriers should buy contracts to mitigate the influence of sudden short-term jumps in price. In the meantime, exterior occasions from volcanic clouds to journey restrictions can see demand transfer round instantly.

This yr has began strongly for IAG. Primary earnings per share for the primary six months had been inside 2% of the determine for a similar interval final yr. For the complete yr, IAG expects robust journey demand in its core markets and vital free money circulate era.

It signifies that not solely is the historic P/E ratio low, the possible one is just too, not less than within the quick time period.

Enhancing stability sheet

Earnings are just one a part of how to worth an organization. Spending obligations matter too. So a agency’s money place is necessary.

In its half-year outcomes this month, IAG stated it expects to “maintain a strong balance sheet” for the remainder of the yr. I’d hardly characterise the stability sheet as “robust“. On the interim level, the enterprise had internet debt of €6.4bn.

Nonetheless, whereas that’s numerous debt, it marked a major enchancment from the midway level final yr, when internet debt stood at €9.2bn.

The corporate’s efficiency currently has enabled it to chop its internet debt, one thing I see as constructive for the funding case.

Is that this a cut price?

So is the IAG share price tremendous low-cost? For one factor, that debt is critical. So wanting simply on the P/E ratio doesn’t inform the complete story. That stated, earnings are robust and look set to remain that means, for now not less than. With well-known manufacturers, ongoing robust passenger demand and a leaner price base than it used to have, IAG has some strengths as a enterprise.

Then once more, in lots of ways in which leaner price base has come at the price of the passenger expertise. My very own experiences flying British Airways in recent times have decreased not elevated my very own loyalty as a passenger.

Airline demand is extremely unpredictable over the medium time period as it will probably instantly drop with out warning, as we’ve seen repeatedly.  

To see the share price as tremendous low-cost, I feel confidence is required that demand and income outlook in coming years can be buoyant. There’s a threat it won’t be, so I don’t have that confidence. I cannot be shopping for IAG shares for my portfolio.