Idea of the Day IAGs time to shine as it outperforms low cost rivals

What: the collapse of Monarch airlines on Sunday night saw a strong rally in other UK carriers such as IAG, Easyjet and even Ryanair, itself beleaguered by its recent cancellation of thousands of flights. The British airline industry has been hit by two major events in as many weeks, and it could impact share price dynamics as we lead up to the end of the year.

How: While we still think that Ryanair will remain profitable, its reputation for reliability has been hurt, which could boost Easyjet’s performance vs. Ryanair for the next few months. However, the Ryanair saga, which hinges on the fact that there have been mass resignations of pilots choosing to move to other airlines where they are given better working conditions, highlights a serious problem for the low-cost short haul airlines: their cost base is likely to rise sharply as pilots and other staff demand higher salaries.

This is not only a problem for Ryanair, higher costs are likely to seep across the low cost sector, which could eat into profits for the long term and ultimately weigh on the share price of its rivals such as Easyjet. This is why higher cost, frillier airlines such as IAG (parent company of British Airways and Iberia), are outperforming the lower cost carriers, as you can see below. Whereas IAG has had years to implement efficiencies to cut costs and maintain profitability, this is a new era of higher costs for the low cost airlines. Thus, after underperforming the low cost airlines in the first half of the year, we expect IAG to continue its outperformance of Easyjet and Ryanair for the foreseeable future. This is why a relative value trade of higher cost airlines vs. low cost airlines, is one to watch this autumn.

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