Sunday, July 01, 2007
British Airways: flying too low?
Yesterday saw terrorists attempt to cause a major explosion at Glasgow airport. This follows two attempted car bombings the previous day in London. The security services have raised the threat level to 'Critical'.
What does this all mean for my investment portfolio? Well, it is likely to damage the market price of a share I have been watching for a few months now, British Airways. As of Friday's close, British Airways shares could be purchased for 418p. This is against broker consensus for the current financial year of 53p earnings per share and 58p per share the year after. So, what we have is a growth company trading on a forward P/E ratio of less than 8.
This would appear to be remarkably cheap.
Normally these kinds of low P/E ratios of sub-double-digits are justified by a company being laden with huge amounts of debt, or considerable uncertainty in the earnings forecasts. Let's look at debt.
We know from the recent announcement that British Airways has 1,151,831,595 shares in issue. I will use this number in my calculations but refer to it as 1.2b.
At the 418p price to buy this gives British Airways (LSE:BAY) a market capitalisation of £4.8b. Against this, we have the net debt figure of £1b (as per final results) and a pension deficit of £1.04b in the company pension scheme.
There are real signs, however, that British Airways is entirely on top of it's debts.
For the twelve month period, interest expense was £168 million, £46 million lower than last year due to the impact of lower debt levels. Interest income was £129 million, £37 million higher than last year, reflecting the higher cash balances.
The news two weeks ago that credit rating agency Standard and Poor's have returned BA's debt rating to investment grade came as further confirmation that British Airways is back in charge of its own destiny.
The company was downgraded to sub-investment grade or junk status in July 2003 following the events of September 11, 2001 and the war in Iraq....During that period the company has reduced its net debt from £6.6bn to £990m and steadily increased its operating margin...British Airways' chief financial officer, said: " We have worked hard over the last four years strengthening the foundations of our business. Regaining investment grade status will enable us to invest in our future growth with confidence."
With profitability rising following an extraordinarily unfortunate couple of years earlier in the decade I don't see why these debts should be a material drag on the company's market valuation and as such, the P/E ratio the market has ascribed to this company in recent years is too low to be applied in the present.
This, however, still leaves the concerns over the visibility of the company's earnings. How confident are we that BA will make 53p this year and 58p the next? How would those figures stand up against a sustained series of terrorist attacks on airline property and facilities, or military action against Iran?
To start with, I consider the consumer and global economy have become much more resistant to terrorism shocks. In face, terrorism is no longer a shock. The World Trade Center atrocities were a shock. With improved security levels (not a single successful terrorist strike on the mainland USA in almost six years) and the increased desperation of the terrorists I do not consider an attack on that scale to be repeatable in the near future. Secondly, governments in the USA and UK do not currently have public support for action against Iran, so I consider that unlikely also.
This leaves the question - what is a fair price for British Airways? I expect on Monday we will see a further fall in the company's share price. Following the successful nCipher tender offer at 285p, the temptation to reinvest may be too great to resist.
The Artful Dodger
What does this all mean for my investment portfolio? Well, it is likely to damage the market price of a share I have been watching for a few months now, British Airways. As of Friday's close, British Airways shares could be purchased for 418p. This is against broker consensus for the current financial year of 53p earnings per share and 58p per share the year after. So, what we have is a growth company trading on a forward P/E ratio of less than 8.
This would appear to be remarkably cheap.
Normally these kinds of low P/E ratios of sub-double-digits are justified by a company being laden with huge amounts of debt, or considerable uncertainty in the earnings forecasts. Let's look at debt.
We know from the recent announcement that British Airways has 1,151,831,595 shares in issue. I will use this number in my calculations but refer to it as 1.2b.
At the 418p price to buy this gives British Airways (LSE:BAY) a market capitalisation of £4.8b. Against this, we have the net debt figure of £1b (as per final results) and a pension deficit of £1.04b in the company pension scheme.
There are real signs, however, that British Airways is entirely on top of it's debts.
For the twelve month period, interest expense was £168 million, £46 million lower than last year due to the impact of lower debt levels. Interest income was £129 million, £37 million higher than last year, reflecting the higher cash balances.
The news two weeks ago that credit rating agency Standard and Poor's have returned BA's debt rating to investment grade came as further confirmation that British Airways is back in charge of its own destiny.
The company was downgraded to sub-investment grade or junk status in July 2003 following the events of September 11, 2001 and the war in Iraq....During that period the company has reduced its net debt from £6.6bn to £990m and steadily increased its operating margin...British Airways' chief financial officer, said: " We have worked hard over the last four years strengthening the foundations of our business. Regaining investment grade status will enable us to invest in our future growth with confidence."
With profitability rising following an extraordinarily unfortunate couple of years earlier in the decade I don't see why these debts should be a material drag on the company's market valuation and as such, the P/E ratio the market has ascribed to this company in recent years is too low to be applied in the present.
This, however, still leaves the concerns over the visibility of the company's earnings. How confident are we that BA will make 53p this year and 58p the next? How would those figures stand up against a sustained series of terrorist attacks on airline property and facilities, or military action against Iran?
To start with, I consider the consumer and global economy have become much more resistant to terrorism shocks. In face, terrorism is no longer a shock. The World Trade Center atrocities were a shock. With improved security levels (not a single successful terrorist strike on the mainland USA in almost six years) and the increased desperation of the terrorists I do not consider an attack on that scale to be repeatable in the near future. Secondly, governments in the USA and UK do not currently have public support for action against Iran, so I consider that unlikely also.
This leaves the question - what is a fair price for British Airways? I expect on Monday we will see a further fall in the company's share price. Following the successful nCipher tender offer at 285p, the temptation to reinvest may be too great to resist.
The Artful Dodger
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