The airline industry has a reputation for losing investors’ money over the long term, thanks to regular cycles of boom and bust.
Some airline investors believe things have changed. They claim that airlines such as International Consolidated Airlines Group (LSE: IAG) have become much more efficient and profitable.
It’s certainly true that IAG has generated attractive levels of profit and free cash flow over the last couple of years. The strong momentum is expected to continue this year. Analysts’ consensus forecasts suggest IAG’s adjusted earnings per share may rise by 48% to €1.08 in 2016, putting the stock on a forecast P/E of just 6.3. The airline group is expected to pay a dividend of €0.28, giving a prospective yield of 4%.
However, this low P/E concerns me. It suggests that the market is pricing-in a decline in profits over the next few years.
One possible risk is that airlines will struggle to cope if fuel prices start to rise again. All airlines have cut ticket prices to reflect lower fuel costs. If oil’s recovery continues, airlines may end up slashing their profit margins in a bid to keep ticket prices low.
IAG is a tempting buy at the moment, but I think profits could peak in the next year or so.
A safer alternative?
It’s a similar story in the UK housing market. Persimmon (LSE: PSN) looks reasonably valued on 11 times 2016 forecast earnings and offers a forecast yield of 5.4%.
At the end of 2015, the group had net cash of £570m — more than one year’s profits. In my view, Persimmon’s dividend is certain to be safe for the next couple of years. What we don’t know is how much longer Persimmon’s profits and sales will continue to rise.
There’s no doubt that demand for new housing is strong. But the firm’s rising profits rely on rising sales prices, coupled with low wage inflation and material costs. There’s also the question of housing affordability.
The reality is that the UK housing market has been cyclical throughout modern history. I don’t’ see any reason for this to change. I believe a downturn is inevitable, but timing the market will be very difficult. Persimmon may continue to deliver attractive returns.
For this reason, I rate Persimmon as a hold.
What about oil stocks?
Shares in oil services firm Petrofac (LSE: PFC) have fallen by 21% since 4 March. The big gains that followed the company’s annual results on 24 February have now largely disappeared. One reason for this maybe that analysts have cut their 2016 earnings forecasts for the firm by about 10% since February.
Petrofac’s falling share price has left the firm’s shares trading on a forecast P/E of 9.3, falling to 8.4 for 2017. That looks quite cheap to me. Petrofac doesn’t have the same heavy exposure to the US shale sector as some of its peers. It’s an essential operations partner for many of its customers.
Petrofac’s net debt fell last year to $686m, a level that seems reasonably safe to me. I suspect that the group will maintain its dividend at 65.8 cents per share. This gives an attractive forecast yield of 5.7%. In my view, Petrofac could be worth a closer look.
