Shares in British Airways owner International Consolidated Airlines Group PLC (LON:IAG) descended after HSBC downgraded the stock, saying it believes the market overreacted to better-than-expected first quarter profits.
HSBC cut its rating on the stock to ‘reduce’ but raised its target price to 590p from 570p.
Earlier this month, IAG reported operating profit before exceptional items of €280mln for the first three months of the year, ahead of €160mln the previous year and analysts’ forecasts of €206mln.
READ: British Airways owner International Airlines Group rebuffed by Norwegian Airlines
“We believe that the market has overreacted to the moderate good news of the Q1 results and seems to be overlooking the pressure from rising fuel prices,” HSBC said.
A recovery in oil prices is set to push up the cost of fuel for many airlines. For IAG, fuel unit costs rose 0.6% in the first quarter, partially offset by a weaker US dollar against the euro and the pound.
HSBC predicts year-on-year declines in profit for fiscal years 2018 and 2019, which is 17% below the latest Bloomberg consensus forecast for 2018 and 26% lower for 2019.
HSBC likes idea of IAG buying Norwegian
More positively, the bank said it “likes the concept” of IAG buying Norwegian Air Shuttle.
Spanish newspaper Expansion reported this week that IAG was planning to offer €1.52bn for Norwegian following two unsuccessful approaches.
READ: British Airways parent IAG reportedly plans to offer €1.52bn for Norwegian Air Shuttle
In April, IAG disclosed that it had bought a 4.61% stake in Norwegian with a view to make a full offer for the airline.
“We are conceptually enthusiastic about a potential Norwegian transaction,” HSBC said.
“However, we recognise this is a minority view and would expect the markets to react cautiously to the leverage consequences of any acquisition.”
HSBC believes there is "powerful industrial logic" for IAG to acquire Norwegian as it would address two of its core concerns for the airline – capital expenditure challenges from the British Airways fleet demographic and Atlantic fragmentation.
The bank also sees value in Norwegian’s short-haul order book.
IAG-Norwegian deal 'complex'
“However, we think progressing the deal would be complex as multi-player negotiations would play out not just between IAG and Norwegian but also with the potential lessors that are considering acquiring Norwegian’s aircraft and the two aircraft OEMs (original equipment manufacturers) that we expect would also have veto rights over any deal since aircraft orders of the scale that Norwegian has placed typically have change of control provisions.”
Should the deal not go ahead, HSBC expects “more vigorous than ever competition” on the North Atlantic between IAG and Norwegian.
Shares dropped 2.5% to 685p in mid-morning trading.