Valuation of Icelandair

Magnús Andri Pétursson & Magnus Freyr Erlingsson

Student thesis: Master thesis

Abstract

Icelandair Group has played an instrumental role in recovering Iceland’s economy after the financial crisis in 2008. After a boom which started in 2010, tourism has become Iceland’s largest industry and a gateway out of the financial crisis. Despite this tourism boom, the market value of Icelandair has been highly volatile and subject to a severe downward trend in recent years. The purpose of this master thesis is to estimate the fair market value of Icelandair Group’s share price as of September 1st 2019 through a discounted cash flow model which is based on a forecast derived from both strategic and financial analysis. Icelandair is currently in a short-term lock-in situation where they are only able to operate Boeing aircrafts. The recent grounding of the Boeing 737 MAX aircraft has decelerated growth for the shorter term and hindered Icelandair from capitalizing on WOW air’s recent bankruptcy. New aircrafts with increased flying range are threatening Icelandair’s geographical advantage, which has been highly important in recent years. However, there are opportunities for Icelandair to utilize those new aircrafts by adding new and fast-growing market such as Asia to their hub and spoke network and connecting it to the European market. From the financial analysis, we see how changes in jet fuel prices influence not only the operating performance of Icelandair but the industry in general. Icelandair is exposed to currency risks, and fluctuations in the ISK/USD exchange rate have an impact on its profitability. It is also clear that airlines which operate in North America are more profitable than airlines operating in Western Europe. Despite difficulties in 2017 and 2018, Icelandair is financially stable and less levered than their peers. From the DCF model, we derive an implied share price of 9.75, which is a 33.5% premium to the market value of 7.30 as of September 1st 2019. The weighted average cost of capital is approximately 6% throughout both the forecasted and the terminal period. The estimated growth rate of the free cash flow in the terminal period is 1.5%. The vast majority of the enterprise value is based on cash flow which occurs in the terminal period. Therefore, the implied share price is highly sensitive to changes in both the WACC and the growth rate. There is a lot of uncertainty regarding both the Boeing MAX aircrafts and the possible entrance of a new low-cost carrier to the market. The DCF model in a way fails to capture and incorporate those additional risk factors as the required return on equity is solely based on the CAPM estimation.

EducationsMSc in Finance and Investments, (Graduate Programme) Final ThesisMSc in Finance and Strategic Management, (Graduate Programme) Final Thesis
LanguageEnglish
Publication date2019
Number of pages143