Shares to buy now: IAG (LSE: IAG) or Rolls-Royce (LSE: RR)?

Risk reward ratio / risk management concept

Over the past few months, I’ve been looking for coronavirus recovery shares to buy now for my portfolio.

Two companies immediately stood out when I started searching. IAG (LSE: IAG) and Rolls-Royce (LSE: RR) have been badly hurt by the pandemic. The aviation industry was essentially shut down in March of last year, and it’s only just starting to recover. It could be several years before traffic recovers to 2019 levels. 

The slowdown hits both IAG and Rolls-Royce like a sledgehammer. Both companies have drastically reduced employees on the payroll and slashed costs across the business. At one point, IAG’s British Airways even resorted to selling bread baskets and casserole dishes once used on its 747 jets. 

Both companies were able to survive the crisis by cutting costs and pulling every available lever to increase financial liquidity. However, I think one of these businesses will struggle more than the other in the years ahead. 

Shares to buy now in the recovery

Every aircraft needs an engine, and there are only a handful of companies that have the experience and reputation required to supply the industry. Rolls-Royce is one of these. 

I think this gives the company a solid competitive advantage. Unfortunately, it hasn’t been able to make the most of this competitive advantage in recent years. Developing products for the aerospace industry is a costly, lengthy process. Rolls is one of the best in the world at producing high profits. However, the business has lurched from one disaster to another over the past few years. 

By comparison, IAG’s profits have taken off. Despite the competitive nature of the airline industry, the company’s size and diversification have helped it achieve economies of scale. Its stronghold over the profitable Atlantic route between New York and London is also a cash cow. 

The airline’s business model is also more flexible. It can add and remove routes, increase prices, or reduce staff relatively quickly. Rolls can’t. Its contracts with suppliers and customers can last years, and it can’t cut development spending too much, or it may miss the next technological development. 

Growth opportunity

Considering all of the above, I think IAG is one of the best shares to buy now as a recovery play. I’d buy the airline over Rolls, considering its flexibility and growth potential over the next few years. 

That’s not to say the company’s growth is guaranteed. It’s anything but. As noted above, it could take years for the aviation industry to recover. A lot could happen in that time. 

Meanwhile, there’s no guarantee Rolls will continue to struggle. Management’s actions over the past year could help the leaner, more streamlined business return to growth in the years ahead. As the aviation industry begins to recover, the demand for new planes may also grow, bulking up Rolls’ order book. 

Considering the fact that the industry is still shrouded in uncertainty, I’d only buy IAG as a speculative investment. I’d avoid Rolls entirely if I had to choose between the two. 

The post Shares to buy now: IAG (LSE: IAG) or Rolls-Royce (LSE: RR)? appeared first on The Motley Fool UK.

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Rupert Hargreaves has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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