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Are these airline stocks still too cheap to ignore?

Airline stocks were hit hard by last year’s Brexit vote. But despite investor concerns, airlines such as Wizz Air Holdings (LSE: WIZZ) and Ryanair Holdings (LSE: RYA) have continued to add new flights and report rising passenger numbers.

Figures released this morning by Eastern Europe-focused budget operator Wizz Air show that passenger numbers rose by 23.3% in December, compared to the same period last year. The airline’s load factor — a measure of how many seats are sold on each flight — rose by 2.1% to 87.3% over the same period.

Not to be outdone, Irish operator Ryanair reported a 20% increase in passenger numbers in December. The group said that its load factor rose by 3% to 94% last month, compared to one year ago.

So it’s all good news?

What these impressive figures don’t tell you is how much profit these low-cost airlines are making on each flight. So do lower ticket prices mean that profit margins are falling? Not necessarily.

Filling seats at any price is a key part of the business model for budget airlines. Cheap ticket prices are subsidised by sales of extras such as checked baggage, and related services like car hire.

To give you an idea of how important ancillary sales are to these companies’ profits, Ryanair said that 21% of its first-half revenue came from ancillary sales. At Wizz Air, the equivalent figure was 38%. The other important thing about this source of revenue is that there’s much more scope for growth. During the first half of last year, Wizz Air’s ticket revenues only rose by 4.1%, but the group’s ancillary revenues rose by 21.3%.

Are Ryanair and Wizz a buy?

Airlines have benefitted from falling fuel prices over the last year. I estimate that Ryanair and Wizz Air have enough fuel hedging in place to protect prices through to early 2018. But they could then face significant increases in fuel costs. Pushing these through into higher ticket prices could dampen demand.

Ryanair currently trades on a forecast P/E of 13, falling to a P/E of 12 for 2017/18. Wizz Air looks cheaper, with a 2016/17 forecast P/E of 11, falling to 10 for 2017/18. I’d hold onto both airlines at current levels, and would consider buying more Wizz Air.

What about a dividend?

British Airways owner International Consolidated Airlines Group (LSE: IAG) has grown very successfully in recent years. Unlike Wizz Air and Ryanair, IAG also offers an attractive dividend, with a forecast yield of 4%.

However, the group’s latest traffic figures — for November — show that its overall load factor fell by 0.4% to 78.9% during the period.

IAG’s passenger numbers rose by 5.2% in November 2016, compared to the same period in 2015. That’s a far cry from the double-digit percentage growth reported by Ryanair and Wizz Air. The reason for this is that as a full-price airline, the group’s business model is different. A lot of IAG’s profit comes from a fairly small number of premium passengers who fly first and business class.

Such passengers expect high standards of service, but aren’t as price sensitive. IAG shares currently trade on a 2017 forecast P/E of about 6.5. They aren’t without risk, but could outperform expectations if the economy remains in good health.

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Roland Head has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.