Does today’s update from IAG suggest it’s time to return to these battered stocks?

Are International Consolidated Airlines and easyJet (LON: EZJ) now tempting contrarian picks?

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2016 will go down as a year most airlines will want to forget. Despite being clear beneficiaries of the oil price slump, shares in companies such as International Consolidated Airlines (LSE: IAG) and easyJet (LSE: EZJ) lost roughly 50% of their value in the immediate aftermath of June’s momentous EU vote. This unexpected outcome, along with air traffic control strikes and the threat of terrorist activity, has only served to reaffirm the belief of some that private investors should stay away from this industry.

But with the former reporting a small rise in profits this morning (and the market responding positively), is it time for investors to start boarding again? 

Green shoots?

Given its “tough operating environment,” today’s update from IAG wasn’t all that bad. The owner of British Airways, Iberia and Aer Lingus reported a Q3 operating profit of €1.205bn (£1bn). Earnings per share rose just over 18% and cash levels were at €6.19bn, up €334m on the 2015 year-end. Thanks to the relatively cheap price of oil, fuel unit costs before exceptional items for the quarter were down by 25.8%. The not-insignificant €162m (£145m) hit from currency fluctuations thanks to the fall in sterling will concern some.

CEO Willie Walsh remained upbeat, however: “Despite this, our unit revenue performance was better than in quarter 2 and our quarterly profit after tax was €970m before exceptional items, an improvement of 9.9% on last year. In the nine months, we made an operating profit before exceptional items of €1,915m, up 6.1% versus last year.”

These figures and comments (and a 10% increase to the interim dividend to 11 cents per share) were well-received by the market. In early trading, IAG’s shares were up over 5% to 435p.

Contrarian opportunity?

Let’s be clear: the share prices of IAG and its peers won’t bounce back to pre-referendum levels overnight. A rising oil price, further industrial action and terrorist incidents could all blight a recovery, at least in the short term. Indeed, after such an awful few months and with so many variables affecting the share price, I wouldn’t be surprised if most investors continued to shun these shares for a while yet, at least until the manner of our departure from the EU is clarified. 

That said, I can also understand the appeal of IAG and other airline stocks like easyJet for those willing to buy and hold the shares for the long term. As investors in blue chip giants like Royal Dutch Shell and BHP Billiton will testify, buying shares in large, resilient businesses at the point of maximum pessimism can be extremely profitable. Moreover, companies like IAG and easyJet are now trading on very low valuations (forecast price-to-earnings, or P/E, ratios of 6 and 10 respectively). Then there’s the dividends to consider.

Shares in IAG and easyJet both come with forecast yields of just below 5%. Despite recent events, both payouts appear safe for now. The Luton-based budget airlines’s dividend will be covered twice by earnings. IAG’s is even more secure with dividend cover at 3.5. The fact that the latter has now agreed to make annual payments of £300m for the next 11 years to plug its pension deficit, while continuing to grow its payout, is also likely to reassure investors.  

All this leads me to think that these airline stocks look tempting at the current time. 

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Paul Summers owns shares in easyJet. 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.

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