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Should you ditch airline stocks after today’s warning?

Irish budget airline Ryanair Holdings (LSE: RYA) issued a profit warning this morning, cutting guidance for the current year by 5%. Ryanair said the weak pound was to blame and reported a 10% drop in fares during the first half of the year.

Ryanair shares fell briefly when markets opened this morning, but have since bounced back. This may be because today’s lower guidance still represents a 7% increase in adjusted full-year profit.

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If you’ve held onto your airline stocks through this year’s slump, you may be sitting on big losses. Ryanair is down by 21% so far in 2016, while key rival easyJet (LSE: EZJ) is down by a whopping 48%.

Does today’s news mean that it’s time to ditch airline stocks, or is a recovery on the horizon?

A short-term problem?

Ryanair now expects full-year profits to be between €1.30bn and €1.35bn, down from previous guidance of €1.375bn to €1.425bn. This decline is the result of an 18% drop in the value of the pound versus the euro since the referendum.

You see Ryanair reports in euros, but sells about a quarter of its tickets in pounds. When converted to euros, these sales are worth much less than they were six months ago. Ryanair says that fares fell by an average of 10% during the first half of the year. They’re expected to fall by 13%-15% during the second half.

The good news is that Ryanair remains very busy. Passenger numbers are expected to rise by 12% to 119m this year, while the airline’s full-year load factor — how many seats are sold — is expected to be 94%.

Indeed, Ryanair boss Michael O’Leary made it clear in today’s announcement that his top priority is to keep his planes full this winter, even if it means further cuts to profit guidance. I believe this is the correct approach, as it should help the group defend and increase its market share.

When the pound does eventually recover, Ryanair’s profits should rise sharply. I estimate that the airline’s shares trade on a forecast P/E of about 11.5 after today’s profit warning. That’s more than most other airlines, but Ryanair’s ultra-low costs mean the shares could offer good value if passenger growth remains strong.

A bargain buy?

easyJet has been one of the biggest post-Brexit fallers in the airline sector. Earlier this month, the firm warned investors that the weaker pound will result in a £90m “adverse impact“. That’s more than double the firm’s original guidance of £35m.

However, easyJet’s passenger numbers hit a new record of 22.0m during the quarter to 30 September, while load factor remained high at 93.9%. These figures suggest to me that like Ryanair, easyJet is continuing to see strong demand for its services.

Full-year pre-tax profit is now expected to be £490m-£495m. That’s a 28% fall from 2015, but is still expected to be enough to allow the airline to pay a 52p dividend for the full year.

Like Ryanair, easyJet should benefit if the pound starts to recover. With the shares now trading on eight times forecast earnings and offering a 6% dividend yield, I believe it makes sense to hold on for better days, and perhaps consider a top-up.

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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.