“The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. Think airlines. Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers. Indeed, if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down.”
Warren Buffett in an annual letter to shareholders (2008)
“If the Wright brothers were alive today Wilbur would have to fire Orville to reduce costs.”
Herb Kelleher, Southwest Airlines (NYSE:LUV) (1994)
“A recession is when you have to tighten your belt; depression is when you have no belt to tighten. When you’ve lost your trousers — you’re in the airline business.”
Sir Adam Thomson
“I think historically, the airline business has not been run as a real business. That is, a business designed to achieve a return on capital that is then passed on to shareholders. It has historically been run as an extremely elaborate version of a model railroad, that is, one in which you try to make enough money to buy more equipment.”
Michael Levine, Exec. VP of now defunct Northwest (1996)
As most are aware, Warren Buffett purchased preferred shares of US Air (LCC) in 1989, in what many consider to be one of his big mistakes. Realizing the difficulty of the industry, Buffett decided to unload his shares and managed to walk away with a profit. He vowed not to go back. In his 2007 letter to his shareholders, he talked about capital intensive businesses that require large additional sums in order to grow revenue. Before you know it, they are deep in debt. When all is said and done, there is very little for the shareholders to take.
Though he had sworn off airline stocks, 1998 was a new year and they acquired interest in NetJets, run by none other than David Sokol. NetJets has also not been a profit maker for Berkshire (NYSE:BRK.A)(NYSE:BRK.B), though current results are indicating that things are improving. As for why he chose to go back into an industry he held in disdain would only be speculation. The results for this investment will only be discovered in due time; however, one would be a fool to bet against Buffett.
With this said, I am always fascinated how airlines continually are able to find investors that will “speculate” in this industry. At the risk of making a few angry, I consider this industry as speculative, with no great catalyst on the horizon that would coerce me into placing money for the sake of profit. I don’t see it as a long-term investment, only as a means of entrance into day trading. It’s a cyclical industry, also very dependent on the price of gas and oil, with an incredible amount of debt that keeps it from any meaningful growth. If you study the industry, for the last 15-20 years, it has gone nowhere. If and when another terrorist incident occurs, the industry will take another step backward.
David Tepper, founder of Appaloosa Management’s $3 billion hedge fund, is an expert on distressed debt companies and has made a fortune investing in them. His record is incredible.
Excess Gain (%)
David Tepper currently owns shares of American Airline (AMR), United Continental Holdings (NYSE:UAL), US Airways Group Inc. (LCC) and Delta Air Lines (NYSE:DAL). His style of investing, based upon his portfolio, would lead you to think he is mostly a value-oriented investor. Ken Heebner, whose record is also good, is also owner of these same four stocks. Heebner is, admittedly, a growth style speculator. Debt-distressed identifies these and most of the other airline stocks.
Some of the risks associated with these airlines include:
1. Higher fuel prices, which take up approximately 20-30% of their operating expenses.
2. Fierce competition among airlines.
3. Labor problems with contracts.
4. Perpetually increasing tax percentage on air fares.
5. Customer complaints indicating airlines are getting worse.
6. Security measures.
7. Pension liabilities.
8. Terrorist attacks.
9. Extreme debt levels.
10. Inflation affecting other expenses.
Always looking for opportunities, it is good to study industry. This includes all industries. If there are redeeming qualities in this industry, they appear to be in the cyclical ups and downs of the business and day trading. They do not appear suited for long-term investment. It is intriguing to try to discover why some of the gurus buy what they do. Sometimes, it is an easy discovery and other times the work is a little harder. After careful study, at times you may discover the hidden gem they have found. Other times, you may find that things are exactly what they appear to be and you will stay away.
Are the airlines an investment potential or are they merely speculation? What were the criteria used in persuading David Tepper and Ken Heebner to buy? What do you think?
Disclosure: I own none of the stocks mentioned in this article (and probably won’t!)