Evidence of David Tepper’s magic touch has been manifest numerous times over his career. This year in particular, his “one big play versus the market” doubled and tripled, helping propel his firm, Appaloosa Management, to gross returns of more than 40%. The play also happened to be in a sector Warren Buffett loathes.
Tepper told Bloomberg in November: “Our big play versus the market is airlines. That’s a big play. We’re the biggest holder of all these different airlines. No hedge fund owned as many airlines as we did and not too many people did. Delta, UAL, LCC, US Air, AMR. We owned big percentages in all those stocks. And you know what, they did pretty good… pretty freaking good. I think Delta more than doubled. I think some of these other stocks are up 70%. AMR obviously I think this year the way it’s set up this year it was probably a triple.”
Tepper’s interest in airline stocks goes back to the first half of 2012. In that period, he bought 9.7 million shares of US Airways Group Inc. (LCC), more than 9.5 million shares of the largest carrier Delta Air Lines Inc. (DAL), and 7.3 million of the United Continental Holdings Inc. (UAL). Combined, the investments represented more than 10% of his $6.28 billion portfolio.
The airline industry experienced a strong rally from its souring in the 2009 financial crisis through late 2010. But by late 2011, just before Tepper’s purchases, it had declined by almost half from its 2010 high, back to its 2009 levels. In 2011 alone, the industry fell 34%.
Valuation multiples on Tepper’s three stock selections within the industry also declined to relatively low levels around the time of his purchases. In January 2012, United Continental’s P/E ratio fell to below 9, and Delta’s fell to the single digits for the first time in over a year and a half. US Airways, for most of the past three years, has traded with a low single-digit P/E.
Likewise, the prices of the stocks came down drastically. From January 2011 to January 2012, US Airways fell 52%, Delta 36%, United Continental 27.5%.
Airlines in 2012 were plagued with economic uncertainty and near-record high fuel prices. Airlines are sensitive to fuel price fluctuations because costs for fuel can consume up to 40% of their budget. According to the U.S. Energy Information Association, from January 2009 to January 2012, the U.S. Gulf Coast jet fuel spot price soared 110%.
The industry began to see some relief in 2012, with prices down more than 9% through November. But the spike in 2012 prompted airlines to take other measures to reduce the impact, such as Delta buying an oil refinery, investing in fuel-efficient technology, switching to aircraft with more seating and reducing the frequency of long-haul flights. From 2001 through 2012, airline fuel efficiency has improved by 18%, including a 1.7% improvement from 2011 to 2012.
The airline industry during the past several years also saw an enormous decline in profitability. Profit fell from $16 billion in 2010, to $8.4 billion in 2011, to $7.4 billion in 2012, according to the International Air Transport Association. The association expects a strong turnaround in the industry soon, however, with a projection of $11.7 billion in profit for 2013.
Buy or Sell
It recently appeared that Tepper was winding down his airline holdings, as he shed millions of shares in the fourth quarter of 2012 and first two quarters of 2013 on higher prices. But though his trading actions of the fourth quarter of this year are as yet unclear, he returned to some buying in the third quarter: Tepper bought almost 800,000 shares of United Continental and more than 46,000 shares of US Airways Group. Delta was an exception, as the holding reflects an almost 2 million-share reduction from the second quarter.
Each of the companies’ share prices continues to climb, with Delta up 43% and United Continental up 16% in the past six months. US Airways on Dec. 9 closed a merger with AMR Corporation to form American Airlines Group Inc. (AAL) and ceased trading under its former symbol.
The P/E of Delta has risen to 11.2, and United Continental has no P/E, but a P/S close to a 10-year high and P/B of 7.9. US Airways Group’s P/E was 7.8 pre-merger. Delta remains Tepper’s seventh-lowest P/E stock in his portfolio, which contains 64 holdings.
The outlook for the industry is also strong. The average operating margin for 2013 is expected to be 3.2%, as the industry continues to make changes to cushion high fuel prices, and consolidation and mergers, such as that of American Airlines Group, continue.
“The upward trend should continue into 2014 when airlines are expected to return a net profit of $16.4 billion,” the USEIA said in its forecast. “This would make 2014 the second strongest year this century after the record breaking $19.2 billion profit in 2010.”
In addition, Tepper appears characteristically bullish about the U.S. economy. He told Bloomberg in November: “I would be worried if I was a long-short guy and not long enough… the market could always go down. If they taper it could go down 5 or 10%. But if you’re talking through the whole year, the biggest risk of the market is that you will have multiple expansion, you will have higher growth, and you will have 10% earnings growth next year. You’ll have another year of 20 or 30%.”
Other gurus who own Delta are Primecap Management, with 1.88% of its shares outstanding – more than Tepper – and Ken Heebner, who added in the third quarter. George Soros and Joel Greenblatt sold out. Primecap also holds more United Continental Airlines than Tepper and added in the third quarter, as did Brian Rogers. Ken Heebner and George Soros sold out the stock.
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