Airline stocks took off in the third quarter last year after it emerged that billionaire investor Warren Buffett (Trades, Portfolio) had acquired stakes worth more than $1 billion in several U.S. airlines.
Specifically, according to Berkshire Hathaway’s (BRK.A)(BRK.B) 13F SEC filing, Buffett and his lieutenants bought shares of Delta Air Lines (NYSE:DAL), American Airlines (NASDAQ:AAL) and United Continental (NYSE:UAL) at $249 million, $797 million and $238 million during the third quarter (values based on a quarter end market values). In the days after the stakes were revealed, Buffett announced that Berkshire had also acquired a position in Southwest Airlines (NYSE:LUV).
Berkshire’s new carrier positions have sparked a debate about whether Buffett has suddenly changed his opinion on airlines. The Oracle of Omaha has long avoided the airline sector, due to its unpredictable nature, uncontrollable margins and record of destroying shareholder equity. But by buying over $1 billion in airline stocks, Buffett has shown the market he now appears to be warming to the sector. Does this mean other investors should follow suit?
Time to buy airlines?
Following so-called super investors into positions just because 13F filings detail the holdings is never a sensible strategy, and this is something to keep in mind when evaluating all of Buffett’s portfolio movements. Even though the billionaire is best known for his long-term investing outlook and ability to pick winners, that’s no guarantee that he is investing for the long term this time around.
Indeed, Buffett's airline buys are relatively small compared to the rest of his portfolio (it’s more than likely that Buffett’s lieutenants picked these investments due to their small size) and are, therefore, unlikely to be long-term holdings. In fact, Berkshire could have already sold the holdings and booked gains made over the past few months.
Assuming Berkshire hasn’t divested its airline holdings, it remains a mystery why Buffett’s conglomerate likes these stocks. True, the market for airline travel is growing, costs are falling, and carriers are becoming more efficient, but the negative factors that have always plagued the industry remain.
Airlines’ largest expense, fuel margins, tend to be volatile over the long term as a result as high fuel costs erode profits. Even though the shale oil boom has gone some way to ensuring that oil prices will remain lower for longer, the cost of fuel remains a significant uncertainty for airline management.
Second, airlines remain exposed to price wars. They are engaged in a race to the bottom when it comes to fares as they look to offer the lowest cost to customers and win more business. Even if ticket prices do stabilize there’s no guarantee this ceasefire will last for the long term.
Finally, airlines are still highly capital intensive businesses, and this will not change. Unlike almost all of Buffett’s other significant long-term investments, such as Coca-Cola (NYSE:KO), American Express (NYSE:AXP), IBM (NYSE:IBM) and Wells Fargo (NYSE:WFC), airlines have relatively low return on invested capital. The significant upfront capital investment required to acquire a fleet of planes takes years to pay off unlike businesses such as Coca-Cola and American Express, which can generate a high return on a small asset base.
What's Buffett's plan?
So what could it be that Berkshire likes about the airlines? Well, it could be something to do with the airlines’ valuation at the time or potential for growth if U.S. economic expansion picks up.
Ultimately, though, it’s not possible to know exactly why Berkshire bought Delta, American, United and Southwest during the third quarter of last year. The airline industry is still likely to suffer from its traditional problems going forward and does not appear to be a sensible investment for long-term investors at all. Buffett may have his reasons for buying, but most investors might do well to stay away from the airline sector.
Disclosure: The author owns shares in IBM, but no other company mentioned.
Start a free seven-day trial of Premium Membership to GuruFocus.