At the beginning of April, we learned that Warren Buffett (Trades, Portfolio)'s Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) had been selling some of its airline holdings. According to SEC filings during the first week of April, Berkshire sold nearly 13 million Delta Air Lines Inc (DAL, Financial) shares for about $314 million and roughly 2.3 million Southwest Airlines Co (LUV, Financial) shares for about $74 million.
The conglomerate was forced to reveal these trades because any business that owns 10% of a particular company is required to report its transactions over that level. The sales took Berkshire's investment below that 10% threshold.
When these deals were announced, I speculated that Buffett could have potentially changed his opinion on the sector and continued seling, as he is not required to report any transactions in securities where Berkshire owns less than 10% outside of normal quarterly filings.
Buffett sells out of airlines
At Berkshire's 2020 annual meeting of shareholders this past weekend, we found out that the Oracle of Omaha has now entirely disposed of his airline holdings.
What's fascinating about this is that Buffett decided to take this course of action only a few weeks after declaring, "I won't be selling airline stocks," in an interview with Yahoo Finance editor-in-chief Andy Serwer.
So what changed? Commenting on the decision at Berkshire's annual meeting, which was held online, Buffett said, "I wouldn't normally talk about it, but I think it requires an explanation. We were not disappointed at all in the businesses that were being run and the management, but we did come to a different opinion on it."
Due to the pandemic, airlines are being hurt by a shock "far beyond their control," according to Buffett. He also added that if Berkshire owned airlines, it would be "a tough decision to decide whether to sustain billions of dollars in operating losses when you don't know how long it's going to happen or occur."
This seems to be the crux of Buffett's decision. While he spent much of the meeting touting the strength of the American economy, it has become impossible to figure out what impact the shutdown will have on airline companies.
Cash flow predictability
Whenever he buys a business, Buffett always considers its cash flows carefully. The Oracle of Omaha wants to know what level of free cash flow generation is normal, and if it's sustainable. From there, he can work out the value of the business.
When it's not possible to calculate future cash flows, the business finds itself on his "too hard" pile. It seems that's just what happened here.
While the airlines might make a comeback, it's now become too difficult to predict their long-term earnings power, and that's a problem. Buffett would prefer to get out and take a loss rather than remain invested in something he does not understand.
As he explained at the meeting over the weekend, the airline industry has changed dramatically over the past few weeks, and it could be years before demand returns to levels seen in 2019. Specifically, Buffett said:
"The world has changed for the airlines, and I don't know how it's changed, and I hope it corrects itself in a reasonably prompt way. I don't know whether the Americans will have now changed their habits or will change their habits because of an extended period if it happens that we're semi shut down in the economy."
However, these companies still have obligations to fulfill, including the delivery of new planes. That means these businesses could be sitting around with hundreds of thousands of new seats in extra capacity. Such excess capacity can be toxic for any business.
Disclosure: The author owns shares in Berkshire Hathaway.
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