Warren Buffett (Trades, Portfolio) on airlines at the start of the century:
“If a capitalist had been present at Kitty Hawk back in the early 1900s, he should have shot Orville Wright. The airline business has been extraordinary. It has eaten up capital over the past century like almost no other business."
Yet, Buffett’s Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) made three very interesting airline stock purchases, as disclosed in a recent 13F filing.
The company bought 21,770,555 shares of American Airlines (AAL, Financial) at $36.61 for a total investment of more than $797 million. It bought 6,333,923 shares of Delta Airlines (DAL, Financial) at $39.36 for a total investment of $249.3 million. In addition, it bought 4,533,013 shares at $52.47 of United Continental (UAL, Financial) for a total investment of $237.8 million. Added up, Berkshire Hathaway invested north of $1.3 billion in the leading airline companies that have a collective market capitalization of $82.6 billion, or less than 1.0% of the total portfolio.
All in all, this is a very small investment for the company, both from an assets under management standpoint and from an industry specific one. It is not as though Buffett’s team of money managers are going all in on airlines, but it raises the question as to why buy at all? Surely it is not to get the annual reports or a proxy vote. Rather, it is to make money.
From a numbers standpoint, it makes no sense at all. Why not just buy the S&P 500 index funds Buffett has touted for years to individual investors? For Berkshire to see a similar rise in the market value of these three airlines, they would have to grow substantially and considering the recent numbers from the U.S. Bureau of Transportation, I do not think it is possible within a timeline that helps Buffett reach his benchmark performance goals.
Airfares since the 1990s
While many are encouraged that President-elect Donald Trump has proposed as much as $1 trillion in infrastructure spending on "our highways, bridges, tunnels, airports, schools, hospitals," as he announced the day after the election, this will not make airlines more profitable or people fly more. We already have heavy traffic in the skies. Just visit the Franklin Delano Roosevelt memorial in Washington, D.C. and watch the number of planes that fly into Ronald Reagan Washington National Airport every day.
Two questions are tied together in my mind.
- How long will the price of oil stay low?
- Will the current level of profitability last?
American Airlines earned over $10 billion in the last two years, but for the decade they only earned $1.5 billion. Delta is a similar story with more than $16 billion in the last three years, but only $3.4 billion for the decade. In fact, United is the only one of these three to end the decade with more net earnings than the last three years. None have a particularly strong track record for growth in earnings per share and book value, mainly because they all have issued a ton of new shares in the last decade.
What I am trying to say is that these new stock purchases do not look very Buffettesque!
Alas, you only get paid on the future of a company’s performance, not on its past.
My take remains the same, small airlines are better than big ones and that will remain the case. Unless Trump plans on tightening regulation on the airline industry, preventing new ones from being formed and giving small ones undue costs of capital for compliance sake. Could this happen? Maybe. It is unlikely as the barriers to entry are already fairly high.
Again, most of the best routes are taken by big airlines. These airlines will have a really hard time charging more while simultaneously allocating capital to either fly more routes or have more planes fly existing routes. Both seem like a nightmare to shareholders. Scaling an airline is not the same as any other consumer driven business. And I did not even get into the potential effects on flight cancellations due to climate change and storms.
The punch line is that just because Buffett is buying airlines does not mean you have to as well.
Disclosure: I have no positions in any of the stocks mentioned in this article.
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