American CEO Doug Parker has been asking investors to take a ‘leap of faith’ that this time is different in the airline industry.
In the most recent quarterly earnings call Parker suggested in support of this view that all the bad things airlines have been through are happening (lower ticket prices, higher fuel prices, higher labor costs, increased capacity) and they’re still profitable.
US airlines think investors ought to trade their stocks at a higher multiple. And many investors took a serious signal when Warren Buffett made big investments in American, Delta, United and Southwest.
Buffett had been famously negative on the airline industry since his 1989 purchase of US Airways debt (convertible to stock, he never converted). In fact, he once said,
If a capitalist had been present at Kitty Hawk back in the early 1900s, he should have shot Orville Wright. He would have saved his progeny money.
But seriously, the airline business has been extraordinary. It has eaten up capital over the past century like almost no other business because people seem to keep coming back to it and putting fresh money in.
You’ve got huge fixed costs, you’ve got strong labor unions and you’ve got commodity pricing. That is not a great recipe for success.
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At Berkshire Hathaway’s annual meeting, Buffett clarified that he’s not convinced airlines are high quality industrials and that the business is entirely different than it’s been in the past just better than it used to be.
Airlines are a “fiercely competitive industry” but even so, it’s not as competitive as it used to be, he says.
The industry “has been operating for some time now at 80% or better capacity” measured by seat miles, and he predicts they’ll continue operating at above average capacity for the next few years.
“They actually at present are earning quite high returns on invested capital,” higher even than FedEx or UPS, he says with a couple caveats. But there could be a price war, which will sap results, he warns.
“It is no cinch that the industry will have more pricing sensibility” than they have in the past, but the conditions have improved, including with its labor relations. All four are buying back stock “at a good clip” and he expects this to continue.
Airlines aren’t growth businesses. Their stock value has been predicated on the idea that they won’t grow quickly. Airlines have been making money and pouring much of it into stock buybacks to bolster share price. At the annual meeting Buffett makes the obvious point (which I’ve been making as well) that stock buybacks are something you do “with funds that (can’t) be deployed well.”
Buybacks are an indication of limited opportunities for profitable investment.
Buffet clearly thinks he can make money on his airline investments. But we shouldn’t take his bet to mean that the industry has been transformed as an investment vehicle.