Over the past several months, reports have been cirulating that Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) may buy an airline.Â
Airline stocks are getting cheap, but why would the insurance conglomerate buy one? In fact, if Warren Buffett (Trades, Portfolio) did, it would be prudent to remind him of things he’s said over the years about the industry.
“As the seat capacity of the low-cost operators expanded, their fares began to force the old-line, high-cost airlines to cut their own… eventually a fundamental rule of economics prevailed: In an unregulated commodity business, a company must lower its costs to competitive levels or face extinction.”
He also famously 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.”
Last year he told CNBC, “I like airlines because they just got a bad century out of the way.” But that’s not a reason to buy one entirely.
Of course, there may be some differences today that were not present the last time he invested in airlines. In 1989, Berkshire bought $358 million worth of US Air preferred with a 9.25% dividend. The investment carried a mandatory redemption in 10 years with a conversion rate of $60 per share. Despite seeking out a small gain on the deal, at the time he quipped that “I now have an 800 number I call every time I think about buying a stock in an airline. I say, ‘I’m Warren and I am an air-aholic.’”
It’s about time for him to pick up that phone again
Berkshire’s current airline holdings include Delta Air Lines (DAL, Financial) at $54.81, Southwest Airlines (LUV, Financial) at $57.28, American Airlines (AAL, Financial) at $51.96 and United Continental Holdings (UAL, Financial) at $69.47 in order of portfolio concentration. Of these, only United is currently profitable, with Delta breaking even, American down 16% and Southwest down 11%. This may be a long-term investment, but investors should not expect Berkshire to buy an entire airline.
Air fares fell 1.9% month over month in May, marking the second consecutive month of sharp declines. The average fare during the month was 6.6% lower than a year ago. The drop in fares stem from higher labor costs and fuel costs for most carriers. As energy costs are rising and until jet fuel is replaced, the cost of operating planes will weigh on cash flow. Even the most profitable airlines are spending far more on capital expenditures than they bring in net.
Delta Air Lines:
Income - $3.5 billion
Capital expenditures - $3.9 billion
American Airlines:
Income - $1.7 billion
Capital expenditures - $5.9 billion
United:
Income - $2.1 billion
Capital expenditures - $3.9 billion
Southwest Airlines:
Income - $3.4 billion
Capital expenditures - $2.2 billion
Many of these numbers are also highly influenced by the recent tax breaks and will not last. Neither will the economic prosperity we’ve enjoyed since 2009-10, which in and of itself brings the lure of poor investments. Interest rates are rising along with operating costs and energy costs.
Of these, Southwest may be the best investment as the management has done well with fuel hedges that will end up hurting others. In the end, airlines may look cheap right now, but they’re going to get a lot cheaper before its over.
Disclosure: I am not long or short any stocks mentioned in this article.
