A word of advice about airline stocks: resist them. I know it’s hard. Warren Buffett once joked about his own addiction, saying, “I’m Warren and I’m an aeroholic.” Buffett’s mentor, scholar, and investor, Benjamin Graham, was right from the start. In 1949, he wrote that it was obvious that the airline industry was going to take off, but that didn’t make airline stocks a good investment.
In the late 1980s, Buffett bought US Airways preferred stock anyway and made some dividend money for Berkshire Hathaway, fueling his election. In his 2007 annual shareholder letter, he wrote: “Had a prudent capitalist been present at Kitty Hawk, he would have done his successors a great favor by shooting down Orville. Investors poured money into the bottomless pit, lured by growth when it should have repelled it.”
But he remained attracted. In 2016, he started to buy a share of almost all of the US. industry, he will eventually pay $7 billion to $8 billion to buy about 10% of American Airlines Group, United Airlines Holdings, Delta Air Lines and Southwest Airlines. He made a small profit in 2019. Then COVID-19 hit and he immediately pulled back, calling his investments an “understandable mistake”. A year later, stocks soared, with United and American more than doubling between May 1, 2020 and May 1, 2021. Such is life with airline stocks. They are only suitable for short-term market timers, and no one – not even Warren Buffett – can time the market knowing exactly when to enter and exit.
This is just one of the lessons that airline actions teach. The more important question is why, as Ben Graham predicted, they have been so unhappy in the long run. If you understand the shortcomings of airlines, you can apply the wisdom more broadly.
Start with the poor performance of these stocks. US Global Jets (JETS (opens in new tab)) is an exchange-traded fund that owns airline stocks, with about 10% of its assets in each of the four largest US companies. air carriers, another 30% in smaller international lines and the rest in related stocks such as Boeing and Expedia. If you insist on owning a diversified portfolio of airline stocks, this is the best option, but it fails. Over the past five years, the ETF has lost an annual average of 12%, compared with a 9.3% gain for the broad S&P 500 market. (Prices and returns are as of Oct. bold. )
US Global Jets only launched in 2015. The long-term returns for major airlines are also daunting. For example, American, annualized over 15 years, returned a negative 9.9%, meaning that a $10,000 investment would drop to around $2,100 over that period. United also lost. Southwest, the top performer of the four major carriers, returned 5.8%, compared with 8.0% for the S&P 500; Delta returned a measly 4.1%. Since 1978, over 100 airline bankruptcies have been recorded. Airlines have suffered in many different years. United filed in 2002, Delta in 2005 and American in 2011. The field is littered with legendary names from the past: Pan American (bankrupt in 1998), TWA (1992 and 2002), Eastern (1989 and 1991) and Buffett’s US Airways (2002 and 2004).
So what’s the problem? There are several of them. The airlines are:
Too competitive. In 1978, Congress deregulated the airlines and allowed the companies to set their own fares and routes, a boon for consumers but the beginning of fare wars (and bankruptcies, as we’ve seen) for the lines themselves. In 1980, the average round-trip ticket to the United States was $593; today it is $328. Adjusted for inflation, rates are down 85%. Meanwhile, 381 domestic airlines compete for business, but regulators and Congress are reluctant to allow mergers that would allow larger ones to be more profitable. For example, JetBlue Airways’ bid to buy low-cost carrier Spirit Airlines, even if successful, would likely face serious obstacles if it gained government approval.
Very commoditized. Domestic airlines have tried very hard, but they cannot distinguish themselves from each other by branding. What counts is the price and time of the flight, so no airline can charge a surcharge.
It is very subject to the vagaries of oil prices. On average, fuel accounts for about 20% to 25% of an airline’s total costs, and while airlines can hedge future-market costs, they often lack the power to control these volatile costs.
Very capital intensive and indebted. the airlines need to invest heavily in aircraft, either through purchases or leases, which means raising equity (it’s hard to attract investors in an industry that isn’t very profitable) or issuing debt. At the end of 2021, Delta had $19 of debt for every $1 of equity; for United, it was $12. Overall, the industry has a debt-to-equity ratio of approximately five to one, compared with one to one for all US listed companies. companies.
Very dependent on organized work. According to Forbes, airlines represent “the largest union in America. industry. At American Airlines, United Airlines and Southwest Airlines, three of the four largest airlines, 80 to 85% of employees are union members. Nationally, about 11% of the workforce is unionized. Additionally, airlines are experiencing severe and ongoing pilot shortages, as well as difficulties hiring flight attendants and other staff in the wake of COVID. This crisis generated operational restrictions and additional expenses with both remuneration and training. Alaska Airlines, perhaps the best run of all US airlines. airlines recently agreed to raise their pilots’ salaries by 15% to 23% this year.
Innovation is very lacking. Airplanes are actually slower today than they were 40 years ago. A flight from New York to Denver takes 19 minutes longer than it did in 1983. And that number doesn’t include the extra time at the airport for security. Much of the innovation in flying has been fuel savings – a big reason for slower planes – but technology hasn’t greatly improved the efficiency or comfort of flying.
Very dependent on the government. Unlike in Europe, nearly all airports in the US are controlled by state and local governments and are therefore subject to the constraints of bureaucracy and politics. An antiquated air traffic control system operated by a federal agency has plagued airlines for decades.
For all these reasons, I recommend that you stay away from airline stocks – and apply the same lessons to the rest of your investments. However, the aviation industry in general offers opportunities to take advantage of the strong trend of more and more people in the world flying.
Consider Air Transport Services Group (ATSG (Opens in a new tab)), a diversified services, leasing and cargo company whose stock has really surged in the last year. It’s trading at a price/earnings ratio based on a next year earnings forecast of 11. Shares in a similar maintenance company, AAR (AIR (opens in new tab)), have doubled from their 2020 lows , but remain with low prices. Grupo Aeroportuario del Pacifico (PAC(opens in a new tab)), which I featured in my emerging markets column last month, operates five airports, mostly on Mexico’s west coast. The stock has held up this year, yielding 5.3%. All of these stocks are small, with market capitalizations ranging from $1 billion to $6 billion.
If you’re having trouble shaking your aeroholism, I suggest Copa Holdings (CPA (opens in new tab)), based in Panama, which flies to 29 destinations, mostly in Latin America. Founded in 1947, Copa trades at a P/E of just 9 based on projected earnings. Yes, it’s an airline, but only one.