A word of advice on 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 aero addict.” Buffett’s mentor, scholar and investor Benjamin Graham, was right from the start. He wrote in 1949 that it is obvious that the airline industry will take off, but that does not make airline stocks good investments.
In the late 1980s, Buffett bought US Airways preferred stock anyway and made some money for Berkshire Hathaway on the dividends, while denigrating his choice. In 2007, he wrote in his annual letter to shareholders: “If a far-sighted capitalist had been present at Kitty Hawk, he would have done his successors an immense service by bringing down Orville. Investors poured money into a bottomless pit, lured by growth when they should have been repelled.
To subscribe to Kiplinger’s personal finances
Be a smarter, more informed investor.
Save up to 74%
But he remained attracted. In 2016, he began buying up nearly all of America’s industry, eventually paying $7 billion to $8 billion to buy around 10% of American Airlines Group, United Airlines Holdings, Delta Air Lines, and Southwest. Airlines. In 2019, he had a small profit. Then COVID-19 hit, and he immediately pulled out, calling his investments an “understandable mistake.” A year later, stocks had taken off, 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 precisely when to enter and exit.
This is just one of the lessons that airline actions teach. More important is the question of why, as Ben Graham predicted, they were so lousy in the long run. If you understand airline shortcomings, you can apply the wisdom more broadly.
Start with the poor performance of these stocks. US Global Jets (JETS (opens in a new tab)) is an exchange-traded fund that holds airline stocks, with around 10% of its assets in each of the four largest US carriers, an additional 30% in smaller international lines, and the remainder in related stocks such as Boeing and Expedia. If you insist on owning a diversified portfolio of airline stocks, this is the best bet, if not perfect. Over the past five years, the ETF has lost an average of 12% per year, compared to a 9.3% gain for the S&P 500. (Prices and returns are as of October 7; stocks that I like are in bold.)
US Global Jets only launched in 2015. The returns of major airlines over long periods are also abysmal. American, for example, reported a negative 9.9% annualized return over 15 years, meaning a $10,000 investment would have collapsed to around $2,100 over the period. United were also a loser. Southwest, the best managed of the four largest lines, managed a return of 5.8%, compared to 8.0% for the S&P 500; Delta returned a meager 4.1%. Since 1978, there have been well over 100 airline bankruptcy filings. Airlines have suffered over many years. United filed in 2002, Delta in 2005 and American in 2011. The field is littered with legendary names from the past: Pan American (bankruptcy in 1998), TWA (1992 and 2002), Eastern (1989 and 1991) and Buffett’s US Airways ( 2002 and 2004).
So what is the problem? There are many. The airlines are:
Too competitive. In 1978, Congress deregulated the airlines, allowing companies to set their own fares and routes – a boon for consumers, but the start of fare wars (and bankruptcies, as we’ve seen) for the routes they themselves. In 1980, the average round-trip airfare to the United States was $593; today it’s $328. After adjusting for inflation, fares fell by 85%. Meanwhile, 381 national airlines are vying for business, but regulators and Congress have been reluctant to allow mergers that would give the biggest a chance to improve profitability. For example, a bid by JetBlue Airways to buy low-cost carrier Spirit Airlines, even if successful, would likely face serious headwinds to gain government approval.
Too trivialized. The national airlines have made great efforts, but they cannot differentiate themselves from each other by their brand. Only the price and timings matter, no airline can charge extra.
Too subject to the vagaries of oil prices. Fuel represents on average around 20-25% of an airline’s total costs, and although airlines can cover the cost in the forward market, they are usually powerless to control this volatile expense.
Too capitalistic and indebted. Airlines must invest heavily in aircraft through purchase or lease, which means either raising equity (it is difficult to attract investors in an industry that is not very profitable), or issuing debts. At the end of 2021, for every dollar of equity, Delta had 19 dollars of debt; for United, the figure was $12. Overall, the sector has a leverage ratio of around five to one, compared to one to one for all listed US companies.
Too dependent on organized labor. According Forbes, airlines are “the most unionized big industry in America. At American Airlines, United Airlines and Southwest Airlines, three of the four largest airlines, between 80% and 85% of the workforce is unionized. Nationally, approximately 11% of the workforce is unionized. Additionally, post-COVID, airlines are facing a severe and persistent shortage of pilots, as well as difficulties in hiring flight attendants and other personnel. This crisis has led to cuts in operations and additional expenses for both compensation and training. Alaska Airlines, perhaps the best-run of all US carriers, recently agreed to raise its pilots’ pay this year by 15-23%.
Too little innovation. Airplanes today are actually slower than they were 40 years ago. It takes 19 minutes longer to fly from New York to Denver than it did in 1983. And that figure doesn’t include the extra time spent at the airport for security reasons. Much of the innovation in flight has been devoted to fuel conservation – a major reason for slower aircraft – but the technology has done little to improve flight efficiency or comfort.
Too dependent on the government. Unlike Europe, almost all airports in the United States are run by state and local governments and are therefore subject to the constraints of bureaucracy and politics. The antiquated air traffic control system, run by a federal agency, has plagued airlines for decades.
For all of these reasons, I urge you to steer clear of airline stocks and apply these same lessons to the rest of your investments. But the wider aviation sector offers opportunities to play on the powerful trend of a growing share of the world’s population getting into the air.
Consider Air Transport Services Group (ATSG (opens in a new tab)), a diversified maintenance, rental and freight company whose shares have actually risen over the past year. It trades at a price-to-earnings ratio, based on earnings forecasts for the year ahead, of 11. Shares of a similar maintenance company, RAA (AIR (opens in a new tab)), have doubled from their 2020 low but remain modestly priced. Pacific Airport Group (PAC (opens in a new tab)), which I recommended in my Emerging Markets column last month, operates five airports, mostly on the west coast of Mexico. The stock held up well this year and lost 5.3%. All of these stocks are small, with market caps ranging from $1 billion to $6 billion.
If you have trouble shaking your aeroholism, I’ll suggest Panama Copa Holdings (ACP (opens in a new tab)), which serves 29 destinations, mainly in Latin America. Founded in 1947, Copa trades at a P/E of just 9, based on projected earnings. Yes, it is an airline, but only one.
James K. Glassman chairs Glassman Advisory, a public affairs consulting firm. He does not write about his clients. His most recent book is Safety net: the strategy to reduce the risks of your investments in turbulent times. He does not hold any of the titles mentioned here. You can contact him at James_Glassman@kiplinger.com.
#airline #stocks #bad #business