Tuesday, November 15, 2016

Why is Buffet buying airline stocks?

From the FT:
US airlines have exercised restraint in adding capacity and launching price wars since emerging from the Great Recession and, together with the effects of lower fuel costs, they managed record profits in 2015. This year’s rebound in oil prices has hit profits, however, and made airline shares cheaper.

See our earlier posts on  How to decrease industry rivalry and When do managers care about rival profit?

6 comments:

  1. After 2010, the airline industry appeared to be struggling as a result of higher fuel cost, however, this increase in expenses open the window for the airline industry to start charging additional fees for more spacious seats as well as the checked bags. As this industry is not very regulated from the standpoint of adding additional fees to consumers’ airlines continue to find ways to increase their profit margin, this includes charging for the legacy food service that was offered while traveling.
    Since the fuel cost has decreased over the last several years and the airline maintenance has increase dramatically year-by-year, one must wonder…why is buffer investing in this industry? Perhaps he is focus in the increase revenue trend that have been observed over the last 5 years as well as the potential of having steady fuel prices for many years ahead. In addition, Buffet rationale might be also focus in competition since airlines are becoming more competitive in terms of pricing over the last 3-4 years, this have open the window for aggressive pricing in routes that have a higher volume of flights. In addition, Buffet might be contemplating potential merger acquisitions that are forecast to happen in the short and long term year ahead. Whichever rationale MR. Buffet has in mind is perhaps one that we are not aware of or maybe one that we have not careful consider in evaluating in relation to existing industry trends.

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  2. The emerging markets are providing new opportunity for airlines in general. The desire for cheap, efficient travel has grown within the third world countries greatly. The ability to leverage gas prices has also added to the ability for the larger airlines to increase their base and grow. Delta Airlines is primed to expand and benefit from their large base. As the number two airline at present, Delta has utilized advantageous mergers and have grown into one of the United States largest airlines. With their ability to sustain and grow on customer satisfaction they are able to block new entrants to the industry. They have great relationships with their suppliers and they are able to purchase in bulk which provides a lot of buying power.
    Airlines will benefit from the changing global situation. With immigrants desiring to migrate globally, airlines are the most proficient and safest form of travel. Consumers are able to price compare at quicker rates due to hubs such as Orbitz, just to name one, airline price competitiveness is at an all-time high. Real time changes are key to allowing consumers to benefit from last minute changes as well as allowing the competitors to control the prices at the same time.

    ReplyDelete
  3. The emerging markets are providing new opportunity for airlines in general. The desire for cheap, efficient travel has grown within the third world countries greatly. The ability to leverage gas prices has also added to the ability for the larger airlines to increase their base and grow. Delta Airlines is primed to expand and benefit from their large base. As the number two airline at present, Delta has utilized advantageous mergers and have grown into one of the United States largest airlines. With their ability to sustain and grow on customer satisfaction they are able to block new entrants to the industry. They have great relationships with their suppliers and they are able to purchase in bulk which provides a lot of buying power.
    Airlines will benefit from the changing global situation. With immigrants desiring to migrate globally, airlines are the most proficient and safest form of travel. Consumers are able to price compare at quicker rates due to hubs such as Orbitz, just to name one, airline price competitiveness is at an all-time high. Real time changes are key to allowing consumers to benefit from last minute changes as well as allowing the competitors to control the prices at the same time.

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  4. I wouldn't be surprised if the increased oil prices are temporary, which would be hiding the mounting profits available in this industry! He's buying low during a time when the price is masked by the oil prices, but I'm sure this will be a worthwhile investment in the long term.

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  5. What I see as interesting in this situation is what has changed since before the crisis and after. If we model the decisions that airlines face in terms of game theory, it is likely that the same pressures to "cheat" exist now as they did before, which leads to the question of what is causing this change in behavior. One explanation is the idea of repeated play, but this was true pre-crisis as well. It could be that industry consolidation has changed the calculations that firms face as well.

    Whatever the case may be, it is likely that some investors see an industry that has overcome its inherent prisoners dilemma. This could lead to economic profits for firms in the airline industry.

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  6. Only a few short years ago, Warren Buffett referred to investing in the airline industry as a “death trap!” So, what has changed? Buffett has recently invested $10B into United, Delta, American, and Southwest (Martin, 2017). The reason seems to be not that the industry has changed, but how airlines manage their operations has changed. Mr. Buffett believes that airlines have figured out how to operate with more discipline and are no longer just adding capacity, this had caused a true correction in the demand of flights (Martin, 2017). This is the key to changing with economic times, industries and companies must be able to be nimble and move with the marketplace. When companies do not embrace change, or look to alter their model to meet the changing demands of the consumer they are doomed to fail. Buffett also realized to power of lower costs on profitability, as the cost of oil has trended down in recent years this has triggered millions in profits for the airline industry. In the airline industry labor costs and fuel costs are the two biggest drags on profitability. So, when the price of oil goes down, profitability soars. As prices have languished at or below $50 per barrel for the last year, some think a new age of low-cost oil is here (Divine, 2016). If this is true, then now more than every airline stocks should be very attractive. Lowered expenses, operational restructures, increased efficiencies, and better managerial discipline, that sounds like a winning combination to me.

    References:

    Divine, John. U.S. News and World Report. 5 Reasons why Buffett Suddenly Loves Airline Stocks. November 16, 2016. http://money.usnews.com/investing/articles/2016-11-16/5-reasons-that-warren-buffett-suddenly-loves-airline-stocks

    Martin, Hugo. Los Angeles Times. Why Warren Buffett is Investing in the Airline Industry he Once Called a Death Trap. March 15, 2017. http://www.latimes.com/business/la-fi-buffett-airlines-20170315-story.html

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