A bit of advice about airline stocks: Avoid 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, the scholar and investor Benjamin Graham, was right from the start. He wrote in 1949 that it was clear that the airline industry would take off, but that did not make airline stocks a good investment.
In the late 1980s, Buffett bought the preferred shares of US Airways anyway and made a little money for Berkshire Hathaway sharing, all while disparaging his choice. In 2007, he wrote in his annual shareholder letter, “If a capitalist is far away in Kitty Hawk, he would do a good job of shooting Orville. Investors have poured money into a bottomless pit, attracted by growth when they should have been driven out by that.
But he was still attracted. In 2016, he began buying up almost the entire US industry, eventually paying $7 billion to $8 billion to buy about 10% of American Airlines Group, United Airlines Holdings, Delta Air Lines, and Southwest Airlines. In 2019, he had a small profit. Then COVID-19 struck, and he immediately quit, calling the investment “an understandable mistake.” A year later, the stock took off, with United and American more than doubling between May 1, 2020, and May 1, 2021. Such is life with airline stocks. It is only suitable for short-term market timers, and no one – not even Warren Buffett – can time the market, knowing exactly when to jump in and out.
That’s just one of the lessons airline stocks are learning. More important is the question of whether, as Ben Graham predicted, they have done so badly in the long run. If you understand the airline’s shortcomings, you can apply a broader wisdom.
Start with how poorly this stock has performed. US Global Jet (JETS (opens in new tab)) is an exchange-traded fund that holds airline stocks, with about 10% of its assets in each of the four largest US carriers, another 30% in smaller international lines, and the rest in related stocks such as Boeing and Expedia. If you insist on having a diverse portfolio of airline stocks, this is the best, but flawed option. Over the past five years, the ETF has lost an average of 12% annually, compared with a gain of 9.3% for the broad market S&P 500 index. (Prices and returns until October 7th; stocks I like are in bold.)
AS Global Jets was launched only in 2015. The return of large airlines in a long period of time is mostly horrendous as well. America, for example, has returned a negative 9.9% annualized over 15 years, meaning that an investment of $ 10,000 will have collapsed to roughly $ 2,100 in that period. United also lost. Southwest, the best-performing of the four largest lines, managed to return 5.8%, compared to 8.0% for the S&P 500; Delta returned a paltry 4.1%. Since 1978, there have been more than 100 bankruptcy filings by airlines. Airlines experienced in different years. United filed in 2002, Delta in 2005 and American in 2011. The field is littered with fabled names of 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. Airlines are:
Coconut too. In 1978, Congress deregulated airlines, allowing companies to set their own fares and routes—a win for customers, but the start of a fare war (and bankruptcy, as we’ll see) for the lines themselves. In 1980, the average US round-trip airfare was $593; day is 328 $. After adjustment for inflation, rates have fallen 85%. Meanwhile, 381 domestic airlines compete for business, but regulators and Congress have been reluctant to allow mergers that would give the larger ones a better shot at profitability. For example, JetBlue Airways’ bid to buy low-cost carrier Spirit Airlines, even if successful, is likely to face serious problems getting government approval.
Too commoditized. Domestic airlines have tried, but they have not been able to differentiate themselves from each other by brand. All that counts is price and schedule, so no airline can charge a premium.
Too subject to the vagaries of oil prices. Fuel represents an average of about 20% to 25% of the total cost of an airline, and although companies can hedge the cost in the futures market, they are generally powerless to control this volatile expense.
Too capital intensive and debt ridden. Airlines have to invest heavily in aircraft 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, for every $1 of equity, Delta has $19 of debt; for United, the figure was $12. Overall, the industry has a debt-to-equity ratio of about five to one, compared to one to one for all listed US companies.
Too dependent on organized labor. According to Forbes, airlines represent “the most heavily unionized major US industry. At American Airlines, United Airlines and Southwest Airlines, three of the four largest airlines, between 80% and 85% of the workforce is unionized. Nationwide, about 11% of the workforce is unionized. Additionally, post -Covid, airlines are facing severe and persistent pilot shortages, as well as difficulty hiring flight attendants and other staff. This crisis has led to operational reductions and additional costs for compensation and training. Alaska Airlines, perhaps the most managed of all US carriers, has recently agreed to raise pilot salaries this by 15% to 23%.
Too little innovation. Planes today are actually slower than they were 40 years ago. It took 19 more minutes to fly from New York to Denver than it did in 1983. And that figure does not count the extra time at the airport for security. Much of the innovation in flying has been fuel conservation — a big reason for slower planes — but technology hasn’t done much to improve flight efficiency or comfort.
Rely too much on the government. Unlike in Europe, almost all airports in the US are run by state and local governments and are therefore subject to bureaucratic and political constraints. The antiquated air traffic control system, run by a federal agency, has plagued airlines for years.
For all these reasons, I urge you to stay away from airline stocks—and apply these same lessons to the rest of your investments. But the wider aviation sector offers an opportunity to play into the strong trend of more and more of the world’s population taking to the air.
Consider it Air Transport Services Group (TSG (opens in new tab)), a diversified maintenance, leasing and cargo company that has risen in the past year. Trading at a price-earnings ratio, based on forecasts for next year’s profits, of 11. Shares of similar maintenance companies, AR (water (opens in new tab)), has doubled from its 2020 low but remains modestly priced. Pacific Airport Group (PAC (opens in new tab)), which I recommended in my column last month on emerging markets, operates five airports, mostly on the West Coast of Mexico. The stock has held up this year and is yielding 5.3%. All of these stocks are small, with market caps ranging from $1 billion to $6 billion.
If you’re having a hard time shaking your aeroholism, I’d recommend Panama-based Copa Holdings (CPA (opens in new tab)), which flies to 29 destinations, mainly in Latin America. Founded in 1947, Copa trades at a P/E of just 9, based on projected profits. Yes, it’s an airline, but only one.
James K. Glassman chairs Glassman Advisory, a public affairs consulting firm. He does not write about his clients. His latest book is The Safety Net: Strategies to Protect Your Investments in Turbulent Times. He has no securities mentioned here. You can contact him at [email protected]