Warren Buffett has long hated two things: gold, and airline stocks. The Oracle of Omaha has described the airline industry as a “death trap,” “capital destructor” and other similar phrases of horror. And he’s been pretty right … which is why his recent 21.8 million-share purchase of American Airlines Group Inc (NASDAQ:AAPL) and its airline brethren have a few people scratching their heads.
Realistically, Berkshire’s purchase of AAL stock and others was likely done by one of Buffett’s lieutenants in their insurance portfolios. But it still marks a sharp shift in Berkshire Hathaway Inc.’s (NYSE:BRK.A, NYSE:BRK.B) overall strategy.
Or does it?
As weird as it seem, AAL and the other airline stocks actually fit the bill pretty well. At the very least, they might be a sign that Berkshire Hathaway’s portfolio might just be in good hands after all.
Berkshire Dives Into Airlines
This isn’t the first time that Warren Buffett and Berkshire Hathaway have owned airline stocks. Buffett held around $350 million in US Airways’ preferred stock back in the late 1980s.
Of course, those shares’ value cratered nearly instantly, and by the mid-1990’s, Berkshire had written the value down to just pennies on the dollar. Buffett had broken his own rule about never losing money. And since that time, airline stocks have been strictly verboten at Berkshire.
But as Bob Dylan likes to say, “The times, they are a-changin’.”
In an SEC filing on Monday, Berkshire Hathaway mentioned that it bought shares in the four biggest U.S. airlines — AAL stock, Delta Air Lines, Inc. (NYSE:DAL), Southwest Airlines Co (NYSE:LUV) and United Continental Holdings Inc (NYSE:UAL). And these weren’t necessarily small stakes, either. Buffett now owns a stake in AAL worth nearly $800 million, while each of the share counts for the other airlines number in the millions and are worth around $250 million each.
You’re looking at about $1.5 billion to $2 billion in total worth of airline shares tucked away inside Berkshire’s portfolio. And while that may not seem like much considering the massive size of Buffett’s empire, it is important when you think about Buffett’s overall disdain for the sector.
The man once said that “He would have done his successors a huge favor by shooting Orville down” in Kitty Hawk.
The fact that Buffett even let his lieutenants think about buying airline stocks, let alone pull the trigger, is astounding.
AAL Stock Is a Very Shrewd Call
The thing is, Buffett’s stock picking successors may actually be on to something.
Airline stocks aren’t necessarily death traps anymore, and you can thank low oil prices for that. High oil prices — and the high costs related to jet fuel that come with them — have been a thorn in the side of AAL and other airline stocks for decades. Fuel costs are the industry’s biggest expense, and are one of the biggest limitations to profitability.
That started to change in 2014.
As oil’s glut has persisted and prices have traded in a tight range, airlines have gotten a break. Meanwhile, various fees to combat higher oil prices haven’t gone away. Consumers still are paying for checked baggage and extra pillows on flights. So now, airline stocks like AAL and LUV are realizing some of their best profit margins ever. That’s a complete 180 in just two years.
In fact, things are so good, many of the airline stocks have been able to pay and/or lift dividends — and meaningful ones at that.
If you think about it, airline stocks actually fit into Buffett’s narrative of “lower for longer oil prices” and buying those firms that will benefit from the trend. Just like refiner Phillips 66 (NYSE:PSX), the airline stocks should be able to feast on lower oil prices. They’re not as “safe” as PSX, of course, but they still benefit via higher cash flows.
So, Buffett’s lieutenants may have set up Berkshire to start reaping those cash flows for a long time.
Should You Follow Buffett’s Lead Into AAL?
The real question for you is whether Buffett’s call on AAL and other airlines is right for you.
I’m inclined to say “yes,” with an asterisk.
Buffett’s buys came over the last three months. At the time, airline stocks still were pretty cheap, and election drama made them cheaper. Today, they can be had for roughly 20 times earnings — not exactly super-cheap. Though nothing really is today.
Given the possibility for failure and risk associated with the sector, that may be a little too rich for investors looking to snag some real dividend growth. And it could example why Buffett may have put the brakes on additional purchases.
But if investors get a chance due to a market dip to snag AAL stock and its rivals, it might be worth taking that shot.