Why Did Buffett Change His Mind on Airline Stocks?

Warren Buffett's about-face with respect to the airline industry has left many wondering: why?

Warren Buffett is one of the most iconic investors of all time, and he hasn’t gotten to where he is by chance. Nearly 90 years old, Buffett possess an incredible ability to change his mind on investments he once dismissed, or those he once was the most fervent supporter of. I’ll be taking a look at airline stocks as an example of the former.

Why Did Warren Buffett Change His Mind on Airline Stocks?
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In 2016, Berkshire Hathaway Inc. (NYSE:BRK.A) initiated positions in four major airlines: American Airlines Group Inc (NASDAQ:AAL), Delta Air Lines, Inc. (NYSE:DAL), Southwest Airlines Co (NYSE:LUV), and United Continental Holdings Inc (NYSE:UAL).

After an investment experiment in the 1980s with U.S. Air — a once-promising airline which eventually merged with American Airlines after intense competition from Southwest Airlines ate away at U.S. Air’s customer base for profitable routes — Buffett experienced what became the industry norm for U.S.-based airlines: very high highs, with lows often resulting in bankruptcy.

Buffett has noted that while he was able to exit the investment and made money before U.S. Air went bankrupt and ultimately merged, he was left scarred by the experience and for many years has vowed in his annual letters and in interviews never to invest in an airline again.

It turns out that never is a strong word, and Mr. Buffett is back at it again, confident that he has picked the right time to jump in and take advantage of the long-term prospects of air travel moving forward.

Airline Stocks’ Fundamentals Much Better Than Before

Warren Buffett has spoken at length about the difficult fundamentals of the airline industry.

Extremely low marginal costs and the desire for airlines to operate at or very near capacity has resulted in price wars which have hampered profitability for decades. While the largest have survived (and in most cases simply gobbled up the competition), the current environment of an effective oligopoly in the industry is one of the reasons Buffett has begun to buy up stakes in each of the companies in the oligopoly.

His bet on airlines is a bet on the industry and profitability increasing across the board for all airline stocks moving forward.

The fact that Buffett did not pick one company out of the bunch is an interesting play, as he has indicated that improving fundamentals will likely be the “tide that lifts all boats,” and by buying into the largest players, Buffett gets long-term exposure to the companies that will drive air traffic for the next 100 years.

Recent Scandals Have Not Changed Buffett’s View

The aforementioned desire of airlines to operate at capacity has gained infamy of late, with United Airlines’ recent scandal involving an incident in April in which a passenger was forcibly dragged off of a flight to make room for staff has sent shockwaves through the industry. Airline passengers who would otherwise not be given the spotlight to voice their grievances publicly against airlines are now speaking up, and issues concerning the operations of all airlines are now being discussed much more fervently than before.

Despite the raucous surrounding airlines and the changing consumer perception of the industry, Warren Buffett has noted that he believes the long-term outlook for airlines is such that the airlines will continue to cram as many people as possible onto given flights to improve upon the economics of the business.

He has also asserted that, as long as people are willing to pay for tickets, anything that improves the fundamentals of the business is something that he can’t disagree with.

Bottom Line

Warren Buffett is a prudent investor with decades of experience investing in other large oligopoly-style industries such as railroads, with similar economics to the airline industry.

If Mr. Buffett says jump, I ask “how high?”

As of this writing, Chris MacDonald did not hold a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, https://investorplace.com/2017/05/why-did-buffett-change-his-mind-on-airline-stocks/.

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