Date
6 December 2016
Warren  Buffett  has repeatedly mentioned the bitter lesson of investing in airlines and complained about the "kamikaze pricing tactics of certain carriers". Photo: Reuters
Warren Buffett has repeatedly mentioned the bitter lesson of investing in airlines and complained about the "kamikaze pricing tactics of certain carriers". Photo: Reuters

Why Buffett is changing his tune over US airlines

Billionaire investor Warren Buffett has stayed away from airline stocks for decades, saying that’s the worst business in the world and “a death trap for investors”.

However, he suddenly changed his mind.

In Berkshire Hathaway’s latest 13-F filing with the Securities and Exchange Commission, the company revealed that it spent US$1.7 billion to buy shares of American Airlines, Delta Airlines and United Continental Holdings Inc. during the third quarter.

Berkshire also hinted in an interview with CNBC that he also bought into Southwest Airlines in the fourth quarter.

Buffett is estimated to have built up a US$2.5 billion position in the top four US airlines which represent up to 70 percent of the US market share.

Buffett once said investors have poured money into airlines and airline manufacturers for 100 years with “terrible results”.

He had decried airline stocks since suffering heartburn on an investment he made in US Airways in 1989.

In 2003, he joked that he had set up a toll-free number to call advisers who would talk him down if he got the urge to buy airline stocks.

Buffett has traditionally detested airline stocks, famously saying in 2002 that if a capitalist had been present at Kitty Hawk in the early 1900s, “he should have shot Orville Wright”.

The airline business has very low marginal variable cost per seat but enormous fixed costs. For that reason, most airlines would try to fill their seats as much as possible. This common strategy often leads to price discounts.

Due to the huge investment involved, exiting an airline business even when it’s not profitable won’t be an easy option.

The industry is hence constantly plagued by frenetic competition. Oil price fluctuation and powerful labor unions add to the woes.

Buffett’s view stems from an airline investing experience in 1989 when he spent US$358 million to buy debt in US Airways. The airline was facing a hostile takeover then. But the share price never picked up and he lost three-fourths of his investment.

He repeatedly mentioned the bitter lesson in his annual letter to shareholders between 1989 and 1996 and complained about the “kamikaze pricing tactics of certain carriers,” and said “it’s impossible to be a lot smarter than your dumbest competitor”.

Why is Buffett changing his mind?

Currently holding between 1 percent and 4 percent of the four largest US airlines, perhaps he would amass more shares and then push for industry consolidation to reduce competition.

The emergence of new energy like shale gas may put a cap on fuel costs over the long run. That could also change the bad economics of the airline industry.

This article appeared in the Hong Kong Economic Journal on Nov.18

Translation by Julie Zhu

[Chinese version 中文版]

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RT/RA

Hong Kong Economic Journal columnist

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