Why investors should not touch airline shares

Ben Kwok May 13, 2020 10:35

Is the Dragon going the way of the Dodo?

According to local media reports, Cathay Pacific Airways is planning to end the operation of Cathay Dragon and merge it with low-cost carrier Hong Kong Express, which it acquired last year. It will be called Cathay Express, the reports said.

The planned restructuring, which Cathay has not exactly denied, comes amid efforts by the airline industry to return to “business as usual” along with the rest of the global economy even while the coronavirus pandemic continues to rage in many parts of the world.

So why has Cathay decided to drop the Dragon, an enduring symbol of power and wealth in China?

Perhaps it has not been an auspicious brand for the regional airline, which focuses on short-haul flights to mainland cities and Japan.

The group adopted the Cathay Dragon brand in 2016, 10 years after it acquired Dragonair.

Following the rebranding, however, the group’s fortunes started to turn for the worse. It reported annual losses in 2016 and 2017, before returning to black in 2018 and 2019, despite the outbreak of social unrest in the latter part of last year.

But with COVID-19, which has cut international air traffic by up to 90 percent over the past few months, the Hong Kong-based airline is likely to report a huge loss this year.

Even without the pandemic, the airline business, one of the most highly regulated industries in the world, has been facing enormous challenges, one of the latest being the grounding of Boeing’s 737 MAX aircraft.

Tycoons from Virgin Group founder Richard Branson to stock guru Warren Buffett also got burned with their airline investments. Branson used to joke, “If you want to be a millionaire, start with a billion dollars and launch a new airline.”

Tycoons, of course, still have their private jets. But the business is no joke for many airline operators, which have suffered much despite the importance of aviation in the global economy.

Earlier this month, Buffett admitted to his fans that he was wrong – again – in investing in airlines.

“The airline business -- and I may be wrong and I hope I’m wrong -- but I think it’s changed in a very major way,” Buffett said. “The future is much less clear to me.”

So his Berkshire Hathaway sold all its shares in four major US airlines – Delta, Southwest, American Airlines and United Airlines – for about US$6 billion last month amid the pandemic. The combined stake was worth US$10 billion at the end of 2019.

Buffett is widely known as a genius in stock picking, but he got stuck with USAir in the late 1980s before he could cash out unscathed nine years later. He joked that he had become an “air-oholic” but still he returned to the airline industry in 2016.

Local tycoons are smarter. They enjoy traveling first class but they don’t invest in airlines. All the big property landlords, with the exception of Swire Group (which owns Cathay Pacific along with Air China), have little exposure to airlines – although Cheung Kong’s CK Asset Holdings and New World Development’s NWS Holdings are in the aircraft leasing business.

Airlines are a glamorous business, associated with charming stewardesses and exotic travels, things that people want to chat about with their friends. In my years in journalism, aviation stories have always flown high in terms of page views.

But the pandemic has only highlighted the troubles in the industry, which has seen load factors plunge to low, single-digit percentages amid the lockdowns and travel restrictions.

Even without the impact of COVID-19, airlines have to contend with labor and fuel costs, which make up most of its operating expenses. If trade unions, which usually threaten industrial action at the peak of the travel season, didn’t hurt airlines, high fuel costs would. That oil dropped to below zero last month didn’t provide much respite as most airlines remained grounded. Meanwhile, operators have to pay staff and maintain their parked aircraft.

Under such a dire environment, how could airlines survive?

Singapore Airlines, for one, had to turn to shareholders to raise US$10 billion via a rights issue in March when the share price dipped to a 22-year low.

On the bright side, the outbreak seems to be getting under control in China and other parts of the world, and people are looking forward to traveling again.

I remember that Cathay shares surged right after SARS was contained in the latter part of 2003.

But this time around, the return to normality may be a lot slower as nations continue to be wary of the resurgence of the outbreak in their communities once the borders are reopened.

And leisure travel may never be the same again after popular destinations such as France and Italy were hit hard by the pandemic. There’s also the fear that the virus may return in the winter.

All this should give investors pause before investing in aviation-related stocks again.

Buffett, still smart at 89, acknowledged his mistake and turned bearish on airlines. Perhaps this is not the time to be greedy when others are fearful.

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Ben Kwok

EJ Insight writer