At Warren Buffett’s annual shareholder gathering on May 2, which took place via video conferencing rather than as a shoulder rubbing of the faithful, he confessed to being “wrong to invest in the airline industry”.
His investment vehicle, Berkshire Hathaway, had sold its entire stock of airline shares, worth more than four billion US dollars in April ‒ the time of divestment. This included 10 per cent of American Airlines, 11 per cent of Delta, 10 per cent of Southwest and nine per cent of United Airlines. He justified this radical step with having doubts about the growth prospects of the business.
Many of Buffett’s critics saw this as yet another sign that the old man, by any account the world’s most successful investor, has lost his golden touch. With hindsight, many of Berkshire’s investments are not quite fit for America post-Corona. Stakes in banks, oil companies, railways and ageing consumer brands like Kraft look now increasingly unsuitable for a fragile future, a future burdened with hesitant consumption, trade conflict, environmental degradation and an insurmountable load of debt.
Cautious for too long towards e-commerce and the tech industry, Berkshire’s shares have underperformed the S&P stock index for quite a while now. In the first three months of 2020 its investment losses accumulated to $50 billion.
Financial pundits calculated gleefully that if Buffett had sold his airline shares just a month later, he could have cut his exit losses by $2.7 billion. They also criticise Berkshire’s ever growing cash pile, which now amounts to almost $140 billion. What good may come out of such vast reserves if they cannot be put to profitable use in new investments? From its nadir in March to a recent peak in June the American stock market has gained almost 50 per cent. How is it possible that the ‘Sage of Oklahoma’ was all the while sitting put on his towering cash stack doing nothing?
I’d like to argue that the pundits are wrong, and Buffet is right. While it is ‘difficult to predict, especially the future’, investment decisions necessitate permanent judgements on things to come. This can only happen in a rational way when based on all known or knowable facts. The eventual outcome of such judgements can never disprove or justify a decision: hindsight makes us never right or wrong, only the misreading of information available at the time does.
In 2016, the year Buffett invested in excess of $8 billion in airlines it looked as if growth was for once unstoppable. Trade was growing, tourism was growing, GDP was growing. And the airline industry seemed to have learned from past mistakes.
For all my life as a retail investor I had shunned airlines... Too many balls had to be juggled
For all my life as a retail investor I had shunned airlines. For this business to yield reliable returns over a long-term investment horizon too many balls had to be juggled, with profit margins being notoriously thin.
Take fuel costs for instance. A third of operational expenses go into aviation fuel. If prices go up, losses quickly accumulate. Hedging, or fixing the price for a financial year, is a mixed blessing. When fuel prices come down, hedging costs amount quickly to the same losses one wished to avoid. ‘Unhedged’ competitors will have a field day.
New airlines, managed well, will have an almost insurmountable competitive advantage over ‘legacy’ airlines, which still pay their staff salaries reminiscent of a time when travel was an expensive luxury. And traditional airlines are burdened with pension obligations that start-ups do not have, supporting legions of retirees. Trade unions too will do their best to preserve the status quo, which is ruinous.
Competition is inexorable and business cycles destructive. When business seems to go well, new planes are ordered, which tend to flood the market exactly at the next downturn. Price wars are burdensome and the marketing of new routes is costly, with planes having to fly half full or even empty.
For years it seemed that only budget airlines like Southwest or Ryanair were capable to create new markets, to manage their business rigorously and to fool their customers with complete price obfuscation.
But then came the end of the Great Recession and the sun seemed to shine on most airlines. Low-cost ideas were emulated and overheads trimmed. The shale oil revolution seemed to guarantee that achy fuel price hikes were a thing of the past. When Buffett invested in 2016, things went so well that pilots became deficit labour.
Then came COVID-19. All the planes on earth were grounded. Air traffic was suspended entirely. When it dawned upon even the most optimistic stock market bulls that the party was over, stocks nosedived. Airlines lost three-quarters of their market capitalisation. American Airlines had more debt than assets. To avoid default, most companies agreed with their creditors on fictional balance statements.
Buffett did not panic. Yet he rightly had to assume that the world will not return to the year 2019 any time soon. He waited for a rebound and then sold. Airlines would be terribly indebted, passenger numbers would not recover for years to come and the virus would pause, linger and then rise again. A fear of flying would remain.
The question was not which airlines would regain satisfactory profitability, but which would survive, crippled by excessive loans and suffering from stringent terms of governmental rescue programmes. Environmental concerns too were raised by governments giving a helping hand.
What Buffet did not account for, and never will, was the sentiment-driven recovery of stock markets against better knowledge. Central bank largesse and federal stimuli were lifting markets beyond reason.
Mid-May I decided to invest in Easyjet. I knew that there was a dearth of reliable data, no way to foretell the future, and almost certainty that it will be grim. Shares had lost 73 per cent of their value. Under the assumption that business might be back to half of where it was, and with credit costs tending towards zero, the stock was clearly undervalued. I paid £4.80 per share in mid-May to see it gaining 50 per cent within two weeks. This was so shocking I decided to sell immediately. It was an astounding, unexpected success.
Yet I still believe Buffett was right. I think he deserves unbridled admiration, because nothing is harder for investors than to cut their losses. We all tend to shy from selling until it is too late. While I write this, Easyjet has already dropped 20 per cent below my selling price. I was lucky, not clairvoyant.
The purpose of this column is to broaden readers’ general financial knowledge and it should not be interpreted as presenting investment advice or advice on the buying and selling of financial products.
andreas.weitzer@timesofmalta.com
Andreas Weitzer, independent journalist based in Malta