Friday, February 3, 2017

Has Warren Buffett Lost His Mind? (asking for a friend) BRK

Some background after the jump.
Blame K. Shubber for the second half of the headline.

From Barron's Ahead of the Crowd column:

Buffett Betting Big That Airline Stocks Will Fly
In November, Warren Buffett loaded up on the sector but an overdone selloff offers a second chance to buy.
Warren Buffett gave investors a boarding call for airline stocks back in November. An overdone selloff in recent days offers a second chance. 

The Berkshire Hathaway (ticker: BRK.A) (BRK.B) chief was a longtime airline bear, complaining in shareholder letters about “kamikaze pricing” and repenting for a past investment in US Airways stock, even though it made money for Berkshire. In November, however, securities filings showed that Berkshire slashed its stake in Wal-Mart Stores (WMT) and added positions in American Airlines Group (AAL), Delta Air Lines (DAL) and United Continental Holdings (UAL). Buffett later told CNBC that Berkshire has also bought shares of Southwest Airlines (LUV).

That’s a sign the airline industry had finally addressed structural problems that Buffett called out for years. He has written that capital requirements are vast, that returns on that spending are low and that airlines have lacked a durable competitive advantage “since the days of the Wright Brothers.” In one letter, he lamented that there hadn’t been a far-sighted capitalist at Kitty Hawk to shoot Orville down. Presumably, he feels better about Orville’s accomplishment today. 

One reason, surely, is the collapse in the number of major U.S. air carriers from seven in 2000 to four in 2015, which Barron’s detailed in a cover story (“Airline Stocks Could Soar Up to 50%”). The global financial crisis spurred airlines to rework their union contracts, shore up pensions, bring down operating costs and add passenger fees for everything short of sneezing. A plunge in jet fuel’s price was a boon. Most important, airlines have suppressed the urge to blow out capacity now that profits are plump. That means they are likely to avert a price war, and keep capital spending under control.

Citigroup initiated coverage of American, Delta and Southwest with Buy ratings shortly after Buffett bought. Fuel and labor costs are creeping higher, it noted, but capacity growth is slowing, pricing is improving and revenue comparisons look easy. Investors aren’t fully convinced. Delta trades at a scant nine times 2017 earnings estimates, and American and United are only a little more expensive. Southwest qualifies as the darling of the bunch, at 14 times. 

Apart from Southwest, the others have sold off 6% to 8% since Jan. 11, noted JPMorgan analyst Jamie Baker in a Wednesday report....MORE
Here's what we wrote back in November:

What the Heck? "Warren Buffett is bullish on airline stocks" (BRK; AAL; DAL; UAL; LUV) 
First a bit of history to explain the headline.

In 1999 Mr. Buffett told Fortune magazine;
...Move on to failures of airlines. Here’s a list of 129 airlines that in the past 20 years filed for bankruptcy. Continental was smart enough to make that list twice. As of 1992, in fact--though the picture would have improved since then--the money that had been made since the dawn of aviation by all of this country’s airline companies was zero.

Absolutely zero.

I like to think that if I’d been at Kitty Hawk in 1903 when Orville Wright took off, I would have been farsighted enough, and public-spirited enough--I owed this to future capitalists--to shoot him down. I mean, Karl Marx couldn’t have done as much damage to capitalists as Orville did.
Mr. Buffett repeated the sentiment on the 2003 centenary of Orville's first flight.

Then in the 2007 Chairman's letter to the shareholders of Berkshire Hathaway he wrote (pp 8):
...Now let’s move to the gruesome. The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. Think airlines. Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers. Indeed, if a farsighted capitalist had been present at Kitty Hawk , he would have done his successors a huge favor by shooting Orville down. The airline industry’s demand for capital ever since that first flight has been insatiable. Investors have poured money into a bottomless pit, attracted by growth when they should have been repelled by it.

And I, to my shame, participated in this foolishness when I had Berkshire buy U.S. Air preferred stock in 1989. As the ink was drying on our check, the company went into a tailspin, and before long our preferred dividend was no longer being paid. But we then got very lucky. In one of the recurrent, but always misguided, bursts of optimism for airlines, we were actually able to sell our shares in 1998 for a hefty gain. In the decade following our sale, the company went bankrupt. Twice.

 To sum up, think of three types of “savings accounts.” The great one pays an extraordinarily high interest rate that will rise as the years pass. The good one pays an attractive rate of interest that will be earned also on deposits that are added. Finally, the gruesome account both pays an inadequate interest rate and requires you to keep adding money at those disappointing returns....
And now this...MORE 
Not that you can argue with the 2 1/2 month results. Here's the only pure-play airline ETF:

 7.7% since the Berkshire positions became public (mid-Nov. gap up), even after the stumble, beats working for a living.