- The recent F13 filing with the SEC reveals that Berkshire has made investments in several airline companies.
- Warren Buffett had called his earlier investment in the airline industry a "mistake".
- This is not the first time Berkshire has made an un-Buffett like investment.
Ever since Warren Buffett has brought in Tedd Combs and Todd Weschler, investors were looking for signs of change, if any, in Berkshire's approach to investing. And after a few years' wait, the signs of change are appearing. In last few months, Berkshire has made a couple of investments which took the market by surprise. The first one was the investment in the technology giant Apple (NSDQ:AAPL) back in May and the latest one is his investment in multiple airline companies.
Time To Fly?
In an SEC filing on November 14th, Berkshire disclosed that it had made investments in three airline companies. At the time of filing, Berkshire owned 21.8 million American Airlines (NSDQ:AAL) shares worth $797 million, 6.3 million Delta Air (NYSE:DAL) shares worth $249.3 million, and 4.5 million United Continental (NYSE:UAL) shares worth $237.8 million. Separately CNBC, citing Buffett, reported that Berkshire has also made an investment in Southwest Airlines (NYSE:LUV) after Sept. 30. While it is not clear who made this investment decision, many expect it to be one of his deputies as Buffett generally concerns himself only with large positions. The position's in the airline companies are relatively small. And after all, it was one of the two who decided on behalf of Berkshire Hathaway to acquire Precision Castparts (NYSE:PCP), the equipment manufacturer for the aircraft and energy industries, for $37.2 Bn.
The latest revelations come as a surprise, as Warren Buffett has famously refused to invest in airline companies stating that no one makes money in them. To be sure, this is not the first time Berkshire has invested in the airline business. Warren Buffett had his first brush with airline industry way back in 1989, when Berkshire had bought $358 million preferred stock of USAir, but he quickly regretted that investment. That investment had remained in red for years.
In 1997, he told Berkshire shareholders that he had misjudged how USAir would "increasingly feel the effects of an unregulated, fiercely-competitive market whereas its cost structure was a holdover from the days when regulation protected profits." But Mr. Buffett later admitted that he had sold the USAir investment for a "hefty gain". In spite of this gain, he remained critical of this industry. In a 2008 letter to shareholders, he wrote "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,". He further added:
"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."
Investment Driven By Value
After bleeding for decades, the airline industry is finally showing some profits. The change in fortune is largely driven by a crash in oil prices, which form a major part of an airline's operating expenses. The declining oil prices have not only contributed to improving margins but have also allowed the airline companies to cut fares, which increased the already growing demand. Air fares are likely to fall 7% this year. Airlines have never had it this good. According to a Guardian article, airlines world over are likely to see a 16% YoY growth in profits this year. To quote Tony Tyler director of International Air Traffic Agency:
“Load factors are at record levels. New value streams are increasing ancillary revenues. And joint ventures and other forms of cooperation are improving efficiency and increasing consumer choice while fostering robust competition,”
The improving revenue and profits have made the airlines attractive. American Airlines is trading at a trailing PE of 4.6 and forward PE of 10.2, United is trading at trailing PE of 8.3 and forward PE of 10.8, Delta is trading at a trailing PE of 7.6 and Southwest was trading at a forward PE of 12.3. In comparison, Dow Transportation Index is trading at 15.17 times its forward earnings. Also, the airlines are likely to continue their strong performance as oil prices will likely remain subdued in the near future, while demand remains strong. The competition in the airline industry has also abated somewhat, after a spate of bankruptcy filings over the last few years. This should give some pricing power to the airlines. However, risks persist. A revival in oil prices can send the airlines back in the red. And, as Warren Buffett has once noted, a year of loss in the airline industry can wipe out decades of profits. (Also Read: Will Berkshire Hathaway Stock Remain A Buy After Warren Buffett)
Changing Times At Berkshire Hathaway
The recent investments by Berkshire shows the increased role of Comb and Weschler in Berkshire's decision making. Warren Buffett has shown increased confidence in their investing abilities. In a letter to shareholders, Buffett had said that "you can rest easy when they take over". It was Combs who had made the first move while investing in Precision Castparts, which Berkshire acquired for $37.2 Billion this year. The investment in the airline industry appears to be largely driven by lower PE multiples and improving future prospects. The same was the case for Berkshire's investment in Apple. These recent investments indicate that the deputies are willing to invest in industries which were previously a "taboo" for Berkshire. But the core principle of value remains. As such there is no reason for Berkshire investors to worry.