Turbulence Hits Buffett's Airline Bets
Not what Warren Buffett wants to hear? Talk of ‘price’ competition coming from a full service major US airline in the shape of United Continental?
Will Buffett ask himself, have I made another mistake in going back into airline stocks?
The Sage of Omaha made headlines in 2016 when Berkshire Hathaway was revealed as buying billions of dollars worth of shares in America’s top four airlines - American, United, Delta and Southwest.
According to its latest SEC filing, as of September. 30, Berkshire had 47 million shares in American, worth $US2.23 billion; 53.1 million shares in Delta, worth $US2.56 billion; 28.2 million shares in United, worth $US1.72 billion, and 47.7 million shares in Southwest, worth $US2.67 billion.
Buffett move into airline stocks (he had been badky burned decades earlier) reversed years of opposition to investing in airlines in the past that he told shareholders in a 2007 note that “if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville (Wright) down.”
"I think there have been almost 100 airline bankruptcies. I mean, that is a lot," he said. “It’s been a disaster for capital,” he told CNBC last May.
Now he's of a different view, as he told CNBC in the same interview:
"It's true that the airlines had a bad 20th century. They're like the Chicago Cubs. And they got that bad century out of the way, I hope,” Buffett said Monday on CNBC. "The hope is they will keep orders in reasonable relationship to potential demand."
So what will he make of the return of fears of a new price war United Continental announced plans on Tuesday of this week to increase seat capacity and signalled its willingness to take on low-cost carriers on prices. The news carved billions of dollars off the market value of the big four - American, Delta, Southwest and United.
Shares in United slumped more than 10% to under $US70 amid concerns over the effect the moves would have on the company’s profit margins. Delta Air Lines shares lost 5.2% (its America’s biggest airline by market value), while shares in Southwest Airlines and American Airlines dropped 4.6% and 6% respectively. The selling got heavier as the session went on.
Up till Wednesday, United shares had risen 16% in the past three months - much of that vanished in the sell off and it is now underperforming the wider market (the S&P 500 is up almost 12% in the same time).
United said at on an investor call Tuesday night that it planned to increase the supply of seats by 4% to 6% over the next three years. It also surprised the market by saying it will try and compete with discount carriers on prices.
“(T)he best way to compete with a low-cost carrier is master prices,” said J. Scott Kirby, United’s president. “Half our revenue approximately comes from customers that are mostly shopping on price and we cannot ignore half of our revenue and we can’t let our low-cost carriers have price advantages in our hubs.
"And no one chooses to fly on an ultra-low-cost carrier if they can get the same price on United Airlines, nobody; at least if they know what they’re buying.”
“And so it’s entirely within our control whether they succeed or fail in our hubs.”
Wall Street analysts say that while good news for consumers, lower fares risk derailing the industry’s rediscovery of pricing power and full-service carriers like United will be the first to suffer and could end up being hit the hardest given that they face higher costs (than discounters) and have been raising wages for their staff in recent years.
Warren Buffett won’t be amused at all if that’s the case.
Glenn Dyer has been a finance journalist and TV producer for more than 40 years. He has worked at Maxwell Newton Publications, Queensland Newspapers, AAP, The Australian Financial Review, The Nine Network and Crikey.
At the AFR he was a finance writer, Finance Editor, News Editor and Chief of Staff. At the Nine Network he was supervising producer of Business Sunday for more than 16 years. He has also written for other online and analogue print publications here and overseas.