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Railroads vs Airlines comparison


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Most airline analyst who are bullish in the airline industry starts to compare them with railroads. What do you guys think? There are currently 4 big players in this industry which is very different than years ago. I know Buffett says to stay away from this industry. I think he also used to dislike railroads and their unions. I think it was Munger who convinced him to take another look at railroads.

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that's fair. smaller amount of players could have a positive impact on the industry. On the otherhand, the number of non-american airlines flying into the states is alot higher now so that's something that is difficult to account for and how that translates into profitability over time. global competition seems fairly high.

 

I'm not sure if i remember this correctly but there are some bad incentives for most airlines when selling tickets. Once they sell xx number of tickets to cover the costs of a flight, employees and other costs the remaining seats are often sold at cheaper prices which leads to poor returns on capital. as the main target was focusing on covering the fixed costs not overall profitability.

 

 

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If you want to start a new airline, you basically just need to lease a plane (read Virgin story in Dhando Investor). It is essentially impossible to build a new railroad.

 

This is true but the big airports have limits on how many planes come in and out at anytime (Let's say every plane arrives in 5 min intervals or leaves in 5 min intervals. So there is a limit of 288 airplanes leaving or arriving within 24 hours period). Airports will have to either expand or there will not be enough capacity.

 

Usually these bigger airports are contracted to the big four airlines for a really long time. Railroads owns them where as airlines do not and these routes are controlled by the airports (government).

 

This is a live flight status tracker http://planefinder.net/.

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If you want to start a new airline, you basically just need to lease a plane (read Virgin story in Dhando Investor). It is essentially impossible to build a new railroad.

 

This is true but the big airports have limits on how many planes come in and out at anytime (Let's say every plane arrives in 5 min intervals or leaves in 5 min intervals. So there is a limit of 288 airplanes leaving or arriving within 24 hours period). Airports will have to either expand or there will not be enough capacity.

 

Usually these bigger airports are contracted to the big four airlines for a really long time. Railroads owns them where as airlines do not and these routes are controlled by the airports (government).

 

This is a live flight status tracker http://planefinder.net/.

 

You could also fly into nearby cities.  This is a tried and true strategy for startup cheap airlines (Spirit).  In Pittsburgh Spirit flies into Latrobe, a regional airport.  I remember reading in an article that Latrobe's traffic went from 50k passengers a year to over 250k passengers a year due to Spirit.  Parking is free and for most of the Pittsburgh metro travel time to Latrobe is maybe 30m longer at most compared to Pittsburgh International.

 

I remember a few years ago some airline flew into White Plains rather than NYC to save on gate fees.  If a ticket costs $400 round trip to JFK or $175 into White Plains is that extra train trip from White Plains into Manhattan that bad?

 

As a consumer I hope airlines never become like railroads.  What we need in the US is more airlines, not less. 

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Railroad

Capex - Mostly proprietary, track maintenance, intermodal station, etc.  Locomotives and rail cars can be shared, but not the dominating part of Capex.

Cost per weight transported - steel wheel on steel track, physics dictates its lowest cost status.  But also slow.  Best for transporting heavy weight per volume commodities, coal, grain, chemical tanks, petroleum tanks.

Regulation - The original monopolists since the Vanderbilt days.  Industry has basically been prime target # 1 of government antitrust regulation through most of the 20th century.  Together with the build out of the highway system and passenger air transport, the industry was brought to its knees, culmunating in the bankruptcy of Penn Central in the 70's.  Regulation has mostly been enlightened since the 90's.

Employee - Relatively low employee count per weight transported.  Unionized, but has mostly been quiet since the industry fortune turned in the 90's.

Operating Leverage - Relatively high, but it's not costless to pull an incremental load.

Financial Leverage - For all to see in public financial filings.

Public subsidy - Original land grants, rights of way, long since dissappeared from public's consciousness.

 

Airline

Capex - Can be shared across industry, therefore industry can easily get to a state of overcapacity. The most valuable part of the capex - landing slots, which is proprietary.

Cost per weight trasnported - high, but also very fast.  Best for transport of high value items - human beings, Fedex packages

Employee - large employee count per weight transported, dealing with different unions.

Operating Leverage - Extremely high, almost costless to fill an empty seat.

Financial Leverage - Hidden, lots of planes are leased, don't show up on airline balance sheets.

Public subsidy - Air traffic controller, build out of all the airports on public dollars.

Regulation - Mostly been focused on employee relations.

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Isn't that an advantage then for the large players? Since smaller players likely dont have that kind of leverage.

 

Yes. This is part of the argument why "this time is different" for airlines. Oligopoly in US.

 

It is unclear how much Alaska, Southwest, Virgin, Spirit can screw up the big 3... Also will international carriers try to get intra-US routes.

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The biggest slice of airline revenue comes from business customers. Most of them have to fly to get to places quickly. Usually they have negotiated contract with the airlines so again the bigger player wins.

 

It looks like they just found another source of revenue http://www.latimes.com/business/la-fi-southwest-airline-trims-rewards-20150213-story.html by slicing the same pie differently.

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Yes. This is part of the argument why "this time is different" for airlines. Oligopoly in US.

 

Canada has a duopoly. Air Canada still managed to lose money four years in a row just barely avoiding its second bankruptcy in less than 10 years.

 

Even if the airlines remain rational (doubtful), fend off Low Cost airlines, and remain profitable, the unions will reassert their power. This remains a terrible industry with very strong cyclical tailwinds. Westjet is 5% of my portfolio but I put no faith in the "this time is different" mantra.

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Yes. This is part of the argument why "this time is different" for airlines. Oligopoly in US.

 

Canada has a duopoly. Air Canada still managed to lose money four years in a row just barely avoiding its second bankruptcy in less than 10 years.

 

Even if the airlines remain rational (doubtful), fend off Low Cost airlines, and remain profitable, the unions will reassert their power. This remains a terrible industry with very strong cyclical tailwinds. Westjet is 5% of my portfolio but I put no faith in the "this time is different" mantra.

 

Why is airline so hard for investors? Is it because of the high capex intensity and Union? Why does railroad not have this problem now?

 

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Why is airline so hard for investors? Is it because of the high capex intensity and Union? Why does railroad not have this problem now?

 

Very high operating leverage + high implied financial leverage creates problem in an economic down turn.  The indispensibie nature of its service makes its pricing very much subject to public scrutiny, which prevents it from making sufficient money in an up cycle to potentially compensate for the inevitable downturn.  Can you imagine the public outcry if airlines were to optimize revenue by cutting services while simultaneously raising prices?  Dealing with several different unions exacerbate the situation, and just makes it difficult all around.

 

Railroads, back when it's the dominant form of passenger travel, was subject to heavy antitrust scrutiny, they were the original mopolists.  The government used to set rates for different classes of cargo, and regulated it much harsher than utilities are today.  Today, there are actually some complaints about rail pricing as well, but it doesn't enter the public consciousness.  And the raw economics of the underlying mode of transport is able to come through the accounting statements. 

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Richard Branson: The surest way to become a millionaire is for a billionaire to start an airline.

 

Defying gravity is expensive it appears

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First, I'm a huge fan of InvestorAnthology.com's work (not sure if he's on this site)! It's too bad that in the investment world, the one with the most ideas and speaks the loudest often is considered the best regardless of actual results. IA.com writes very infrequently because his selection criteria is so high. At the same time, when he writes, you should make time to read it! In general, the best investors generally trade infrequently and have very few new ideas.

 

Anyways, here's a post of his explaining the airline industry that I think is pretty accurate description. I was going to try to write my own but why bother when he did such a great job.

 

http://investorsanthology.blogspot.com/2011/12/fundamentals-of-value-creation-part-ii.html

 

 

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First, I'm a huge fan of InvestorAnthology.com's work (not sure if he's on this site)! It's too bad that in the investment world, the one with the most ideas and speaks the loudest often is considered the best regardless of actual results. IA.com writes very infrequently because his selection criteria is so high. At the same time, when he writes, you should make time to read it! In general, the best investors generally trade infrequently and have very few new ideas.

 

Anyways, here's a post of his explaining the airline industry that I think is pretty accurate description. I was going to try to write my own but why bother when he did such a great job.

 

http://investorsanthology.blogspot.com/2011/12/fundamentals-of-value-creation-part-ii.html

 

Well the author seems to be fitting negative arguments into each aspect of michael porters model. I am not saying I don't agree with the author. But it just seems so much simpler than the article. The article says there are 30 new airlines a year. That's the crux of the issue. All these new entrants put pressure on returns. Basically, airlines are very easy to start because the capex is portable. All you need is to find some used airplane and fly it to your base airport. Get a few gates and viola you have a business. In brick and mortar businesses you cannot move your capex as easily.

 

That's always been my explanation for the airline business.

 

 

 

 

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First, I'm a huge fan of InvestorAnthology.com's work (not sure if he's on this site)! It's too bad that in the investment world, the one with the most ideas and speaks the loudest often is considered the best regardless of actual results. IA.com writes very infrequently because his selection criteria is so high. At the same time, when he writes, you should make time to read it! In general, the best investors generally trade infrequently and have very few new ideas.

 

Anyways, here's a post of his explaining the airline industry that I think is pretty accurate description. I was going to try to write my own but why bother when he did such a great job.

 

http://investorsanthology.blogspot.com/2011/12/fundamentals-of-value-creation-part-ii.html

 

Well the author seems to be fitting negative arguments into each aspect of michael porters model. I am not saying I don't agree with the author. But it just seems so much simpler than the article. The article says there are 30 new airlines a year. That's the crux of the issue. All these new entrants put pressure on returns. Basically, airlines are very easy to start because the capex is portable. All you need is to find some used airplane and fly it to your base airport. Get a few gates and viola you have a business. In brick and mortar businesses you cannot move your capex as easily.

 

That's always been my explanation for the airline business.

 

Always stay away from businesses where costs[/mile] are lowest on the first day!

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Railroad companies are currently trading at their highest forward valuation, measured by ev/sales in 4 decades, while EBITDA margins are at all time high. On the other hand, US legacy carriers are in the long run a poor business, but are still in the mids of a capacity restraint renaissance that has lead to improved pricing power. Yet, those stocks are trading at attractive levels and most analyst estimates haven't factored in the decline in kerosine prices.

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