Airline Industry and Buffett

[nickenumbers]

Genius Folks of CoBF,

 

What happened to make the airline industry something that made WEB, CM, Todd and Ted want to invest in it?  And they didn't just invest in 1 carrier, they invested across the industry in like 5 carriers.  [i know that this is someone old news, but I have been turning it over in my head.]

 

A determination was made by the 4 of them that this was now a strong industry with a moat deep and wide and stable enough that they wanted to go long in it.

 

I can make crap up myself as to what might have happened, but I am a 40+ yr old pup value investor.  I would like to sit at the feet of the wiser, smarter value investors with gray hair and a rocking chair that can give me thoughts and opinion on what changed.

 

Economics of the industry

Competitive environment

Cost Structure

Relative price and value

Regulation

Something else, or all of the above

 

Buffet talks and talks about why this industry is horrible for investors, and now they are long in a big way across multiple airline stocks.

 

School up the young punks on what is going on here??  Thanks in advance.

[OracleofCarolina]

https://moiglobal.com/phil-ordway-airlines/

 

This might help you out.

[rb]

As far as I understand Berkshire's thesis it's around capacity and competition.

 

What's happened is that there was a big round of mergers in the airline industry. After all of this consolidation these mega airlines cut a whole bunch of capacity. The big 4 control about 75% of capacity. This is quite similar to what happened with the railways and as we know that turned out to be very profitable.

 

The other side is competition. Historically any asshole with a pilot license and aviator glasses could get a plane and start an airline. Once they did that of course they went after the most profitable routes and made all the profit go away. But now the plane makers have HUGE backlogs and they're locked up by the big boys. So if pilot Dan wants a plane, that's a long, long time away. So this takes pretty good care of the possible competition.

 

All in all it's actually a really good thesis. But I still can't bring myself to invest. This industry has been so horrible for so long and there were so many "this time is different" and it turned out not to be that I'd rather pass on the profit than get involved with it.

[KJP]

I cannot find the link now, but there was a thoughtful analysis published several years ago suggesting that U.S. regulations regarding pilot training, hours, etc. give pilots tremendous bargaining power over the airlines.  As a result, all (or nearly all) economic profits of a airline would be siphoned off to pilots over time via increased pay as their collective bargaining agreements come up for renewal.  (This is similar to the theory that movie theaters will always be a tough business because their key suppliers, e.g., Disney, have too much bargaining power.)

 

If true, this would be something that would play out over many years, so wouldn't be immediately apparent during the early years of a change in the industry's competitive dynamics.  The theory may be wrong, but I offer it as something to consider.

 

[Cigarbutt]

Possibly, there is a coming paradigm shift that only a few can see and there may be pockets of opportunity but the paradigm shift, if it is to manifest itself, must include a scenario of low growth and low volatility of fuel costs and a departure from the historical competitive rivalry that has existed for, at least, the last 50 years.

 

Revenue growth and productivity gains have essentially been captured by different participants along the value chain (including the customer who complains about poor relative value...). For fun, just checked the price for a Montreal-Toronto ticket and what I could get today is, in nominal terms, comparable to what could be obtained decades ago. An argument can be made that service received is less and hidden fees have become the new normal but there is no question that the price/value proposition has tremendously improved, very much at the expense of the airline industry equity holders.

https://www.mckinsey.com/industries/travel-transport-and-logistics/our-insights/a-better-approach-to-airline-costs

 

When looking at the value chain and competitive landscape, the overriding conclusion that seems to remain is that the industry has been characterized by high cyclicality (both demand side and volatile input costs), high capital intensity and very high degree of competition based on a product which remains, essentially, a commodity. The labor issue that KJP mentions is discussed in the following document (page 24). I understand that it is a factor but would say that it is not the major one. Last time I looked, the proportion of crew costs over total costs per block-hour of operations was typically slightly less than 20%.

https://www.iata.org/whatwedo/Documents/economics/profitability-and-the-air-transport-value%20chain.pdf

 

In the above article, the conclusion seems to say that the value chain needs to be fixed and investors are expecting higher returns compared to historical trends but one doesn't spontaneously always get what he/she wants or needs.

 

Looking forward to opposing views and would look at specific opportunities but otherwise the airline industry will remain in no man's land.

[John Hjorth]

What's the perception among fellow board members with regard to the pollution footprint of this industry going forward? [The same issue with regard to shipping is already actively discussed here on CoBF in the SSW topic recently.]

[rb]

Well pollution is going to increase due to more flights.

 

But, the new generation of planes is more fuel efficient: ligter planes due to composite material use and more efficient engines. This will lower the emissions not by regulation but by circumstance. The existing airline flee is quite old and newer, more efficient planes, lower fuel costs. Once the airlines transition to the new generation of planes you have a jump to lower emissions. Then it stays there because the equipment has a 30 year life span.

 

So you have a positive factor and a negative factor. I'd say that the end result will be a decrease in emissions in the near term as airlines renew their fleets and then a steady increase in emissions as growth of the industry takes over. Then in the long term you end up with higher emissions as higher use overcomes technological improvement.

[John Hjorth]

Thanks for your post, rb,

 

I get what you say here. And I actually concur - in some way - with your reply. Actually, my question was not - far from - phrased with the precision intendended for my part. My question was actually addressed to the regulatory environment with regard to pollution [, however I failed miserably of making that a clear point of my post].

 

Isen't there a political risk here of regulatory matters & decisions deteriorating the value of productive assets [airplanes]?

[rb]

As far as I know there is no such regulatory items with airlines as with the shipping industry and there likely won't be.

 

Firstly there's no need. As carriers transition to the new generation of planes they would have improved their emissions. There's nothing more they can do past that point. Why would you regulate the impossible?

 

Secondly, the economics of the two industries are vastly different. Both want to cut costs. Airlines use aviation fuel. For them cutting costs means using less fuel and being as efficient as possible. So the economics incentivize lower emissions. Ships use bunker fuel which is really nasty stuff. Just switching to diesel would reduce emissions by a lot. But bunker is cheaper than diesel. So the economics of shipping incentivize higher emissions. That's why you see regulation in the case of shipping but not airlines. Because the airlines will do it on their own.

[John Hjorth]

rb,

 

I respectfully disagree. Please look up the SSW topic with regard to scrubbers on ships. It evolves - gradually - into "green transportation" becoming a competitive parameter/pitch.

 

Ships and airplanes are major pollution sinners. Political systems don't give a damn about the concept of "impossible". Please take a look at what happened in Germany post the Tepco accident with regard to nuclear power.

[Cigarbutt]

What's the perception among fellow board members with regard to the pollution footprint of this industry going forward? [The same issue with regard to shipping is already actively discussed here on CoBF in the SSW topic recently.]

Whether one agrees or not as an individual, is it not reasonable to expect increasing pressures to deal with perceived or true externalities?

 

Historically, efficiency gains have not been sufficient to reduce variables like CO2 emissions because of volume increases (trade and number of passengers).

 

Air transportation is so much less efficient (CO2 emission per tonne-kg) compared to maritime transport (10x less versus heavy truck and 30x less versus cargo) that IMO it makes it an obvious target for increased regulation and taxation. Right now, maritime transport accounts for 90% of volume of global trade and is associated with an about 3% share of CO2 emissions, which is only slightly more than for global air transportation.

 

Our world is changing and the rules of the game will be redefined. Here are two "visual" references that show how global movement has changed and where it is today.

https://www.shipmap.org/

https://www.theguardian.com/world/ng-interactive/2014/aviation-100-years

 

 

 

[Ismael]

In addition to consolidation, there is also more stable demand from credit card rewards programs.  There have also been innovations in more effective yield management and segmentation processes.  Additionally, these days the planes fly themselves so ideally, over time, society becomes comfortable with only one human pilot instead of two, but I don’t think this last piece is part of their thesis. 

[Cigarbutt]

In addition to consolidation, there is also more stable demand from credit card rewards programs.  There have also been innovations in more effective yield management and segmentation processes.  Additionally, these days the planes fly themselves so ideally, over time, society becomes comfortable with only one human pilot instead of two, but I don’t think this last piece is part of their thesis.

You make good points. Just want to add that technology can go both ways.

Have heard of this from the local media but it seems to be gaining traction.

It's called Hopper and will likely be included in my planning process.

https://www.hopper.com/research/bunny-saves-money/

https://www.forbes.com/sites/kathleenchaykowski/2018/04/10/the-vacation-predictor-how-the-fastest-growing-flight-booking-app-is-using-ai-to-transform-travel-hopper/#65069ec323bd

 

[Gamecock-YT]

It’s about them becoming cannibals. Munger made comment at one of the DJ meetings that if you read between the lines that’s what he was getting at.

 

But fully agree with KJP, unions are going after their share of the pie that they gave up during the bankruptcy period. Throw in a growing shortage of pilots avavilable and they are looking pretty now. (Of course the way the industry works is a few of the European LCC carries are going to bust soon which is going to have a lot of pilots back on the market ((not to mention all those aircraft on lease whose owners seem to be the darlings of Wall Street))

[Gamecock-YT]

Wasn't sure where to post this but settled for a general airline industry thread...

 

United Airlines just finished the first displacement bid for their pilots. Approximately 4,500 pilots will be displaced from where they are currently flying (Hub and aircraft) to another seat. Roughly that means that they will be furloughing ~4,500-4,000 more junior pilots who won't be able to hold a seat when the employment lock up expires on October 1st.

 

Just the first shoe to drop, it's going to be ugly and kind of like what WB said yesterday it has ramifications for the entire aviation/travel industry. 

 

 

[mattee2264]

 

I am curious to what extent price increases can offset to some extent the decline in passenger volumes. If the industry has become more rational it makes sense to charge very high prices to take advantage of the fact that it is mostly going to be essential travel taking place over the next few years.

[Spekulatius]

 

I am curious to what extent price increases can offset to some extent the decline in passenger volumes. If the industry has become more rational it makes sense to charge very high prices to take advantage of the fact that it is mostly going to be essential travel taking place over the next few years.

 

I am not sure that increasing prices at a time of lower demand is going to work. If that were to happen, I bet someone takes advantage of the combination of surplus cheap planes cheap capital and furloughed pilots and starts a new airline unencumbered by legacy issues.

 

The industry being rational depends on capacity restraints , lack of new entrants and lack of competition. Also, how much business travel is really essential and cannot be done by other means? Business travel is one of the first things to get cut when the economy is slowing down or goes into a revision. Now ad rising prices to this and the incentive to save costs becomes even larger.

 

I think the real essential travel will go on Netjets and private business jets, as you can avoid crowded airports and planes

[rb]

To add to what Spek said above. The industry didn't actually become more rational. They started better pricing because of lower supply (capacity). So natural market forces at work. Now you get a big comeback in supply. It's a commodity service. Market forces at work again. Prices will drop. They may even stop stressing you about your bag.

[bizaro86]

Furloughing the most junior pilots will also increase their costs, since the senior pilots make way more money. So they're cutting their lowest cost labor.

 

I actually think a big part of the demand that will remain will be price sensitive leisure travellers attracted by good deals. There is a big cohort of young people who dont think they're at risk, and will travel. But that is a very price sensitive demographic.

[SharperDingaan]

The industry really needs to be thought of, in terms of different holding horizons.

Short (0-2 yr), medium (3-6yr), long terms (7yr+)

 

Long term, it's hard to see why we do NOT have more passenger 'flag' carriers, and freight 'flag' carriers. Oligarchs, with one of the players being the state. Specialist niches (bush pilots, off-shore rig servicing, etc.) with combined military/private overlap. Stable, robust, net benefit to all, and the size/number of 'survivors' market determined.

 

Short term. Industry collapse, lots of BK's, lots of job loss.

China is still down 50-60% post Covid-19, 80% during Covid-19. A country where the distances between cities, and the state of the inter-city infra-structure, pretty much requires that you fly. Not the same thing in many other parts of the world, where you can travel by high-speed train instead. https://www.flightradar24.com/blog/air-traffic-at-chinas-busiest-airports-down-80-since-the-beginning-of-the-year/

 

To bring operating leverage back to 'normal', at least 50% of the industry has to go. To bring financial leverage back to 'normal', will require dilution of at least 25%+. The smart thing is to just sell, and let the market do its thing. Buy back on better terms, once the BK's/restructurings have worked their way through.

 

Precisely as WEB has just done.

 

SD

 

 

[physdude]

China actually has by far the biggest high speed rail network in the world (bigger than Europe and Japan combined). I am not sure why you think they don't have more travel options than air. That doesn't detract from your point of the severe effect of covid 19.

[SharperDingaan]

Was thinking more the distances between major centres.

Much past 550 km (3.5 hours by train @ 160 km/hr), most business people will fly. Wuhan to Shanghai (700km) by train is about 6 hrs, and 4 hrs by air. To get there and back in one day, and do your business - you have to fly. It's only when you can stay a few days, and meet with other clients, that train becomes preferable.

 

Bit different if you can travel via bullet train. Wuhan to Hong Kong (900km) is only 4.5 hours. You can be in HK by lunch, do your meetings in the afternoon, take a client to dinner, and be back by lunch next day. But if you fly - it's just 1.5 hrs one-way, and you can get some sleep in as well - hence still the preference to fly.

 

https://www.travelmath.com/flying-time/from/Wuhan,+China/to/Hong+Kong

 

SD

[Spekulatius]

Was thinking more the distances between major centres.

Much past 550 km (3.5 hours by train @ 160 km/hr), most business people will fly. Wuhan to Shanghai (700km) by train is about 6 hrs, and 4 hrs by air. To get there and back in one day, and do your business - you have to fly. It's only when you can stay a few days, and meet with other clients, that train becomes preferable.

 

Bit different if you can travel via bullet train. Wuhan to Hong Kong (900km) is only 4.5 hours. You can be in HK by lunch, do your meetings in the afternoon, take a client to dinner, and be back by lunch next day. But if you fly - it's just 1.5 hrs one-way, and you can get some sleep in as well - hence still the preference to fly.

 

https://www.travelmath.com/flying-time/from/Wuhan,+China/to/Hong+Kong

 

SD

 

China has high speed trains. I have a pic with me on a Chinese maglev train going 431km/h. With such a speed and counting boarding etc, you are better off going 1200km in a train rather than an airplane if you have a direct train connection.

 

The German ICE trains go 250 km/h. Those are good for 700km and they covers most of Germany. The US still needs air travel for coast to coast, but you could connect the East coast  north East with trains, if you could create a high speed rail network.

[physdude]

Wuhan to Shanghai is about 4h by most of the high speed trains. https://www.travelchinaguide.com/china-trains/shanghai-wuhan.htm . With the extra time taken for check in and security and the travel time to the airport, I am not so sure that the planes save too much time for intermediate distance journeys. But the high speed train tickets in China are also not too cheap.

[SharperDingaan]

The time estimate came from this link https://www.rome2rio.com/s/Wuhan/Shanghai

Agreed, the Wuhan to Shanghai bullet train is 4-6.5 hrs, dependent upon the train. https://www.travelchinaguide.com/china-trains/high-speed/wuhan-shanghai.htm

 

It's great to have the trains for shorter distances; but once the distances start getting up there - its better to fly.

Everything is closer in Europe, and rail is more time competitive. A lot of people also see it as 'safer' in today's time of Covid-19.

Hard to see a eurocentric airline recovering particularly strongly.

 

SD