Airline Industry and Buffett

[gary17]

high speed rail (300km plus) will be better

even at 200.  3h is easier on train

flying may be 45min

but add arrive at airport 1.5h before

and hassle of security

forget it

now many more travels will be substituted  by virtual

[adhital]

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

 

It’s getting better

[Broeb22]

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

 

It's pretty damning of the business model as a whole that every time some "unforeseeable" catastrophe occurs that airlines go belly up very quickly (w/o government support). In the past, there was a somewhat legitimate argument that airlines were under-pricing their services due to an overcompetitive market structure. Now, the industry is very consolidated and most would argue that pricing has not been too aggressive because airlines have been making gangbuster profits for years. Still, something "unforeseeable" comes along and the industry takes a nosedive.

 

Admittedly, coronavirus has been a very extreme stress test, but I believe that a more minor event that dropped passenger traffic would still be crippling to the current set of competitors.

 

Its surprising that Buffett would buy into a business with extreme operating leverage and significant financial leverage.

 

If we're going to bail out corporate America every time something bad happens, then perhaps we need to institute stress tests for each industry that force them to hold certain amounts of capital. As a taxpayer, I have a big problem with the degree to which we are bailing out corporations (and their executives). I would rather "tax" corporate returns on capital and minimize the risk of this kind of mass bailout than socialize the risk that was knowingly borne by shareholders and their managements.

 

 

[Guest cherzeca]

"If we're going to bail out corporate America every time something bad happens, then perhaps we need to institute stress tests for each industry that force them to hold certain amounts of capital."

 

I agree that American industry is generally overleveraged.  if we eliminated the tax deduction for interest (and gave on for dividends) then you would see much more resilient industries imo.

 

however, this nationwide shutdown is not just "something bad happening".  this couldn't be planned for.  but I agree if there was less leverage there would likely be better performance under stress.

[rb]

Companies didn't lever up in order to take advantage of the tax shield on interest. Companies levered up to do buybacks in order to drive up stock prices to increase compensation on their options. Kinda how the executive pension plan is almost always fully funded but the employee pension plan is almost always underfunded.

 

If you look over to continental Europe leverage levels are significantly lower. Almost no buyback activity. Why? Option based compensation isn't really a thing.

 

So tinkering with the interest tax shield will achieve absolutely zero.

[Guest cherzeca]

Companies didn't lever up in order to take advantage of the tax shield on interest. Companies levered up to do buybacks in order to drive up stock prices to increase compensation on their options. Kinda how the executive pension plan is almost always fully funded but the employee pension plan is almost always underfunded.

 

If you look over to continental Europe leverage levels are significantly lower. Almost no buyback activity. Why? Option based compensation isn't really a thing.

 

So tinkering with the interest tax shield will achieve absolutely zero.

 

if you increase the cost of levering up (by eliminating tax deduction), you will see less of it.  munger 101. 

[rb]

Companies didn't lever up in order to take advantage of the tax shield on interest. Companies levered up to do buybacks in order to drive up stock prices to increase compensation on their options. Kinda how the executive pension plan is almost always fully funded but the employee pension plan is almost always underfunded.

 

If you look over to continental Europe leverage levels are significantly lower. Almost no buyback activity. Why? Option based compensation isn't really a thing.

 

So tinkering with the interest tax shield will achieve absolutely zero.

 

if you increase the cost of levering up (by eliminating tax deduction), you will see less of it.  munger 101.

Sure incentives 101. Problem is that you have a much bigger incentive at play: Executive Compensation which towers over the interest tax shield. It's like when the elephant meets the cricket.

[SharperDingaan]

Just make the tax zero on a medium-term holding of 5-10 yrs.

Keeps the greed and gaming of agency, but forces the executive to play the long game - consistent with the long lives of their planes/leases. Can't get paid unless the company survives both your strat plan, AND that of the guy after you.

 

SD

[Broeb22]

"If we're going to bail out corporate America every time something bad happens, then perhaps we need to institute stress tests for each industry that force them to hold certain amounts of capital."

 

I agree that American industry is generally overleveraged.  if we eliminated the tax deduction for interest (and gave on for dividends) then you would see much more resilient industries imo.

 

however, this nationwide shutdown is not just "something bad happening".  this couldn't be planned for.  but I agree if there was less leverage there would likely be better performance under stress.

 

The same could be said for 9/11. The same will likely be said about some other "unforeseeable" event that occurs every 10-20 years and results in airline equity values being impaired when people stop flying for some reason. The point is that when you have billions in debt, aircraft leases, and unfunded pension liabilities, you are financially levering up an operationally leveraged business. It should be a surprise to no one that results have been so horrible. If they were net cash would results have been significantly different in this instance? Probably not. Most businesses won't do well when their customers decline by 80-90% within 1 month. But at this point, that is kind of a feature of the airline industry.

 

Would you say the same thing about an insurance company that got surprised by a once in a generation hurricane or earthquake? Whoops we didn't know this could all come crashing down for everyone at the same time. Please bail us out. Maybe airlines need to be required to have some kind of capital buffer since when airlines struggle, it tends to happen to everyone at the same time.

 

I'm not sure the right answer, but as a taxpayer I am not really excited about us bailing out most of an entire industry that knew it had operational leverage. If anything, at least having to keep capital caps some of the upside for the shareholders of these businesses that are now asking the American taxpayer to cap the downside.

[rb]

Broeb, you're missing one point. It's not actually the airlines you're bailing out. It's the airlines' bondholders.

[Broeb22]

Broeb, you're missing one point. It's not actually the airlines you're bailing out. It's the airlines' bondholders.

 

Can you elaborate on why that distinction is important?

[LC]

Bailout out the airlines without forcing them to change is essentially a transfer of wealth from the many (taxpayers) to the few (airline bondholders).

 

Airlines will exist either way.

 

In one case, we have subsidized profits to bondholders who are continuously bailed out and never have to change their behavior (by forcing the airline to hold more capital, pay higher rates, etc.)

 

In the other case (which I suspect will not happen) the government either lets them fail, or saves them and forces capital regulations, as they did the banks/mortgage insurers they bailed-out in 2009.

[Guest cherzeca]

if I am not mistaken, the airlines and treasury are still in negotiations, correct.  there is no certainty yet what the govt will do...

[rb]

Broeb, you're missing one point. It's not actually the airlines you're bailing out. It's the airlines' bondholders.

 

Can you elaborate on why that distinction is important?

I think LC covered it pretty well. But what you are essentially doing is socializing losses. The bondholder got paid to take on some risk that's why it got paid interest. How is it ok  that because the bondholder didn't handicap its risks well now the taxpayer has to pick up the tab? In what way is that equitable?

 

I don't want to really dive into politics. But you just know that once this is done and behind us we'll get back to cutting medicare and social security because we can't afford it. So basically grandma ends up subsidizing bond investors.

 

This can be said about most cases of bailouts but it's specifically acute to airlines because these companies always find a way to get themselves into trouble. So as an airline bondholder you really should be thinking about all kinds of risks when you were buying those bonds. It just happened that it's this risk that showed up instead of another.

 

The other thing is that the US has bankruptcy laws. AND they work very well. Airlines in particular are very familiar with the process. So why not let the market take its course. As LC pointed out, air travel will still be there. The planes won't vanish, pilots won't perish, etc. What would change is the owners of the capital structure. So the only reason we have an airline bailout is to socialize bondholder losses.

[Broeb22]

Broeb, you're missing one point. It's not actually the airlines you're bailing out. It's the airlines' bondholders.

 

Can you elaborate on why that distinction is important?

I think LC covered it pretty well. But what you are essentially doing is socializing losses. The bondholder got paid to take on some risk that's why it got paid interest. How is it ok  that because the bondholder didn't handicap its risks well now the taxpayer has to pick up the tab? In what way is that equitable?

 

I don't want to really dive into politics. But you just know that once this is done and behind us we'll get back to cutting medicare and social security because we can't afford it. So basically grandma ends up subsidizing bond investors.

 

This can be said about most cases of bailouts but it's specifically acute to airlines because these companies always find a way to get themselves into trouble. So as an airline bondholder you really should be thinking about all kinds of risks when you were buying those bonds. It just happened that it's this risk that showed up instead of another.

 

The other thing is that the US has bankruptcy laws. AND they work very well. Airlines in particular are very familiar with the process. So why not let the market take its course. As LC pointed out, air travel will still be there. The planes won't vanish, pilots won't perish, etc. What would change is the owners of the capital structure. So the only reason we have an airline bailout is to socialize bondholder losses.

 

Great points rb and LC.