Tuesday, November 15, 2016

Warren Buffet: Investing in US airline industry

There's an old joke: How do you make a small fortune in the airline industry -- start with a large one!
Granted its not particularly funny, but in view of WB's $1.3 billion investment into Delta, United and Southwest, it would seem that WB has gotten over his fear of investing in the airline business.  Part of the problem of making money in the business has always been the low barriers to entry, and the generally identical (if unpleasant) experience of flying commercial.

Any guy/gall could start up an airline with leased (grounded) aircraft and "steal" the business from the established carriers.  People's Express was the first in the late 1970s but a string of players have made the airline business largely unprofitable -- for most of the last 20 years the industry generated net losses.  What has changed?

In the US, the three above airline now account for 3/4 of the country's total traffic -- the US airline industry is back at the oligopoly it had many decades ago.  This means that pricing power is up!  The fact of the matter are that operating an airline is expensive and complex, regulation and excess capacity are both the cause of the industry's poor financial performance.

As for regulations, it seems that an important factor is the safety of passengers -- this role taken by the FAA insures "higher barriers to entry" especially in the US domestic market where most prime airports are now operating near or at full capacity (and building new airports or runways these days can be a nightmare).

Now, WB has not been perfect on this score, in fact he purchased a large stake in US airways in the early part of the '00 and saw a good chunk disappear in 2007, leading him to quip that the world would have been a better place had Orville Wright had been shot down at Kitty Hawk...

Now I am not suggesting following WB's investment strategy, rather its an interesting train of though that the US airline market has reached a place where it oligopoly power now exist, and with the arrival of Trump -- there is almost no likelihood of antitrust action against the airline (should they collude).  Although these days with very simple search engine its easy for an operator to know what the competition is doing, no need for coordination -- especially since they have independent markets. It is possible that WB has found a good investment, after all his investment into SantaFee railway was a stroke of genius -- when everyone thought he was wrong -- transporting fuel via rail instead of pipeline.

No position in any of the companies mentioned here


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