Warren Buffett has changed his mind.
The famed investor has long railed against airline stocks, saying as recently as 2013 that they’re a “death trap for investors.” Buffett struggled with an investment in USAir back in 1989 and has avoided the boom-and-bust—mostly bust—industry ever since.
Until this year. The latest security filings by Buffett’s company, Berkshire Hathaway (BRK-B) show that in the third quarter, the firm bought stakes in the three largest US carriers—Delta (DAL), United Continental (UAL) and American Airlines (AAL). Buffett told CNBC recently he also bought shares in Southwest (LUV) during the current quarter. The stakes range in size from less than 1% of Delta’s outstanding shares to 4.2% of American’s, and show that Buffett is placing a broad bet on an industry he once regarded as perilous.
What changed? A lot, actually. For much of the time since the government deregulated the airline industry in 1978, too many airlines offered too many flights, causing chronic financial instability. Since 2000, there have been at least 14 major airline bankruptcies, including Delta, United, American—and U.S. Airways twice.
But those bankruptcies led to consolidation that has produced a more rational industry. Delta merged with Northwest, United with Continental and American with U.S. Airways. “The airlines say, this time is really different, and there are signs that it really is,” says Seth Kaplan, managing partner at the trade publication Airline Weekly. “Now that there are just 3 or 4 giant airlines, it looks more like other industries.”
Buffett is a value investor who studies fundamentals before making a wager. Here’s what the fundamentals show:
Airline capacity is under control. Overcapacity has been the biggest profit-wrecker in the business, with airlines habitually adding flights or expanding to new routes, to gain market share. And startups looking to gain a foothold often pile on flights to popular hotspots such as Florida, forcing the established carriers to match low fares and roll out even more flights.
But consolidation has cooled capacity expansion. Since 2006, domestic capacity, measured by available seat miles, has increased just 7.4%, according to Airline Weekly data. GDP has increased by 34% since then. With the economy growing by substantially more than airline capacity, airlines ought to have more power to protect profit margins.
Speaking of profits…. They’re strong. American, United and Delta earned a combined $11.5 billion in net income during the last 12 months, excluding special items. In 2006—which was a bubble year with exaggerated profits in many parts of the economy—the same carriers and all their predecessor companies earned just $910 million. Lower fuel prices during the last few years have boosted airline profits, but a bigger factor may be the new revenue they earn from “unbundled” services—charging for checked bags, seat upgrades, food and other things. The four biggest carriers earned about $17 billion in such “ancillary” revenue in 2015. Regular airfares, meanwhile, have been falling, even when adjusted for inflation.
The stocks were relatively cheap when Buffett bought them. We don’t know the exact dates Buffett bought his shares, except they were during this year’s third quarter. But around that time all four stocks had been drifting down from 52-week highs. The stocks had generally peaked around the time oil prices bottomed out in early February. Oil prices then began to rise, at the same time airline pricing softened, pushing airline stocks down. Apparently that didn’t worry Buffett and his team at Berkshire, who presumably felt longer-term fundamentals trumped rising fuel costs and pricing concerns. Here’s a one-year chart of the four airline stocks:
Buffett is famously bullish on the US economy. In his latest letter to shareholders, Buffett wrote, “For 240 years it’s been a terrible mistake to bet against America, and now is no time to start.” There will always be recessions, as Buffett surely knows, but he expects the US economy to continually exceed its own peaks. The airline industry can only do well if the broader economy does well, which is something Buffett anticipates. That’s the wind beneath the wings.
Rick Newman is the author of four books, including Rebounders: How Winners Pivot from Setback to Success. Follow him on Twitter: @rickjnewman.