Why Airlines do not fly on Value Investing

Q&A: Questions & Answers
1

I am wondering if we have so far figured out any concrete reasons to stay away from Airlines Industry in Value investment. In other words, investment in Airlines industry is not considered as sound investment, why?

I have couple of favorable arguments:

1). Industry has a huge moat, not everyone can enter in it.

2). You can fly from anywhere to anywhere, for example Places like Andaman, north east would be a distant dream for tourists, if airlines did not exist.

3). Substitute are less, for example if one has to travel from Delhi to Paris, nothing can be imagined except airlines.

4). Is is good for society, I would say yes. Saves time.

So in my view Industry as a whole is good, what makes individual investment dumb. or in other way for example in an airline operating in only one sector and no other airline operate in that sector, still would it be worth to choose Airline as Value investment. Provided it satisfy x.y.z value tests.

Sandeep

2

While the industry is a necessity in today’s world, it is not worth investing in because, there are just a few airlines across the world which have been consistently profitable; many have declared bankruptcy. This is what Warren Buffet said about the airline industry: “But seriously, the airline business has been extraordinary. It has eaten up capital over the past century like almost no other business because people seem to keep coming back to it and putting fresh money in. Youâve got huge fixed costs, youâve got strong labor unions and youâve got commodity pricing. That is not a great recipe for success.”

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3

Why Airlines do not fly on value investing? because value investors crawl, don’t fly. :slight_smile:

jokes apart, airlines is strictly a commodity business. No matter how good management is, in the long run it is disruptive. Indigo is exceptional in India.

Although, of late, there are new entrants coming with some novel ideas eg. AirAsia, Singapore Airlines (both in JV with TATA). So one has to find out the morale behind TATA’s interest in this sector again.

4

There is an old saying about airline industry " if you want to be millionaire in this industry…easy… Start as billionaire and the ind will get you there easily". Lol. Ask king of good times.

Too many regulations, unpredictable fuel costs, falling prices. Nothing ever goes right here. Forget it. Except one or two, no one hasn’t found the secret sauce

5

With all due respect and no offence to you Sandeep, this is what I think of airlines

1). Phenomenal capital costs required to expand - you are operating a mumbai to delhi flight segment. You want to add a delhi to bangalore sector? Great!!! Investment is $200 million for a boeing 737 only! Make this investment and then cross your fingers and pray to God that no-one else will crowd the sector and you can reach the 65-70% capacity utilisation to first break even.

2). Volatile fuel costs with no ability to pass on increases in cost.

3). Severe competition intensity - every day there is a new company offering tickets at Rs. 1.

4). Huge burden of taxes on jet fuel - taxes cost more than the fuel itself

5). Commodity nature of business - people pick the lowest cost airline that gets them from point A to B. Period. Thats the only reason why anyone would ever travel air-india! If there was no cost saving incentive, who would want to subject themselves to that kind of torture?!

6). Huge amounts of regulation - its almost ironic because airlines lose the maximum amount of money because as soon as an airline raises prices and starts to make that tiny iota of a profit, govt/DGCA/CCI steps in to control prices

7). No pricing power and no bargaining power with suppliers (main cost which is interest, depreciation and fuel costs) - Can you imagine having any sort of upper hand when negotiating with a company like Boeing or Airbus? Its a duopoly, you have no choice, you have to buy from 1 or the other and they will charge you every last penny that you can afford to pay them!

8). Unscrupulous promoters are rampant in the industry. Although not discussed openly, it is a well known fact in the industry and there are a lot of side deals involved in purchasing air planes. True story!

I think it is quite possibly the worst industry in the history of mankind from the point of view of a minority shareholder (as a promoter you don’t end up doing as badly!). Unless I have an idea and the capital to start a new airline and have the conscious that allows me to siphon off money while making air plane purchases, I would rather withdraw money from my account, make a firecracker of it and watch it burn, rather than invest in an airline. Either way I am guaranteed to lose money. Here, atleast, I will be able to derive the enjoyment of watching fireworks.

6

The issue with this industry is that principles of economics do not hold true due to promoter ego. Be it governments or be it the industrialists, no one wants to close the airline business even when its not profitable for long time. That doesnt happen with other capital intensive businesses where non performers move out eventually.

Manufacturers such as Airbus or Boing would be decent investment due to technological Moat. Really find difficult to think how any new manufacturers could ever emerge and beat them in next 50 years. But the , we cannot really invest in these…

7

Thanks Abhishek and Gaurav for stating clearly why Airlines are not best suited. Then I am surprised by the phenomenal growth ofAir Methods Corporation (NASDAQ: AIRM)

People just denied it long because it belong to same Airline services, but it was not same as all Airlines. Here is my point wise response Abhishek made and I see it as a great business.

1). High capital cost : For sure it is, but it is also advantage that no one easily enter in this Industry.

2). Volatile Fuel Cost:Finding a niche in same business allows them not be treated ascommodity and passchanges in fuel price to customer. Did not face much of the competition.

3). Severe Competition: Govt and agencies like DGCA kept on acting as moat.

4). Huge burden of tax on jet fuel: Do they really use it? Even if it is there, who cares for it if they areconsistentlyable to pass to the customer. Taxes are High onCigarettes too look at the PE of the companies selling Cigarettes.

5). Commodity Nature: Check point 2.

6). Huge Regulation: Good as well, it will act as Moat.

7). No pricing power: Does not apply, anyone in emergency will pay any price to Air Methods.

8.Promoters: This is only a risk which needs to be carefully analysed.

Above all Good for civilization. Does not eroded shareholders wealth in any period of History.

I think Airlines Industry as a whole may have all the short comings as defined above but we could always find gems within them.

8

I read a comprehensive study on Airlines’ value chain. The study covers returns earned by Airlines as well as other players in the value chain. It covers the pricing power and margins of each player in the chain that helps to understand returns for each player.

I believe this might answer your question that why Airlines have been a losing proposition for a long time.

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9

This post is a fantastic analysis of why airlines isn’t usually a good business: http://investorsanthology.blogspot.in/2011/12/fundamentals-of-value-creation-part-ii.html?m=1

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10

You’re using broad strokes to rule out individual investments, i.e. Mixing a top down approach with bottom up. Therein lies the problem

If you want to invest based on themes then you have to pick some trend that’s taking off and in India typically we just look at what happened a decade or two ago in developed markets and extrapolate that. Mobile phones, airlines, cars, etc.

But the bottom up analysis shuns the industry averages and looks at the individual players to determine their strengths. Nearly all the profits in the enormous mobile phone industry are captured by just one player - Apple. Now you can’t say that Apple is a bad investment just because nearly every single player is bleeding money.

So as a macro, airlines are a bad business, as a bottom up approach, generalizing it to “every airline is a bad business” will be an enormous fallacy.