“If a capitalist had been present at Kitty Hawk back in the early 1900s, he should have shot Orville Wright."
So complained Warren Buffett in 2002 – one of several occasions in which the ‘Sage of Omaha’ counseled against investing in airlines.
Last week, though, it was revealed that Buffett’s Berkshire Hathaway Group had acquired $1.7 billion of shares in American Airlines, Delta and United, and that an investment in Southwest Airlines was also likely.
So, why the change of heart? Buffett’s objections to the airline industry usually centered on its vulnerability to labor unions and oil prices, both of which incur costs that are difficult to offset with higher ticket prices because of fierce competition.
That competition, however, has lessened significantly in the past decade through a wave of consolidation among major US airlines. American Airlines and US Airways have merged, as have United and Continental, and Delta and Northwest. In the low-cost sector, meanwhile, Southwest absorbed Air Tran.
The result is that four airlines now control more than 80 per cent of US domestic traffic - an oligopoly that should, in theory, allow them to raise fares and post fatter margins for a sustained period.
Yet IATA predicts that global airline yields will actually fall seven per cent this year, and US airlines are unlikely to escape this trend.
American Airlines – in which Buffett acquired almost 22 million shares – has reported lower yields in 2016, which it partly ascribed to competition from ultra-low-cost carriers such as Spirit.
Cheap fuel means that the big carriers are still posting big profits – a factor resulting in greater MRO spend – but Buffett’s investment case wouldn’t be predicated on what could be a transitory phenomenon.
Instead, he may be banking on rising passenger demand allied to capacity discipline by the big four airlines, which should boost revenues.