Did Warren Buffet Dump Some Airliners Too Soon?

Welcome to the worst air travel market since the Wright Brothers’ first flight; a closer look at the struggling stocks.
Anthony RussoMay 21,2020,03:55

Since Warren Buffet sold full stakes in America’s four largest airline stock carriers, some of those stocks are heading towards a crash landing. While it speaks volumes when one of the world’s most successful investors in history—and one who has always backed the industry even when he questioned that wisdom—finally bails, even Buffet can (and has) been wrong. 

Airplanes Aren’t Exactly Alphabet…But Still. 

Despite his incredible success in investing and building Berkshire Hathaway Inc. (NYSE: BRK-B) Buffet has been wrong on a few occasions. One of his biggest mistakes was not buying Alphabet Inc.’s (Nasdaq: GOOGL) Google and the e-commerce giant Amazon.com, Inc. (Nasdaq: AMZN) 

“I made the wrong decisions on Google and Amazon,” Buffet said in an annual shareholder's meeting in 2018.

“We’ve looked at it. I made the mistake in not being able to come to a conclusion where I really felt that at the present prices that the prospects were far better than the prices indicated.”

Are Airline Stocks Ever Going to Fly High Again?

It’s certainly understandable why one wouldn’t want to take any chances on the airlines' sector, as the top carriers in the industry are burning through millions of dollars each day to stay alive. Buffet’s case for selling the stocks in the four major airline carriers is because of the coronavirus changing the industry in a “very major way," according to the investor.

According to a report from Barron’s in mid-March, U.S. airline stocks shed $73 billion in market value since late February. To make matters worse David Calhoun, the chief executive officer of the airplane manufacturer The Boeing Company, (NYSE: BA) said last week to NBC that there will "most likely" be a bankruptcy to one major U.S. carrier. Right now, the industry is about as close to a zero revenue sector as you’re going to find. 

There’s no question, once shareholders in the airline industry look at companies’ full-year financial 2020 reports, they won’t be able to stomach the losses. But if you’re an investor you have to ask yourself are you in it for the long or the short term? If the answer is long term, then you have to evaluate the full perspective. That includes other industries hit hard from the pandemic and compare them to the airlines' sector. 

Airlines Stocks Have Nosedived Before 

The airlines industry has come a long way since 70% of U.S. carriers were operating under Chapter 11 bankruptcy protection between the years 2005 and 2008, as reported by Forbes. Before the outbreak of the virus in the U.S., the International Air Transport Association projected the global airline industry to generate $29.3 billion in profits in 2020 compared with $25.9 billion last year. 

For long term shareholders, there is some encouraging news. The Transportation Security Administration recently reported that the number of daily commercial air passengers is starting to rise. According to the data on May 11, daily traveling more than doubled to 215,645, up 130% from a month ago. On the same date last year, more than 2.5 million passengers boarded planes. While airliners still have a long way to go to get back to normal, investors should feel a bit better as traveling picks up on loosening travel restrictions. 

Betting Against Buffet 

Many analysts are betting against the Oracle from Omaha’s sell-off, including Michael J. Linenberg at the Global investment firm Deutsche Bank Securities. 

"We are of the view that [airline] stocks have likely seen their low points based on where they traded following 9-11,” Linenberg said. 

He added, “As we have indicated in past reports, valuations have become untethered from any sort of reasonable framework, particularly since 2020 is shaping up to be a “lost” year for the industry. As such, we are now starting to focus on next year when we expect the industry to experience a significant recovery."

American Airlines’ Cargo Packed Full of Debt 

If you were going to sell an airline stock, American Airlines may be the one to ditch while you still can. American Airlines is down more than 65% year-to-date; shareholders are having a tough time hanging on to a company that was going bankrupt just less than a decade ago, reporting liabilities of $29.55 billion in 2011. This time around, it has accumulated $34 billion in debt and could very well be headed towards another bankruptcy. 

Yahoo Finance AAL.png

(Yahoo Finance: AAL)

In the three months through March, American Airlines posted revenue of $8.52 billion, down 20% year-over-year adjusted losses per share of $2.65. The results were worse than expected, as Wall Street surveyed by Refintiv expected the Fort Worth-based company to report revenue of $8.94 billion on an adjusted loss per share of $2.33 per share.

And things may get worse. During the second quarter, American Airlines expects to burn through $70 million of cash per day; the company projects a reduction to $50 million a day through the summer. American Airlines ended the first quarter with just $6.8 billion in liquidity, and Citi analyst Stephen Trent has estimated that the company will have $40 billion in debt and $6.1 billion in pension liabilities by the end of the year. Even if it does survive until traveling demand picks up, the debt may be too high to overcome. Ill side with one of if not the most successful investor in history on this one. 

Hold United Airlines

Another U.S. airliner holding a considerable amount of debt in the industry is United Airlines Holdings, Inc. (Nasdaq: UAL) More than $23 billion in debt, the company pulled its $2.25 billion notes offering earlier this month because it wasn’t satisfied with the terms, as reported by Bloomberg.

In the first quarter, United Airlines reported revenues of $8 billion, down 17% year-over-year on an adjusted net loss of $639 million. In the second quarter, it is expecting to burn $40 million to $45 million a day.

However, the Chicago-based company is in much better financial shape than American Airlines, with $9.6 billion in liquidity, as of Apr. 29. Last month, it raised around $1 billion from a stock offering and has received $5 billion in government bailouts to cover payroll expenses through September.

The company decided to cut thousands of its full-time employees’ hours to 30, promoting a union lawsuit. As a result, some of the mandatory schedule cuts were changed to voluntary to assuage the outrage and any litigation.

“We will monitor the participation rates and report back to you on the program’s performance at the end of June,” Greg Hart the chief operating officer of United Airlines, said in a staff note earlier this month.

He added, “Without a high level of participation, we will have no choice but to reconsider a mandatory reduction to 30 hours for our full-time employees.”

Expect the debt on United Airlines to widen, but the company has a much better chance of returning to friendly skies than American Airlines. Right now, the company is a hold at $25.00 per share. There is a chance it will rebound from the more than 70% YTD drop. Keep an eye on this stock, as this could be a wise buy once the industry gets back on a roll. There is no rush to buy, however. 

Yahoo Finance UAL.png

(Yahoo Finance: UAL)

Potential Upside with Delta 

Delta Air Lines, Inc., (NYSE: DAL) posted its first quarterly loss in more than five years. The Atlanta, Georgia-based company reported first-quarter revenue declined 18% to $8.6 billion on a net loss of $534 million. In the second quarter, Delta expects revenue to plunge by 90%. 

Through the CARES Act’s payroll support program, Delta said it would receive $5.4 billion in emergency funding, of which it has already secured $2.7 billion. The company has also applied for an additional loan of $4.6 billion. It ended the first quarter with $6 billion in unrestricted liquidity and expects that to grow to $10 billion by the end of the second quarter. 

Delta was burning through $100 million a day in March, but projects to cut that in half by the end of the second quarter. Compared to American and United, Delta is in a solid spot. Bernstein analyst David Vernon seems to think there is upside in Delta, putting a price target of $39 on the stock. With it trading at $19 per share and down more than 60%YTD, Delta’s stock might fly high once again.  

Southwest is the Best Bet 

The airline best positioned to survive the coronavirus crisis is one that Buffet sold –and one that he was heavily invested in. 

Luckily for Southwest Airlines Co. (NYSE: LUV), it benefited from two strong months in January and February. As a result, its adjusted net loss for the first quarter was minimal comparatively, at $77 million on revenues of $4.2 billion, an 18% year-over-year decrease. That also marked its first quarterly loss since 2011.

However, clear skies are by no means right ahead. Southwest expects operating revenues to tumble 85% to 90% year-over-year for April and May. The good news is that it is only burning through $30 million and $35 million in cash per day, significantly less than the other three major carriers. The Dallas, Texas-headquartered airliner had just $6.3 billion in debt at the end of the first quarter and $9.3 billion in cash as of Apr. 24.

A strong balance sheet that Southwest is working to enhance further, as Southwest raised around $4 billion by selling stock and convertible notes at the end of April. In total, Southwest has raised $13.9 billion since the beginning of the year. It is also set to receive the rest of its government funds by July. 

While shareholders may feel hapless and hopeless with investments in the airline sector, they have to feel better about betting on Southwest than any other airline. Gary C. Kelly, the chairman and CEO of Southwest told analysts in a first-quarter conference call, “While no one anticipated this economic catastrophe, we were prepared.” With shares down more than 45% YTD, Southwest is a buy. Southwest will likely suffer for the majority of 2020, but it is set up for the future.

Yahoo Finance LUV.png

(Yahoo Finance: LUV)

A Look at Some Chinese Flyers

China Eastern Airlines Corp. Ltd. (NYSE: CEA) is beginning to see better days. Despite posting a net loss of $555.8 million in the first quarter, the air traveler is looking to resume 70% to 80% of flights by the end of June, according to Forbes. August should see an even bigger increase in flights, the report said, 

In China, as restrictions start to ease, the country is seeing more than 6,000 daily domestic flights, still about half of the normal number, according to data provider Airsavvi. While bailouts for the company have been announced, expect the company to suffer for the rest of the first half.

Earlier this month, China Eastern overtook Southwest as the largest airliner in the world in terms of available seats. The Shanghai-based company will now look to rebound, as its shares are down nearly 35% YTD. China Eastern is a stock to watch. 

Yahoo Finance CEA.png

(Yahoo Finance: CEA)

Things are a little less clear when it comes to China Southern Airlines Company Ltd. (NYSE: ZNH). The Beijing-based company posted a loss of $4.8 billion in the first quarter and has warned of a deep financial impact in the first half. 

Earlier this month, China Southern said it was looking to issue up to $2.25 billion in A-share convertible bonds. The bonds will be used to fund purchases of aircraft, maintenance services and spare engines, and other working capital. Right now, this stock is a hold, but one to monitor. Shares are down roughly 35% YTD. 

Aside from a couple of carriers like American Airlines and United Airlines, it was premature of Buffet to sell off all his airline stocks. The industry as a whole has had good, profitable years recently (for the industry, anyhow), and once traveling takes off again, Buffet may regret bailing. But Buffet isn’t so optimistic about that rise in demand, seeing sea-change in airline travel for the near future –and not for the better.  

“I don’t know that three, four years from now people will fly as many passenger miles as they did last year,” Buffet told shareholders earlier this month.

He added, “You’ve got too many planes.”

The Bailout Paid for Airliner’s Stock Buybacks

The amount of debt that the top U.S. carriers hold is alarming. It is worth noting that one of Latina America’s largest carriers Avianca Holdings S.A., (NYSE: AVH) has filed for Chapter 11 bankruptcy, which could be an ominous sign for major U.S. airlines. 

Now Boarding American Government Airlines 

To avoid bankruptcy as Boeing’s CEO warned, perhaps it’s time to nationalize airliners. While news of that happening would tick off shareholders, the government would be responsible for meeting debts and would give smaller class citizens more control.

Radical? Yes. And even more radical in this country. But the industry has been bailed out more times than one and, while it is a last resort, it may just come to that. And not only that, the companies have often used the taxpayer-funded bailout money to fatten executives’ pockets and buy back stock. 

Delta, American Airlines, United Airlines, Southwest, and Alaska Airlines have spent nearly $45 billion in share repurchases and dividends over the past five years, according to Guardian research.

If they didn’t, perhaps they wouldn’t have asked for a $50 billion bailout. 

While Covid-19 was not something the airlines could have predicted, the government has essentially re-payed them for buying back their stocks. 

As a taxpayer, it should infuriate you. As an investor, it should worry you, as the top airliners' have made poor decisions that have helped put them into this mess.

But like it or not, airliners are receiving their bailouts. And chances are, if they survive, they will be controlled by their shareholders, not their government. If you want to buy into this space, Southwest and Delta are the ones worth considering. 

Buffet was right to give up on some of the air travel operators, but maybe he was wrong to give up on them all. And though his company suffered a $50 billion net loss last quarter, he is still worth $70 billion—plenty to finance his own airline, let alone guarantee a window seat. As for me, I hope we start to travel soon: First and last stop, Mask Island.