Over The Pond – High Flyers
Written by Julian Wheeler – Partner and US Equity Specialist
The great Warren Buffett is famous for his dislike of two industries in which he has lost money as an investor: investment banks; he said the problem was that the assets walk out the door each night – undeniably correct, and Airlines; they grow rapidly, require significant capital and earn little or no money – but I think that is no longer correct. Why am I disagreeing with the “Sage” of Omaha?
To be fair, I probably have a shorter time frame and I am definitely more nimble than Berkshire Hathaway can ever be, but I genuinely believe the industry has changed for the better. I see you all running for the door.
How can this be the case? Delta Airlines just reported terrific earnings and forecast that 2025 will be the best they have ever seen. Their comparable peers will probably suggest the same thing. Is the economy so strong, are we really all flying around the place instead of doing anything else, or has commerce switched the movement of all goods from the ground to the air?
None of the above. Those are all demand factors, which ebb and flow and have many variables making forecasting harder. The answer is revealed in a comparison with the earnings report a week later from the largest trucking company in the USA – JB Hunt – who missed expectations and guided for weaker results ahead. It is all about supply. There is a glut of ground transport in contrast to a glaring shortage of aeroplanes. That means that one industry is running at full capacity which means it has pricing power while the other does not. On the day of their respective reports Delta rose 9%, Hunt fell 7%.
Some might say: “but it’s a cycle stupid, that’s why these shares trade on such a low multiple of earnings and will continue to do so”. Yes, demand is cyclical to an extent, although I would argue that for airlines it might be much less than the market believes. While technology will continue to disrupt many industries (Netflix has replaced a trip to the cinema) no chatbot is going on holiday for you and unless the promise of teleporting arrives from Star Trek, we know how you are going to reach your destination. But here is why I expect a re-rating of this sector.
Positive and lasting change has occurred during the last 5 years thanks to a series of unforeseen events which on reflection almost amounts to a ‘wish list’ for the airline industry. The greatest shock was obviously Covid: it almost bankrupted all of them, but having survived the ensuing weakness created the shortages (engines, pilots, supply chain) that has enforced a discipline hitherto unseen.
These effects will pass eventually, as will the other recent benefits that have helpfully occurred such as the problems with Pratt & Whitney’s engines overheating and the 400 lost aircraft stranded in Russia due to sanctions. But this windfall increased airline cashflow which has paid off that Covid debt. But ok, that has happened and is perhaps short term? You can’t invest based on that!
It is the time that it will take to return to ‘normality’ which is completely misunderstood, until you fully comprehend what the mess at Boeing has done to the supply of aircraft. According to the two largest owners of commercial jets in the world – the giant lessors Aercap and Airlease, who should know a thing or two about this – the global fleet that stands at 28,400 is now about 4,500 planes shy of where it would have been if the combination of the Max crashes and Covid that took place in 2018-2020 had not occurred. Large commercial jets are made by only two companies. While Boeing wasn’t producing, Airbus did not possess the capacity to take up the slack in full afforded by that opportunity. Supply chain problems still mean that even they failed to deliver their expected number of aircraft last year. It will take another 15 years before the market returns to its former state.
Put simply, as a collective, the Airlines are usually their own worst enemy and each cycle ends as they spend too much and oversupply the market. But this time they are unable to aim that shotgun at their feet.
‘Over the Pond’ focuses on the US stock market, but in a global sector like this, it pays to look everywhere. While Delta (my gold standard) has now recovered to pre-Covid levels, the market is finally remembering that there is in fact a large airline in UK that could do the same. IAG may be cumbersomely titled, but not in my expected performance. Fly me to the moon? Well… about 500p anyway.
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