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Just a few months ago Berkshire Hathaway (NYSE: BRK.A) (NYSE: BRK.B) It was one of the largest shareholders of the four major US airlines: American airlines (NASDAQ: AAL), Delta airlines (NYSE: DAL), Southwest Airlines (NYSE: LUV)and United airlines (NASDAQ: UAL). The Warren Buffett conglomerate owned approximately 10% stakes in the four airline shares. At the end of 2019, Delta, Southwest and United were among Berkshire Hathaway’s top 15 equity investments.
However, the COVID-19 pandemic has caused air traffic to stop. As a result, airlines have been reporting losses during the first quarter and expect a wave of red ink starting in the second quarter. As expected, airline stocks have plummeted since mid-February.
Comparative performance of airline stocks. YCharts data.
This market crash gave Buffett the opportunity to increase Berkshire Hathaway airline properties at lower prices than he had paid a few years ago. But instead, Buffett chose to sell all of the Berkshire airline’s properties at a loss, as he revealed Saturday at the company’s annual meeting.
Buffett’s unexpected airline romance
Berkshire Hathaway began investing in airline stocks in the third quarter of 2016. At that time, one of the conglomerate’s two portfolio managers, either Todd Combs or Ted Weschler, bought shares of American Airlines, Delta Air Lines and United Airlines. . Soon after, the Omaha Oracle itself became involved. In the fourth quarter, it added the shares of Southwest Airlines to the Berkshire Hathaway portfolio. And over the next three years, Berkshire’s holdings of the four airlines increased significantly.
Buffett’s decision to get involved with airline actions a few years ago was always a scratch. For years, he had been warning followers about the danger of investing in airlines. During that time, he frequently described airlines as capital-intensive product businesses that were doomed to destroy investor capital.
Presumably, Buffett changed his mind sometime around 2016. He was probably impressed with a solid streak of significant free cash flow generation in Delta, Southwest, and United. This seemed to indicate that the airline industry had matured; Rather than fighting for market share at the expense of profits, airlines focused on generating strong returns for investors. That said, Berkshire Hathaway also opened up a large stake in American Airlines, which barely generated free cash flow amid an industry boom, due to extremely high capital spending.
Airlines like Delta have generated a lot of free cash flow in the past decade. Image source: Delta Air Lines.
Airlines no longer conform to Buffett’s investment style
Investors first got the idea that Buffett was selling airline shares in early April, when regulatory documents showed Berkshire Hathaway had sold some of its shares in Delta and Southwest. This made the conglomerate’s holdings in those two carriers less than 10%, at which point it was no longer required to submit immediate notices of any further sale (or purchase) of those shares.
Some investors speculated that Berkshire Hathaway may have wanted to reduce its holdings to less than 10% due to the language of the CARES Act that could have prevented major holders of airline shares from buying additional shares in the near future. To put it bluntly, they expected stock sales to be just the first move in a larger plan to try to buy Delta or Southwest directly.
This idea was not totally implausible. Buying an airline like Delta Air Lines would have allowed Berkshire Hathaway to put in a lot of cash at once. Furthermore, with Berkshire’s backing, Delta would have had the ability to make large investments that rivals could not afford, putting it in a position to emerge from the crisis in a dominant position.
However, as I pointed out in late March, Buffett’s investment philosophy prioritizes owning high-quality companies. Clearly, no airline can be considered a high-quality business at this time. Sure enough, in his comments at the annual meeting, Buffett said he had made a mistake regarding the airlines and decided to take a clean break by selling all of the Berkshire Hathaway stock.
I will not follow Buffett’s example
While I wasn’t surprised by Buffett’s decision to abandon the Berkshire airline’s investments, I don’t plan to do the same. At 34, I have plenty of time to be patient, and I hope that the stocks of higher quality airlines like Southwest and Delta will fully recover in the years to come.
Buffett appears to be concerned that airline traffic will remain below 2019 levels for many years. I am significantly more optimistic about this score. Sure, even if a vaccine is available sometime next year, air traffic is likely to remain well below 2019 levels in 2021, and possibly even 2022. But by 2023 or 2024 at the latest, I hope bring the global economy back to health, fueling a rebound for the airline industry as people and businesses make up for all the travel they are missing now.
Also, I think Buffett is underestimating the airlines’ ability to make money during a period of lower demand. While it is impossible for airlines to avoid massive losses when demand has dropped more than 90% of normal levels, they have many tools to adapt to a world where travel demand is 10% or 20% lower than previous levels ( which could be the case in the second half of 2021 or 2022). Older aircraft that are more expensive to operate may be retired. Labor costs can be reduced through desertion, purchases, and reduced overtime. The least profitable flights can be cut and the most lucrative routes intact.
So, I think investors have overreacted by removing more than $ 20 billion from Delta’s market cap and around $ 15 billion from Southwest’s market cap since February. I increased my bets on both airlines last month. If airline stocks plummet this month due to news about Berkshire Hathaway sales, I will probably continue buying.
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