American Consequences - August 2020

THE DEATH OF AIRLINES

By 1994, Berkshire wrote down 75% of its investment. Ten years after the initial investment, Berkshire ended up getting the dividends it was owed in arrears before converting the shares to common stock and selling its position. Altogether, Buffett did make money on the investment, but he still considered it a mistake. In a 1994 letter, Buffett told shareholders that he “failed to focus on the problems that would inevitably beset a carrier whose costs were both high and extremely difficult to lower.” A smart investor like Buffett knows when it’s time to preserve capital and move on. More often than not, he can see what’s coming. By 2016, Buffett relapsed. He once again found circumstances across the airline industry too tempting to refuse. And he invested between $7 billion and $8 billion in the four largest U.S. airlines... taking an 11% stake in Delta Air Lines (DAL)... a 10% stake in American Airlines (AAL)... a 10% stake in Southwest Airlines (LUV)... and a 9% stake in United Airlines (UAL). At the time, Brent crude oil – the international standard – had crashed from around $115 per barrel in 2014 to less than $30 per barrel. As a result, the price of jet fuel also plummeted. And Buffett knew cheap fuel would be a boon for the airlines in a strong economy.

Buffett’s bold bet on this group of major airlines looked good for a while. But that all changed with the onset of COVID-19 in the U.S. at the beginning of this year. Air travel – like pretty much everything else in the country – came to a halt. Airline passenger volume was down 96% in the first week of April, compared to the year earlier. In April, Buffett finally threw in the towel and liquidated all of Berkshire’s airline holdings. All told, he took a total loss of around $2 billion on the four positions in the airlines. Some critics believed the Oracle was losing his touch. But I’d argue to the contrary... A smart investor like Buffett knows when it’s time to preserve capital and move on. More often than not, he can see what’s coming. And in this case, he knows airlines are in trouble for at least the next few years . As Buffett told Berkshire Hathaway shareholders in early May... I don’t know that three, four years from now if people will fly as many passenger miles as they did last year. Buffett went on to say that even if 70% or 80% of the airlines’ business returns, the industry still has “too many planes.” That type of overcapacity will lead to lower ticket prices and billions of dollars in unsustainable operating losses. And today, these airlines are nowhere close to 70% or 80% of their business returning – which Buffett said would still cause an overcapacity problem.

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August 2020

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