“There's no worse business of size that I can think of than the airline business. You're selling a commodity product with no variable costs. Huge fixed costs. It's a terrible business.” – Warren Buffett
If there is one business that should not be invested in for the long-term, it is the airline business. The airlines have proven to underperform the market over time. Investors should have a goal of beating the market, not underperforming it. Let’s take a look at the reasons for the airlines' poor performance.
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One problem facing the airlines is that they have high fixed costs and operating costs. These include: fuel , labor, airplanes, engines, and parts.
The airlines have not been getting a break on fuel lately. The price of oil has remained relatively high due to increased demand in emerging economies. This is eating into the airlines' earnings. They can try to pass this cost onto consumers, but that may lower demand. Instead, the airlines must do their best to use hedging to offset their fuel costs.
Consumers are cutting back on leisure travel, reducing the demand for flights. Many are saving money by taking shorter trips by car. A six hour 300 mile car drive is cheaper than taking a flight over the same distance that may also take six hours when factoring in travel to and from an airport, security checks, etc.
Another obstacle is the high cost of purchasing and maintaining airplanes and engines. These are high cost items that need high cost labor to maintain. This also eats away at the bottom line.
The airlines are facing lowered demand due to consumers cutting back on leisure travel. If the demand continues to remain low, this will ultimately result in lower prices. Lower prices will shrink their slim profit margins even further. Currently US Airways (LCC), Delta (DAL), and United Continental (UAL) have profit margins under 2%. American Airlines (AMR) currently has negative profit margins.
The debt to equity ratios are horrendous for the airlines. This is a measure of a company’s risk. It shows how much money the company is borrowing to finance the company’s assets.
Debt to Equity Ratio
N/A (Has negative
Let’s compare a few large companies that have respectable debt to equity ratios: Procter and Gamble (PG) has a figure of 51.57; McDonald's (MCD) has a ratio of 82.15; Coca Cola (KO) has a ratio of 87.13; Mastercard (MA), Visa (V) and Apple (OTC:APPL) have zero debt and therefore the ideal debt to equity ratios.
Due to the high cost nature of airlines, their debt to equity ratios are terribly high, putting them at risk for failure.
The five year annual projected earnings are only 3% for the four airlines mentioned above. With the market’s five year annual projected earnings at 10.91%, there is no reason to go long the airlines. The airlines will continue to lag the market and will be at risk of filing for bankruptcy as they have in the past. They can be profitable if you trade them on the short side, however. Wait for them to become overbought, then short them until they’re oversold. Rinse and Repeat.