Why Did Warren Buffett Sell His Airline Stocks?

Why Did Warren Buffett Sell His Airline Stocks? Warren Buffett is used to making headlines with his investments, but he got everyone abuzz when Berkshire Hathaway wiped its hands clean of the airline sector in the beginning of May 2020.

He announced his decision during the company’s annual call, and it turned heads because airlines were among the investments assumed to be future proof, especially the way he did it.

The company doesn’t just own shares in one airline – the Oracle of Omaha always diversifies his investments, so he held a stake in all four major airlines in the U.S., which are:

·       American Airlines (AAL)

·       United Airlines (UAL)

·       Delta Airlines (DAL)

·       Southwest Airlines (LUV)

These four airlines account for 80% of all U.S. air traffic, and Berkshire Hathaway was quick to enter into a 10% ownership position on each before the global pandemic ramped up in the start of 2020.

When airline stocks dropped in February, Buffett at first saw this as a time to shore up his investments for a discount.

However, the Trump administration’s $25 billion airline bailout, combined with global shutdowns, turned this reality into a pipe dream.

Instead of remaining stable, the stocks further dropped, signaling investor uncertainty in several key areas necessary for recovery. What was once a surefire bet may now go the way of Pan Am or TWA. So, why did Warren Buffett sell his airline stocks?

There are likely four key ingredients to his reasoning.

1. Airlines Balance Sheets Are Frightening

Running an airline is expensive, so it’s no wonder there’s an incoming onslaught of bankruptcies. None of these businesses were prepared for the financial impact of the global shutdowns.

Airlines take on lots of debt to finance purchases of planes and other necessary equipment, giving them hefty bills to eat away at revenues and profits. This pushes them to run on tight margins, so they’re always spending cash towards operations as fast as they earn it to keep things afloat.

This puts these companies in a precarious position during the global civic lockdowns in response to the COVID-19 outbreak.

Revenue declines of 80% crush these businesses, quickly evaporating cash levels, destroying profits, and forcing them to close in a hurry.

They simply aren’t prepared to weather the financial hit, and their only lifeline would be a buyout that’s unlikely to happen because of their balance sheets. It’s not just the airline operators either – airplane manufacturer Boeing was already experiencing turbulence before the global lockdowns hit.

And the U.S. airline industry doesn’t just operate in a bubble. The International Air Transport Association estimates COVID-19 will create $314 billion in lost revenues in 2020 compared to 2019, a difference of 55 percent.

Domestic and international travel restrictions, along with a chaotic geopolitical climate add up to decreased passenger demand.

Even business travelers are working remotely and attending virtual business conferences. Airlines are going to continue being pounded with very little liquidity to get themselves out with.

Major airlines are going to need a major cash infusion to survive 2020, as their lack of liquidity is a tall hurdle to overcome. Even the $25 billion stimulus provided by Congress only covers six months of liabilities for these companies.

The fact is that any single straw could have broken these companies, and they were hit with bales of hay instead. In fact, let’s discuss the airline stimulus package in a bit more detail.

2. New Government Debt Hurts Shareholders

While the cash injection from the government stimulus sounds great in theory, the application gets scary when the balance sheets are taken into consideration. Each airline is receiving billions of dollars in grants and low-interest loans, to the chagrin of industry labor unions.

Airlines run on low profit margins, averaging nine percent in the 2010s and projected to slim down to between five to six percent even before the COVID-19 pandemic dealt a massive blow to the travel industry and economy as a whole.

As a shareholder, Buffett will continue to be financially hurt by airlines taking on this new debt from the government.

Even with a low interest rate, it’s going to eat into the already-dismal profit margins. It’s not a position Berkshire Hathaway is used to holding without some sort of long-term benefit potential, and it’s unclear whether any of the airlines can continue to squeeze by with these conditions.

Whereas before Buffett could invest close to $10 billion and make $1 billion per year, he would earn significantly less when airlines take on more debt.

Even though the company has over $100 billion in cash reserves, it can’t afford to continue pouring cash into the airlines to extend their runway if there’s no exponential lift in the foreseeable future.

His reward to risk ratio was no longer attractive by holding the airlines, even with his diversified investment across the board. He seems to have concluded that propping these businesses up was not financially viable. Consumer sentiment is shifting in the wake of the coronavirus too.

3. Consumer Behavior Changes Could Affect Airlines Long-term

Although Berkshire Hathaway booked substantial losses by selling airline stocks, the move was meant to stave off potential losses in the future. Buffett and Co believe people may be less inclined to jump on planes in a post coronavirus world.

Even though municipalities are reopening across the country, it’s unlikely airlines will return to full capacity any time soon, so the recovery timeline is uncertain. This is causing many airlines to cut workers’ hours in response, something that wasn’t supposed to happen under the terms of the stimulus deal.

Both Delta and United (along with JetBlue and others) drastically slashed worker hours, in some cases significantly decreasing pay in the process.

Because of this, Congressional lawmakers are pushing Treasury Secretary Steve Mnuchin to take action. In the meantime, it’s unclear whether summer 2020 travel will be as robust as previous years. Summer is a popular time for tourism, but we don’t yet know the long-term impacts of the coronavirus lockdowns on consumer behavior.

April 2020 was the hardest hit timeframe for the airline industry. A low of 87,500 air passengers traveled on April 14, 2020, according to the Transportation Security Administration (TSA). This means that people are increasingly booking flights, but rates of 200,000 going into June still haven’t reached numbers from before the quarantines.

Social distancing best practices fly in the face (so to speak) of how airlines have been generating profits by squeezing more seats (thus more paying passengers) into smaller cabin spaces. Expanded hygiene is just one of the potential downsides of future air travel.

First-class and business-class perks are becoming a standard expectation, and the added cost of these benefits could hike ticket prices up.

In addition, airport security may start to include biometric data and other tracking technologies to help with monitoring and reducing the spread of infectious diseases moving forward. The booking process will need to be heavily upgraded, and even when flights are being booked, they may not necessarily be generating revenue.

When the COVID-19 quarantines hit the United States (which included restricted travel for military personnel and dependents), it created a situation where flights were cancelled or delayed, and Air Passenger Rights were exercised.

Passengers were often given flight credits and other considerations to compensate them for their troubles. These amount to gift card balances for retailers and are sure to attract travelers looking to redeem their credit before it expires. However, it’s unclear how sustainable this demand will be, which leads to the final point.

4. There’s Better Opportunity Cost Out There

As many analysts pointed out, there’s still hope for the airlines. But the fact is that Buffett could take the money he’d invested in airlines and invest it more wisely elsewhere and gain exponentially more in an industry that’s outperforming the entire air travel sector.

Warren Buffett has always made moves that were different than everyone else. That’s why he sticks out as a wealthy investor to keep an eye on. A shaky economy has some investors debating his efficacy, but there’s no denying he’s a force on the market.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.