Last week, UK’s budget airline – Monarch Airlines went belly up stranding 100,000 passengers across Europe. Germany’s budget airline – Air Berlin filed for bankruptcy few months ago. For several weeks now, Irish carrier Ryanair has been cancelling thousands of flights. Things are not much prettier stateside. The US airline industry has reported negative net income in almost all of the 39 years since deregulation. The explanation among many airline analysts has been to blame the industry’s poor performance on overly burdensome taxes and high fuel costs.
Three decades after deregulation the industry’s financial track record is dismal. In 1978, economists, analysts and industry participants predicted that deregulation would spark growth and success in the airline industry. It is a puzzle that still befuddles deregulation advocates. Despite robust investments, the industry continues to struggle.
While there have been several taxes added to the cost of flying (passenger facility charges, the segment tax, and the September 11 security fee etc.), most of these charges have been passed on to the customers. And while fuel costs increases have certainly been a significant component of losses in some years, airlines continue to lose money even when oil prices are low.
So, why is the airline industry so dysfunctional and why should anyone invest in airline stocks?
Future Wealth’s View
Even with demand increasing year after year and the industry continues to lose money? The excuses of taxes, high fuel costs or economic downturns affecting airline industry profits, grows old very quickly and expecting investors to believe that only when demand growth is completely constant and steady will the industry turn a profit, is simply unrealistic.
The fundamental problems in the airline industry become obvious when we look at technological advances in other forms for transportation i.e. automobiles. With every new generation of cars and trucks – fuel efficiency, entertainment, engine control, safety, performance, comfort have all seen marked improvements and consumers are willing to pay for these added features. Twenty years ago, one could buy a new Honda Accord for less than $10K. The list price for same car with improved features and fuel efficiency is $25K now.
But, after 20 years, one can still go from San Francisco to New York for less than $300 and it still takes 6 hours for the trans-continental flight and the travel experience has become much worse. All of this points to a broken business model that needs massive overhaul. Which brings us back to the original question – Is there a compelling reason for investors to put their money in airline stocks?
Apparently, yes. Warren Buffett’s Berkshire Hathaway revealed earlier this year that it had taken a stake in American Airlines, United Continental Holdings and Delta Air Lines. While it is ill-advised to argue against Warren Buffett’s investment decisions, we note that it is highly unlikely that he has taken a commercial flight in several decades