Legendary investor Warren Buffett revealed last November that his Berkshire Hathaway group had taken a stake in the four major US airlines: American Airlines, United Continental Holdings, Delta Air Lines and Southwest Airlines.
The positions were relatively small by Buffett’s standards, leading many to believe they were acquired by one of his protégés — Todd Combs and Ted Weschler — and that the great man himself may have had no input into these investments.
However, in a recent interview, Buffett revealed that the decision to buy into the airlines was “in large part” his. This represents a major U-turn by the man who’s been telling the world for years that airlines are “a death trap for investors”. He previously said that “if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favour by shooting Orville [Wright] down”.
If Buffett’s now happy to buy into the big US players, should UK investors pile into the FTSE 100‘s International Consolidated Airlines (LSE: IAG) and easyJet (LSE: EZJ)?
What’s changed?
Buffett declined to say why he’s changed his mind on airlines. But an investor conference last year by American Airlines chief executive Doug Parker may have been an influence. Parker urged a “leap of faith”, arguing that consolidation has ended the boom-and-bust cycles that have plagued the industry for decades.
Of course, Buffett is also a numbers man and the table below, which shows the trend in average operating margin of the four US airlines (and those of IAG and easyJet), lends quantitative weight to Parker’s words.
| 2009 | 2010 | 2011 | 2012 | 2013 | 2014 | 2015 | |
| US 4 average | (1.1) | 5.2 | 2.6 | 2.6 | 6.4 | 8.4 | 17.2 |
| IAG | – | 5.3 | 2.8 | (3.4) | 2.8 | 5.1 | 10.1 |
| easyJet | 2.3 | 5.9 | 7.8 | 8.6 | 11.7 | 12.8 | 14.7 |
Source: Morningstar
As you can see, there’s been an improving margin trend for the US airlines and also for the Footsie pair, albeit IAG’s has been a little more erratic and generally inferior.
Now, it might be argued that the collapse of the oil price through 2014-15 is behind the margin improvement. Sure this has helped, but margins were already improving in 2013 when the price of oil was high, so it seems that lower fuel costs aren’t the sole reason for the far healthier picture we’re seeing.
Cheap flights
The US airlines were trading on an average forward P/E of about 10.5 when Buffett was buying. How do IAG and easyJet compare today?
IAG is 11% below its 52-week high and trading on a forecast 2017 P/E of just 7.1 at its current share price of 504p. Meanwhile, easyJet is 39% down and its forecast 2017 P/E is 12.2 at 950p.
I’ve never been too keen on airlines as long-term investments, largely on the same view that Buffett held before his recent epiphany. And I’m not entirely convinced that consolidation in the industry means boom-and-bust is over.
Having said that, the P/Es of IAG and easyJet are very cheap and reasonably cheap respectively. I believe they could be worth buying at this level, simply in the belief that the price of oil will remain fairly favourable for airlines for a good few years yet.
