The best time to buy stocks is when they’re out of favour with investors. And this the case with airlines right now. Rising jet fuel prices have caused shares to fall. But is this an opportunity, or is the entire sector one to avoid?
Warren Buffett
Warren Buffett‘s well-known for being wary of airlines. A good example is the following from the 2013 Berkshire Hathaway shareholder meeting: “You’ve got huge fixed costs, you’ve got strong labour unions, and you’ve got commodity pricing. That’s not a great recipe for success.”
The issue is that most of the costs associated with a flight – the plane, staff, fuel – are all fixed. They don’t change much depending on how full it is. That gives operators a strong incentive to fill the aircraft at pretty much any price. And the main thing customers care about is how much they’re paying.
As a result, airlines generally can’t charge any more than their nearest competitor. But that competitor might be charging nearly nothing to fill a plane. Given this, it might be unclear why anyone should be interested in the industry at all. Buffett however, has bought US airlines stocks more than once.
Competition
The problem for airlines is that there’s too much competition. This leads to low prices for customers and low returns for businesses. It doesn’t really matter whether a rival makes any money on a low-cost flight. If they’re selling it, people won’t buy a more expensive one.
The US has already seen some consolidation and is now dominated by four main carriers. These are the four Buffett bought in 2016.
Ryanair (NASDAQ:RYAA.Y) CEO Michael O’Leary sees this coming in Europe. He’s identified both easyJet and Wizz Air as potential takeover targets.
I’m unsure about this. But I do see the latest difficulties as a chance to have a look at what I think is the outstanding name in the industry.
Which stock?
There’s only one way to stand out in an industry where customers are driven by price. And that’s to have lower costs than everyone else.
The firm that does this best is Ryanair. It is relentlessly focused on keeping its own costs down so it can charge customers less than competitors.
It flies from less busy airports, keeps turnaround times short, and uses one type of aircraft. But the real highlight is the way it manages its fleet. Ryanair’s outstanding at finding opportunities to buy aircraft at a discount. This is often when Boeing is in some sort of difficulty and needs orders.
That puts the business in a position to make more money than competitors while charging customers less. And I think that’s a winning formula.
Time to buy?
The airline industry is one that I’m generally not interested in. But Ryanair is a rare – in fact, unique – exception. The company isn’t immune from the effects of higher oil prices. Fuel is one of its biggest costs, so it’s likely to have a real impact.
My view is that it’s likely to be much more resilient than rivals. This comes from its uniquely low cost base and best-in-class balance sheet. That’s why I think the falling prices across the industry might be an opportunity for me that I’ll investigate further. But only in one particular stock.
