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Why have airline and auto companies been such poor investments?

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February 26, 2012 – Comments (27) | RELATED TICKERS: F , DAL , LUV

Over my short investing career, I have tended to stay away from airline companies and auto companies.  This is because early on in my learning, I always heard that these two industries never made much money.

Although I had heard this many, many times, I never was told why.  I feel this way about many things in life; people tell you things, but they don't tell you (or don't know) why.

My guesses:

1) Strong unions.  Unions are bad for business

2) Airlines have high fixed costs.  So when the economy is booming, they have to take on debt to build more aircraft carriers, and when the economy slows down they have a bunch of empty seats.  I have heard that auto companies too have high fixed costs, but that makes no sense to me, since they are selling cars to individuals.

 

What other reasons?

27 Comments – Post Your Own

#1) On February 26, 2012 at 9:14 PM, portefeuille (99.67) wrote:

Including dividends German automakers have done alright.

Porsche preferred (PAH3:GY) in Frankfurt trading.



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BMW (BMW:GY) in Frankfurt trading.



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Volkswagen preferred (VOW3:GY) in Frankfurt trading.



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Daimler (DAI:GY) in Frankfurt trading.



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#2) On February 26, 2012 at 9:23 PM, portefeuille (99.67) wrote:

#1

There are currently 250/140/1100/35 BMW/DAI:GY/VOW:GY/VOW3:GY shares in my fund with break-even of around 41.67/58.11/-17.58/-646.49 EUR. VOW:GY shares are the 5th largest long position, PAH3:GY shares are the 10th largest, see comment #88 here.

fund performance since March 8, 2010: ≈56%.

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#3) On February 26, 2012 at 9:35 PM, portefeuille (99.67) wrote:

Lufthansa shares have also done alright. Not in the fund, I can't have them all ...

Lufthansa (LHA:GY) in Frankfurt trading.


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#4) On February 26, 2012 at 9:44 PM, portefeuille (99.67) wrote:

BMW/

BMW:GY/

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#5) On February 27, 2012 at 1:04 AM, MyunderratedLife (90.99) wrote:

For airlines it is because the business is enormously capital intensive - like none other.  You are buying airplanes in fleets before you can even begin operating.

Your human capital needs to be highly trained - do you know how many hours a commercial pilot has to log before he can fly people?  The sheer amount of jetfuel (cause they sure aren't allowed to log all of those hours on cessnas) is staggering.  Then the pilots have very strict policies regarding how much they can work consecutively, weekly, etc.

Then there's the unpredictability of fuel costs.  I once went to a speaking event where herb kelleher was talking about how a lot of southwest's success is attributed to them being able to hedge their fuel costs - which other airlines have trouble with because no one wants to take their counterparty risk (due to their horrid financial state).  

Also, LUV's employees do a lot of "cross-functional" work.  Stewardess' clean toliets, etc - this reduces costs somewhat...

So:

1.) huge capital outlay to get started

2.) need extremely experienced human operators who cannot be overworked due to regulation (so its not like PE/Investment banking where you can get someone up to speed by having them do comps for 100 hours a week).  You can't stretch pilots thin - they work like 36 hours a week and that's toeing the line.

3.) unpredictable variable costs. 

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#6) On February 27, 2012 at 1:05 AM, MyunderratedLife (90.99) wrote:

Didn't mean for that to come off so pedantic.

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#7) On February 27, 2012 at 1:10 AM, MyunderratedLife (90.99) wrote:

There have been plenty of auto companies that have done well over time.

That argument is more of an innovative one - often times the new technology is not where you want to be unless you can effectively employ a basket approach.  Out of 2,000 american car companies only 3 (sorta) made it out of the gauntlett... And if you held GM common equity you still got wiped out.

I heard something to the effect once that when you come across new technology if possible don't bet on specific companies bet on the technology.  Charlie Munger touts that betting inversely would produce better results than trying to pick the winner in this case.

Instead of trying to find the next general motors or microsoft you would short horses or typewriters (realistically publicly companies that made horsewhips)  The losers are easier to find than the winners.

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#8) On February 27, 2012 at 1:11 AM, MyunderratedLife (90.99) wrote:

publicly traded companies*

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#9) On February 27, 2012 at 1:30 AM, Valyooo (99.40) wrote:

Makes sense to me.

However, having an economics degre where it is ingrained in me that prices adjust to expenses, supply/demand etc...

1) They have high capital outlays- so can't they just pass the costs on to consumers in the form of higher airline prices?

2) The not being able to stretch workers thin is a problem I did not think about.  This makes sense and I have no counterargument

3) Unpredictable vairable costs- every company has this.  When oil goes up, it is tough for everybody to do business.

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#10) On February 27, 2012 at 1:44 AM, goalie37 (90.50) wrote:

I don't claim to have the answers either, but one thing Valyooo mentioned gave me a thought.  You said, "They have high capital outlays- so can't they just pass the costs on to consumers in the form of higher airline prices?"  The answer would seem to be no.  Airline seats are pretty much a commodity, in the sense that a coach seat on United varies very little from a coach seat on American.  The airlines, even though they have huge barriers to entry, really don't have the moat that Buffett talks about.  To a lesser extent, this would also be true with the auto makers.  There may not be tons of companies in the field, but there are just enough to prevent any real pricing power.

Like I said, I'm just guessing. 

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#11) On February 27, 2012 at 1:56 AM, Valyooo (99.40) wrote:

Right, and that would make sense in an individual company with high capex compared to competitors.  But, if ALL airlines require intensive capital outlay, I would think they would ALL be passing along the costs.

If anything, it seems not completely capital intensive.  It does not cost an airplane more to fly 200 people then it does to fly 5 people, so it seems that as demand goes up since their fixed costs are already all factored in and the variable cost is basically zero, the company should soar once its costs are paid.

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#12) On February 27, 2012 at 2:18 AM, goalie37 (90.50) wrote:

I remember Buffett saying once in an interview, "If there had been a capitalist at Kitty Hawk, he would have shot down the plane."

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#13) On February 27, 2012 at 2:21 AM, goalie37 (90.50) wrote:

I just took a look at some airline stocks.  Interesting find on net margins.

AMR - (8%)

LUV - 1%

UAL - 2%

DAL - 2% 

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#14) On February 27, 2012 at 9:55 AM, Mega (99.96) wrote:

Airlines are highly regulated - but unlike utilities they don't have geographic monopolies and regulators don't set rates to ensure a reasonable level of profits.  Heavy regulation without positive price regulation makes them unbalanced.

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#15) On February 27, 2012 at 10:29 AM, Teacherman1 (28.03) wrote:

Airlines tend to make money on short distance flights where they have at least a semi monoply, but there is so much competition on long distance flights that they can not raise their prices enough to overcome fuel costs.

An interesting thing about ticket costs on the longer distance flight is that there are so many different ticket costs. If you have 200 people on a flight, there is a very good chance that at least 50 different prices were paid for their tickets.

The thing that some airlines are now doing is to treat the ticket revenue, and the cost of the fuel and labor for a given flight as pretty much break even, and are adding many, seemingly small extra costs, i.e. bag check fees, food and beverage charges, their own credit cards with resulting fees, etc.,; to make any profit.

The former chairman of American Airlines stated that he would never invest in airline stocks.

One would think that as more airlines faced bankruptcy, and more mergers take place, they could eventually get profitable, but unfortunately, there are always people out there who think they have a "big new idea" and start up a new airline.

Automobile companies are not all created equal. as PORT pointed out. Many are making good returns, some are getting by, and some are always on the edge.

In the U.S., the biggest detrement to consistent profitability was a combination of union costs and rules and a lack of inovation in the way they did things.

They overspent on advertising, rebates, drastic model changes, too many models, the "that's the way it has always been done" attitude, etc.

Much more than you wanted to read, no doubt, but hey, I had some extra time this morning.

Hope you all have a good week.

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#16) On February 27, 2012 at 11:18 AM, edwjm (99.88) wrote:

One transportation industry no one has mentioned is railroads.

They have very high fixed costs and the unions nearly slaughtered them in the last century.

The passenger trains in the United States today travel no faster than those of a century ago.

The situation in other parts of the world is quite different.

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#17) On February 27, 2012 at 11:44 AM, Earendil (< 20) wrote:

As many have intimated, the structure of the industry is the reason why automotive and airline companies do not tend to make a lot of money.

When the US automotive market consolidated down to three players, as you might expect, the market leader made good profits.  For a long time, there was nothing wrong with investing in General Motors.  This industry structure, however, disintegrated as national automotive markets became one global market, and the number of competitors rose from usually no more than three in each national market to several dozen in the new global market.  The industry is slowly consolidating and perhaps eventually we will be back to three global competitors.  If that happens, the market leader is likely to be consistently profitable again.

Many competitors in an industry is good for the consumer,  but not for corporate profits.

Many competitors are even worse for profits when the technology is mature, and the scope for innovation is reduced.  The last car company to make major gains through innovation was Toyota in the ‘80s and ‘90s, when they innovated in quality and supply chain costs, and gained profitability and market share for at least a decade before other competitors began to copy the Toyota production system.

Innovators in the airline business have also been rare.  If you look at stock charts for Southwest Airlines (LUV) or Ryan Air (RYAAY), however, you will see that early investors in these innovative airlines did very well ((1000% returns in Ryan Air between 1998 and 2008). 

In short, super profits, which produce good investor returns, come from either a favorable market structure, or successful innovation, and the automotive and airline industries have not had a favorable market structure and have not seen much successful innovation in the last few decades.

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#18) On February 27, 2012 at 11:47 AM, eldemonio (98.04) wrote:

Most airlines are examples in extreme inefficiency.  From the way they charge less for multiple connection routes, to the way they board the plane, to the way they overbook their routes and then end up paying disgruntled passengers for inconvenience - it seems like airlines go out of their way to run their businesses into the ground.

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#19) On February 27, 2012 at 12:08 PM, Mega (99.96) wrote:

eldemonio

Good point.  One example of irrational price gouging - I once saved $150 by booking a 2 leg flight through Atlanta and skipping the second leg of the flight.

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#20) On February 27, 2012 at 12:10 PM, Mega (99.96) wrote:

Delta probably put me on a TSA watchlist for doing that though.

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#21) On February 27, 2012 at 12:37 PM, Turfscape (42.81) wrote:

MegaShort wrote: "One example of irrational price gouging - I once saved $150 by booking a 2 leg flight through Atlanta and skipping the second leg of the flight."

Wow. This is my favorite story of the day! It's a true example of inefficiency at its worst.

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#22) On February 27, 2012 at 12:44 PM, ikkyu2 (99.17) wrote:

Auto companies are not always bad investments.  They are crippled by dependence on technology, massive regulatory overhang (safety and emissions regs are as complex as any set of regulations anywhere), pension costs, and at least in the US, the cost of employer-sponsored healthcare for employees.  But they are cyclicals and their stocks do well in the late part of economic expansions as they participate in multiple expansion.

Airlines completely lack the ability to form a durable competitive advantage.  Advertising, special clubs, and frequent flier miles are an attempt to get around this but the bottom line is that they move people from point A to point B and the average airline consumer opts for the cheapest ticket.  As you point out, their costs are fixed and they have little flexibility to respond to changes in demand for tickets or in the price of fuel supplies.  And the number of hoops they have to jump through in the name of safety is really incomprehensible to someone who hasn't worked in the field.  Most companies have to put shareholder value first but airlines are regulated such that safety comes before it.

Makes it hard for airlines to make a profit.  Most airlines are state subsidized, as are many auto manufacturers including those in the US. 

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#23) On February 27, 2012 at 12:49 PM, ikkyu2 (99.17) wrote:

Also, you are not correct to state that it costs the airline the same to fly 200 passengers as it does 5.  For one thing, lifting that extra (150 lbs * 195 passengers =) 29,250 lbs and moving it through space requires a lot of additional fuel.

For another thing, transporting 5 passengers can be done with a tiny airplane.  Transporting 200 passengers requires a larger airplane that burns more fuel, requires more mechanic attention, requires a more highly trained pilot, etc etc.  Airlines are getting much better at having the correct-sized "equipment" at the departure terminal to serve a given day's demand, but the investment in computing infrastructure to allow this to happen is costly in and of itself, as are the numerous additional 'repositioning flights' that don't create any revenue.

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#24) On February 27, 2012 at 1:00 PM, JaysRage (88.45) wrote:

Most of it has been covered above.  

Auto companies are not always a bad investment.   American auto companies suffered for a long time from bloated union contracts and extremely poorly run business structures.   They should have had to restructure their business models years ago, but they had a SUV-aided bubble that burst with the high oil prices and the coming of the Great Recession.  The business itself can and should be profitable if done well.   They are finally getting around to doing it better. 

Airlines have no chance.    They have many more problematic issues.   They have to deal with multiple labor unions, they have EXTREME government regulation.   They are capital intensive, and they are extremely price elastic (making price increases difficult), and they cannot participate highly in economic expansion, because high fuel costs put a cap on their profitability.   They will never be highly profitable.   From time to time, a niche develops that has short-term profitability, but it is quickly eliminated. 

Travel agencies or non-capital providers are much more profitable.   They make their living by squeezing between the consumer and the provider.   That has the potential to make some money.   Note the success of Priceline and others. 

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#25) On February 27, 2012 at 1:49 PM, Valyooo (99.40) wrote:

I mostly understand now.  But why are they extremely price elastic, and aren't most industries extremely hurt by high oil prices?

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#26) On February 27, 2012 at 2:44 PM, JaysRage (88.45) wrote:

I think air travel is so price elastic because there is a large enough portion of it that is discretionary.   Familes that cannot afford expensive tickets to travel for vacation will vacation closer to home.   Businesses that cannot afford an increase in the travel/training budgets just travel and train less, substituting with virtual travel via tele-commuting or video-conferencing and web-conference training.   Ultimately, with technology the way it is today, travel is a luxury in many situations.   

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#27) On February 27, 2012 at 10:01 PM, MyunderratedLife (90.99) wrote:

regarding the variable price of oil - most industries can hedge those costs atleast somewhat.   Very few airlines can do that because no one is willing to take the counterparty risk on account of the shakely underlying economics of the airline business.

Obviously a few have been able to do it (southwest) but most of them cannot hedge out these risks like other input sensitive buisnesses can.

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