Richard Branson once quipped that the way to become a millionaire is to become a billionaire and then buy an airline. Yet one of the most successful equity investors of all time, Warren Buffet, once humoured an audience by jesting that he calls an emergency “air-aholic” hotline whenever he feels the urge to buy airline stocks.
Investors in airline stocks tend to fall into two camps – lovers and fighters.
The fighters don't buy airline stocks for a number of reasons. The first is that the industry has high fixed costs, its revenue is highly reactive to the business cycle and its product is perishable.
Fighters also complain about how exposed the industry is to rising energy costs, it's heavy tax and regulatory burdens, its union intensity and complexity, the regularity of uncontrollable shocks (such as SARS or September 11) and its exposure to monopoly providers (such as airports).
The persistent excess supply in international aviation, which prevents airfares from rising to pay for higher costs, is also a common complaint.
Airline stock lovers believe the volatility in stocks presents greater opportunities to buy at the lows and sell during the highs.
Larger institutional investors also like airline stocks because they act as a natural hedge against other stocks in their portfolio, including mining and oil stocks, while they also believe that the more profitable airlines pay a reasonable dividend.
So which of the airline stocks in the Asia Pacific catchment have performed best over the past decade?
In terms of share price growth, China Southern wins with a growth rate of 12.8 per cent per annum. This is followed by Air Asia at 9.7 per cent and Hainan Airlines at 7.4 per cent. Coming in last was Virgin Australia at -24.4 per cent and then Qantas at -14.4 per cent.
Nine out of the 15 airlines investigated experienced negative growth.
In terms of the risk associated with share price movements, it's an all-China affair, with China Southern the lowest risk, followed by China Eastern and Hainan. The riskiest airline was Thai, followed by China Air and then Qantas. Virgin Australia was found to be the fifth-riskiest.
Which airlines have the best prospects? There are a few variables to examine when answering this question, but the stand-outs are average distance travelled, the expected performance of the economy to which the airline is most exposed, competition, the quality of management decision-making in the international business, and the impact of government.
The average distance travelled or sector length is an important consideration because it determines the airline's exposure to jet fuel prices. Airlines with high average sector lengths are more exposed, so if you believe jet fuel prices will continue to rise then steer away from airlines with long average sector lengths.
Singapore Airlines has the highest average sector length travelled in the Asia Pacific at 5000 kilometres, followed by Cathay Pacific and Eva Airlines at about 3500 kilometres. The airlines with the shortest are Kingfisher, Air Asia and Garuda, at between 1000 and 1300 kilometres. Qantas's average sector length is around 2200 and Virgin's is 1600 kilometres.
The Chinese economy is likely to be the best performer in the Asia Pacific over the next couple of years. This will help the Chinese carriers most and to a lesser extent Hong Kong and Australian carriers. The Chinese carriers have relatively short sector lengths (around the 1500-kilometre mark) and so they will win on fuel as well.
The Japanese economy will be one of the weakest in Asia over the period ahead and so All Nippon and Japan Airlines will struggle, particularly as more capacity is added to the market with the introduction of Jetstar Japan and Air Asia Japan services.
Qantas is easily the most heavily taxed airline in the Asia Pacific. Since early 2000, the income tax it has paid has exceeded $US1.7 billion ($1.61 billion). All Nippon Airways runs second, paying $US1.6 billion. Singapore paid the third-highest amount of income tax, $US1.3 billion. Paying large amounts of tax means airlines are more reliant on costly debt to fund their investments.
The Asia Pacific airlines that face the strongest competition are those that are most exposed to international aviation. This is the same set of carriers as those with the longest average sector length.
In terms of management decision-making in the international segment of the business, both Simon Hickey (chief executive of Qantas international) and John Borghetti (Virgin chief executive) are outstanding executives and the best in the Asia Pacific. They have to be exceptional because they are competing against carriers that have a superior product on average, lower unit costs and lower sustainable pricing ability in an increasingly price-sensitive market.
Hickey may have already stamped his mark of quality, with the Qantas share price rising by about 40 per cent since he started the CEO gig.
In an article I wrote on November 29, Qantas tie-up is bad for tourism, I estimated that the fair value of the Qantas share price was $1.45 when the share price at the time was $1.32. It's currently trading at $1.53, with the fair value now revised upward to $1.49.
The best buys at the moment, with an eye on the medium-term, appear to be in China.