Qantas dive comes as no surprise
In investment circles, the airline industry is about as unpopular as you can get.
Long decried for being voracious destroyers of capital, there are few investors who can say they’ve made money on the back of airline investments. That doesn’t stop many trying.
If only the Wright brothers had failed
In perhaps the most famous airline investing quote, the Oracle of Omaha, Warren Buffett once said investors would have been better off had Orville Wright been shot down at Kitty Hawk. It’s a nice one-liner, but the full quote is rarely repeated, and that’s a shame because the full text has a lot to teach us.
In his 2007 letter to shareholders, Buffett wrote:
“The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. Think airlines. Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers. Indeed, if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down.”
Despite such a clear and long-held belief, even Buffett succumbed to the allure of airline shares – twice. Perhaps it’s the romanticism that’s still inherent in air travel (despite our experiences to the contrary), but many people can’t help themselves.
That’s a shame, because airline stocks are very, very rarely a good investment.
Be careful what you wish for
You might remember back in 2006 when a consortium known as Airline Partners Australia (APA) lobbed an $11 billion bid for Qantas (ASX: QAN). The consortium included Macquarie Bank (now Macquarie Group (ASX: MQG), two Allco vehicles and private equiteer Texas Pacific Group.
Putting the political machinations to one side, it does beggar belief that there were shareholders who were actively battling the prospective buyers to scuttle the deal.
The offer was lobbed at $5.50 – just under 5 times yesterday’s closing price. While APA would have certainly have had plans to improve the airline’s profitability, there can’t be a day that goes by when the surviving consortium members don’t thank their lucky stars that the deal fell over. Even before yesterday’s Qantas profit downgrade, APA’s money would have bought Qantas almost 4 times over.
The $11 billion that was on the table for Qantas would now leave a lazy $8.4b on the table for walk-around money. In fact, you could buy Qantas, Virgin Australia (ASX: VAH) and Regional Express (ASX: REX) for a combined $3.6b – and you could have your choice of buying AGL (ASX: AGL), Stockland (ASX: SGP) or Insurance Australia Group (ASX: IAG) outright with the change.
Anatomy of a poor business
As if to spell out how poor the airline business is, Qantas laid its problems out for all to see in its downgrade announcement. As is the rage these days, Qantas didn’t call it that, of course – opting for ‘profit update’.
I’m not sure why you’d bother with euphemisms at the best of times – after all, these are your owners that a company is supposed to be informing – but it was never going to disguise an awful profit forecast.
How awful? I’m glad you asked.
Qantas’ apparently ‘flagship’ domestic division is profitable, but Qantas is focused on (not committing to, mind you) ‘returning Qantas International to profitability in 2014’ – two financial years from now.
And combining both businesses, the company hopes to deliver returns that are greater than the cost of capital (loans and shareholdings) ‘within 5 years of August 2011’.
We always knew that Qantas’ international arm wasn’t making money, but that last sentence is truly breathtaking. Qantas is going to spend most of the next 5 years making less money than it costs to fund the airline’s operations.
If you ever wanted proof that investing in airlines is a mug’s game, you have it right there.
Management doesn’t stand a chance
Despite any PR misjudgements Alan Joyce may have made (and I don’t necessarily think he did the wrong thing), running an airline is a special kind of purgatory. He and his management team are on a hiding to nothing – and Qantas is traditionally one of the more profitable airlines in the business.
While Buffett might have been let down by Orville landing successfully at Kitty Hawk, he also gave us another insight into poor businesses. He said:
“When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.”
That same quote could be said of an investor brave – or silly – enough to invest in airlines. The odds are well and truly stacked against them, and they’ll be lucky to escape with their reputations – and portfolios – intact.
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Scott Phillips is a Motley Fool investment analyst. You can follow him on Twitter @TMFGilla. The Motley Fool's purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691).