David Kuo: Shares fly on a wing and a prayer
Investment Insider: Investors need a leap of faith to put their money into airlines – even national carriers
Sunday 09 October 2011
Richard Branson once quipped that the best way to become a millionaire is to start out a billionaire then go buy an airline.
Warren Buffett said something similar. In his annual letter to Berkshire Hathaway shareholders in 2008, he wrote that the worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. He said an airline's durable competitive advantage has proven elusive ever since the days of the Wright brothers. He mused that if a far-sighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favour by shooting Orville down.
We don't have to go quite that far, but as investors it is worth heeding the danger signs emitted regularly by airlines. Just consider the airlines that have faced financial ruin over the years. They include Pan Am, US Airways, Air Canada, Delta Air Lines, Japan Airlines, Swissair, Sky Europe and XL Airways. It doesn't matter whether you are a large flag carrier or a small-time operator, the same rules apply.
The issue is high operational gearing, which is another way of saying that airlines need to fill as many seats on each flight as possible simply to recover the high overheads. Once they have succeeded in doing this, then even very small improvements to turnover can provide a huge boost to profits. It is worth bearing in mind, though, that high operational gearing is a double-edged sword: any deterioration in sales can swiftly wipe out profits, too.
Low-cost operators have long since identified operational gearing as the main culprit that undermines any airline's performance. So, to avoid the pitfall, budget operators have worked hard at keeping a lid on costs, almost to the point of being unpleasantly frugal. They also aim to fill their planes as near as possible to capacity, even if it means selling tickets at seemingly giveaway prices.
However, the latest caution from the airline industry association IATA is a chilling reminder that the fortunes of some airlines may only be hanging by a thread. It said airline profits, which were set to total some £18bn in the three years through to 2012, may be unsustainable. It appears that overcapacity and impending regulatory costs concerning pollution could weigh on margins.
IATA also pointed out that an economic slowdown could see airline profits slump by more than 30 per cent. In an even more distressing revelation, it said the industry has lost money in seven of the past ten years even as global sales doubled to almost £340bn.
The shock waves sent shudders through AMR Corporation, which owns American Airlines. Shares in AMR, which has lost 70 per cent of its value this year, slumped further last week on worries that it may be forced to seek bankruptcy protection. Flybe, Europe's biggest regional airline, tumbled by over 30 per cent last week after it missed first-half revenue targets. The shares are down almost 80 per cent since flotation last December. Elsewhere, Lufthansa could not even provide a profit estimate for the full year. The best it could do was to say that operating profit would be at the "upper end of the three-digit-million-euro range".
There is too much capacity, which in turn means that yields are too low for operators to make money. However, this has not stopped Sir Stelios Haji-Ioannou, the founder of easyJet, from revealing plans for a new airline, FastJet. Whether this will take off remains to be seen. On the face of it, there appears be little merit in another airline. But this is an industry that is wrapped up in misguided entrepreneurial spirit and national pride. And we all know what comes after pride. Investors should beware that airlines can be a long-fall flight.
David Kuo is director of financial advice site fool.co.uk
Independent Partners; request a free guide on NISAs from Hargreaves Lansdown
- 1 Rihanna 'nude pictures' claims emerge on 4Chan as hacking scandal continues
- 2 Cyclist in Russia narrowly misses being hit by car and lorry
- 3 'F*ck it, I quit': KTVA reporter Charlo Greene quits live on air in spectacular fashion
- 4 What are your fingerprint words?
- 5 Gary Lineker involved in Twitter row after presenter rubbishes claims he will be warned by BBC over foul-mouthed tweets
Scotland could still declare independence – even without referendum, says Alex Salmond
Scottish referendum results: Cross-party consensus collapses amid Tory-Labour spat on the 'English question'
Hilary Mantel 'should be investigated by police' over Margaret Thatcher assassination story, says Lord Bell
Scottish independence: David Cameron is becoming the 'George Bush of Britain'
Plebgate MP Andrew Mitchell called officer a 'little s**t', claim court documents 'exposing ex-Chief Whip's 'record of abusing police'
Archbishop of Canterbury admits doubts about existence of God
iJobs Money & Business
£65000 Per Annum Benefits + bonus: Clearwater People Solutions Ltd: If you are...
£20000 - £25000 per annum + OTE £40,000: SThree: SThree are a global FTSE 250 ...
£20000 - £25000 per annum + OTE £40000: SThree: As a Recruitment Consultant, y...
£20000 - £25000 per annum + OTE £40,000: SThree: SThree Group have been well e...
Day In a Page
A state-of-the-art farm-building conversion on the former Cliveden Estate, with 11,420sq ft of internal space, cinema and wine cellar
A three-bedroom, 15th-century cottage with original features in the picturesque village of Sissinghurst
A six-bedroom terraced house with large south-facing roof terrace, cinema room and wine cellar
A new seven-bedroom home built in Queen Anne-style with swimming pool and parkland views in Mortimer
A listed, four-bedroom farmhouse in the rural hamlet of Rushall with detached barn, four acres of gardens and paddocks
A first-floor flat with two bedrooms, a spacious reception room and communal grounds in a leafy part of London
A three-bedroom flat with a spacious rootop terrace and balcony, accessed from a private gated courtyard
A Grade II-listed pile with six bedrooms, stables and 39 acres of grounds in Standlake
A two-bedroom flat with boutique hotel-style interiors, close to the foodie haunt of West End Lane
A two-bedroom flat in a beautiful old vicarage, with many original features, close to the city centre
A three-bedroom 16th-century home with an aga kitchen, private gardens and heated outdoor pool, in Hadleigh
A three-bedrom home in sought-after Queen's Gate Mews, with Italian marble-finished bathrooms
Surrounded by glorious countryside in the village of Udimore, sits this impressive four-kiln oast and barn conversion
A five-bedroom house in the picturesque village of Kettlewell, north Yorkshire
An 18th-century former coaching inn with original staircase, open fireplaces and beams throughout
A Grade II-listed Georgian town house with three bedrooms and a south-facing courtyard, near Arundel Castle
Feel on top of the world at this über chic penthouse on the 37th floor of one of Europe’s tallest blocks.
A Grade II-listed Victorian villa with six bedrooms and two further cottages, all with spectacular sea views
A grade II-listed, Georgian cottage with mature 50ft garden, perfect for summer entertaining
A magnificent Georgian pile with turrets, seven bedrooms, a heated pool and four acres of gardens
Fairoak Farm has five bedroom suites, gym, outdoor swimming pool and golf course
Chic two-bedroom river-fronted flat with a private lift that delivers you directly to your home
A spectacular seven-bedroom Tudor pile, once owned by Henry VIII, with 18 acres of land
A seven-bedroom Georgian property previously used as a picturesque wedding venue
A split-level flat in a church conversion with two en suite bedrooms and 1,200sq ft of living space
A three-bedroom bungalow situated behind an impressive stone wall, £645,000
Windsor Castle overlooks this three-bedroom Victorian cottage located on one of Windsor's smartest roads
Chapel House is a former vicarage with nine bedrooms in the beautiful Upper Wye Valley
A five-bedroom B&B and separate owner's accomodation with potential for conversion
Enjoy summer by the Thames in this two double-bedroom converted warehouse in Rotherhithe village
A one-bedroom, luxury apartment with private gym and concierge service in Moorgate
A four-bedroom house in Hermitage Gardens with three reception rooms and landscaped gardens
A seven-bedroom Grade II-listed property with a separate self-contained apartment
A five-bedroom Victorian house with three reception rooms and galleried landing, £695,000
A six-bedroom farmhouse with five acres of land in a former cloth-making village
A secluded seven-bedroom detached house with large private garden, £490,000
A three-bedroom cottage overlooking Sarratt village green with open fires and solid oak floors
A three-bedroom maisonette flat in a Grade I-listed, Georgian townhouse in a sought-after location
A one-bedroom apartment located within a private gated development, north of Turnham Green