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2017: Why did Berkshire invest in the four major airlines?
GREGG WARREN: Warren, my question relates to some recent stock purchases as well.
Unlike the railroads, which benefit from colossal barriers to entry due to their established, practically impossible to replicate, networks of rail and rights of way, the airline industry seems to have few, if any advantages.
Even with the consolidation we’ve seen during the past 15 years, the barriers to entry are few and the exit barriers are high.
The industry also suffers from low switching cost and intense pricing competition, and is heavily exposed to fuel costs, with rising fuel prices being difficult to pass on, and declining fuel prices leading to more price competition.
Compare this with rail customers who have few choices and thus wield limiting buying power, and where fuel charges allow the industry to mitigate fuel price fluctuations.
While you’ve noted several times since the airline stock purchases were announced that the two industries are quite different and that comparisons should not be made to Berkshire’s move into railroads a decade ago, could you walk us through what convinced you that the airlines were different enough this time around for Berkshire to invest close to $10 billion in the four major airlines?
Because it would seem to me that UPS, which you have a small stake in, and FedEx, both of which have wider economic moats built on more identifiable and durable competitive advantages, would be a better option for long-term investors.
WARREN BUFFETT: Yeah, the decision in respect to airlines had no connection with our being involved in the railroad business.
I mean, you can classify them, you know, maybe in — as transportation businesses or something. But it had no connection, had no more connection than the fact we own GEICO or, you know, any other business.
You couldn’t pick a tougher industry, you know, ever since Orville [Wright] went up and I said, you know, that if anybody’d really been thinking about investors, they should have had Wilbur [Wright] shoot him down and save everybody a lot of money for a hundred years.
You can go to the internet and type in “airlines” and “bankrupt,” and you’ll see that something like a hundred airlines — in that general range, you know, gone bankrupt in the last few decades.
And actually, Charlie and I were directors for some time of USAir. And people write about how we had a terrible experience in USAir. It was the — one of the dumbest things I’d ever done. And there’s a lot of —
CHARLIE MUNGER: You made a fair amount of money out of it, too.
WARREN BUFFETT: Yeah, and we made a lot of money out of it. (Laughs)
CHARLIE MUNGER: It was undeserved.
WARREN BUFFETT: But we made a lot of money out of it, because there was one little brief period when people got all enthused about USAir. And after we left as directors and after we sold our position, USAir managed to go bankrupt twice in the subsequent period.
I mean, you’ve named all of the — not all of them — but you’ve named a number of factors that just make for terrible economics.
And I will tell you that if capacity — you know, it’s a fiercely competitive industry. The question is whether it’s a suicidally competitive industry, which it used to be.
I mean, when you get virtually every one of the major carriers, and dozens and dozens and dozens of minor carriers going bankrupt, you know, it ought to come upon you, finally, that maybe you’re in the wrong industry.
It has been operating for some time now at 80 percent or better of capacity — being available seat miles — and you can see what deliveries are going to be and that sort of thing.
So if you make — I think it’s fair to say that they will operate at higher degrees of capacity over the next five or 10 years than the historical rates, which caused all of them to go broke.
Now the question is whether, even when they’re doing it in the 80s, they will do suicidal things in terms of pricing, remains to be seen.
They actually, at present, are earning quite high returns on invested capital. I think higher than either FedEx or UPS, if you actually check that out.
But that doesn’t mean — tomorrow morning, you know, if you’re running one of those airlines and the other guy cuts his prices, you cut your prices, and as you say, there’s more flexibility when fuel goes down to bring down prices than there is to raise prices when prices go up.
So the industry, you know — it is no cinch that the industry will have some more pricing sensibility in the next 10 years than they had in the last hundred years. But the conditions have improved for that.
They’ve got more labor stability than they had before, because they’re basically all going to — they’ve been through bankruptcy.
And they’re all going to sort of have an industry pattern bargaining, it looks to me like. They’re going to have a shortage of pilots to some degree. But it’s not like buying See’s Candy.
CHARLIE MUNGER: No, but the investment world has gotten tougher with more competition, more affluence, and more absolute obsession with finance throughout the whole country. And we picked up a lot of low-hanging fruit in the old days, where it was very, very easy. And we had huge margins of safety.
Now we operate with a less advantageous general climate. And maybe we have small statistical advantages, where in the old days it was like shooting fish in a barrel.
But that’s all right. It’s OK if it gets a little harder after you get filthy rich. (Laughter)
WARREN BUFFETT: Yeah. Charlie’s more philosophical than I am on that point. (Laughter)
CHARLIE MUNGER: Well, I can’t bring back the low-hanging fruit, Warren. You’re just going to have to keep reaching for the higher branches.
WARREN BUFFETT: Gregg, the — I don’t — I think the odds are very high that there are more revenue passenger miles five years from now or 10 years from now.
If the airlines — if the airline companies are only worth, five or 10 years from now, what they’re worth now, in terms of equity, we’ll get a pretty reasonable rate of return, because they’re going to buy in a lot of stock at fairly low multiples.
So if the company’s worth the same amount at the end of the year and there’s fewer shares of stock outstanding, over time we make decent money. And all four of the major airlines are buying in stock at a —
CHARLIE MUNGER: You’ve got to remember that the railroads were a terrible business for decades and decades and decades and then they got good.
WARREN BUFFETT: Yeah, it — we like — I like the position. Obviously, by buying all four, it means that it’s very hard to distinguish who will do the — at least in my mind — it’s hard to distinguish who will do the best.
I do think the odds are quite high that, if you take revenue passenger miles flown five or 10 years from now, it will be a higher number. And that will be —
There’ll be low-cost people who come in. And, you know, the Spirits of the world and JetBlues, whatever it may be. But the — my guess is that all four of the companies we have will have higher revenues. The question is what their operating ratio is.
They will have fewer shares outstanding by a significant margin. So even if they’re worth just what they’re worth today, we could make a fair amount of money. But it is no cinch, by a long shot.