Warren Buffett famously has a contentious relationship with airlines. More than a decade ago, he wrote in a shareholder letter: "I have an 800 number that I can call if I get the urge to buy an airline." Another remark was, "If a capitalist had been present at Kitty Hawk in the early 1900s he would've shot Orville Wright."
These statements came about after he had an unpleasant experience in the late 80s following an investment in U.S. Air. So, it was surprising when he decided to plunge back into the sector in recent years with investments in Delta Airlines (NYSE: DAL), American Airlines (NYSE: AAL) and Southwest Airlines (NYSE: LUV). His investments were more than 10% in Delta and Southwest, so it was major news and quite ironic that he had reduced these positions aggressively in recent days.
Bullish Thesis Destroyed
Buffett's logic in buying airlines was that the industry had gone through a wave of consolidation which resulted in less capacity, more pricing power, and lower costs, especially with lower oil prices. All of these remain true but those issues are no longer relevant given the coronavirus which has essentially reduced all air travel by more than 90%.
Airlines are now in survival mode. They are losing money every day and are dependent on a government bailout to remain in business. That is assuming that things quickly return to normal. Any bailout will come with strings attached given the experience of 2008 that would reduce management's ability to attract and retain talent, buy back shares, or issue dividends.
Companies that were bailed out in 2008 tended to underperform as their share counts were diluted and they had increased regulatory burdens. However, many of them continued to richly reward executives which led to a massive public backlash. So, it's likely that even more stringent conditions will be placed on any bailout recipients this time.
What's Warren Thinking
Bill Gates has been one of the most prescient thinkers about the coronavirus, and he has a tight connection with Warren Buffett. Despite the steep decline in stocks and Berkshire's (NYSE: BRK.A) cash haul of more than $150 billion, he still hasn't deployed any of his money. Typically, these markets when there is "blood on the streets" and fear is the predominant emotion, is when Buffett gets aggressive with his purchases.
Many are interpreting Buffett's sale of airlines and lack of interest in buying as a signal that he expects the coronavirus situation to get worse and continue to hamper the economy. In a way, it makes sense, stocks are down from their peak.
But even at their peak, they were overvalued. Now, they're closer to being fairly valued not undervalued. Yet, it's possible that in a post-coronavirus world, companies' ability to earn is hindered for many years. By that logic even though prices have dropped, valuations have not. Therefore, stocks are not cheaper than they were six weeks ago, despite being meaningfully lower in price.