Here’s Why Warren Buffett Invested in Southwest Airlines

The economics of the airline industry are dreadful. Here are some reasons why I believe so.

  • high fixed costs — employee, fuel, rents (terminal, etc),
  • no pricing power — commodity like pricing which is often dependent on your competitor,
  • violently cyclical — each time the economy sneezes, the industry catches a bad cold
  • capital intensive — simply think of the cost of a single airplane,
  • highly mobile capital assets — if one market is unprofitable, airplanes can be flown to the next location
  • labor intensive — each large airline has tens of thousands of employees,
  • asymmetric exposure to negative events — think 9/11,
  • fluctuating raw material costs — no one really knows what oil prices will do next
  • tight safety, security and other regulations leading to higher cost

Thus, it is easy to understand why Mr. Buffett has been so vocal in his opinions against the industry over the last three decades:

“Since our purchase of US Air, the economics of the airline industry have deteriorated at an alarming pace, accelerated by the kamikaze pricing tactics of certain carriers. The trouble this pricing has produced for all carriers illustrates an important truth: In a business selling a commodity-type product, it’s impossible to be a lot smarter than your dumbest competitor.” — 1990
“As the seat capacity of the low-cost operators expanded, their fares began to force the old-line, high-cost airlines to cut their own. … Eventually a fundamental rule of economics prevailed: In an unregulated commodity business, a company must lower its costs to competitive levels or face extinction.” — 1994 shareholder letter
“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.” — 2007
“Investors have poured their money into airlines … for 100 years with terrible results. … It’s been a death trap for investors.” — 2013

This is why it was mystifying when he recently bought large stakes in the four large airlines: American Airlines (NasdaqGS: AAL), Delta Air Lines (NYSE: DAL), United (NYSE: UAL) and Southwest Airlines (NYSE: LUV). So I decided to dig deeper into the airline industry, and found something that mystified myself even further.

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