As all forecasts point to ‘better-this-year’, Sally White ponders conventional wisdom about airline investments

Never invest in an airline! This warning, made repeatedly by industry experts and the legendary Warren Buffet, needs to be borne in mind right now. Airlines shares are booming!

Not only the likes of EasyJet, China Airlines, Ryanair, or the UK’s little Dart, but also the US’s No.1, American Airlines, are seeing profits take off. Industry body, the International Air Transport Association (IATA), thinks the industry as a whole made $33billion last year, rather more than the $29.3 billion it forecast last summer.

Last year passenger numbers soared by 6.7%, says IATA, and for 2016 it is currently forecasting a rise of 6.9% to 3.8bn. New routes and new airlines are being rushed to the market. Records were broken in 2015 on new route launches - 3,100 from 359 of the world’s airlines across 173 countries, according to anna-aero’s New Route Data Base. There is at least $500bn of work going on to construct new airports, says the Centre for Aviation (CAPA). So it goes on, and plummeting oil prices are adding to the industry’s hype.

Before noting all the predictions of better-this-year, it is worth taking a look at what Warren Buffet says on airlines. “The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. …………….The big problem is not aggregate costs, but costs versus competitors. If your costs are out of line, you’re going to get killed eventually.”

Yet all those growth numbers are drawing hedge funds and other sophisticated speculative investors to queue for airline stocks. When shares of India’s IndIGo’s were put up for sale near the end of last year in a $465 million IPO, demand was three-and a half times the number on offer. Major global investors Fidelity, BlackRock and GIC were among the cornerstone investors. However, investors are still acting with restraint and have not pushed share prices up to the point where they look expensive against earnings – they are at quite a hefty discount the market as a whole.

For investors, IndiGo’s success with a no-frills offer has helped made it an attractive bet. It has dodged the high operating costs and taxes that grounded debt-ridden Kingfisher Airlines and forced a bail-out of budget airline SpiceJet.

Referring to IndiGo, Gaurav Narain at Ocean Dial Investments, a London-based India-dedicated fund, told Reuters: ‘"They have figured out that people are more focused on getting to their destination on time than anything else. And they deliver that better than any airline."

Maybe Buffet’s caveats don’t carry as much weight as formerly. Revenue is improving, and not just because of rising passenger numbers and falling fuel costs. Consolidation has shrunk competition and restructuring has refinanced airline companies. Marketing has become more focused, particularly online, and airlines are putting in programmes that enable them to sell tickets directly rather than split the profits too many ways.

Growth in the budget sector

A major factor in changing airlines’ status with investors is the growth of the budget sector (low cost or LCC, and ultra-low cost. or LCC) where the bills absolutely must be kept low to compete and the penalty for failure is swift. Passengers, governments, businesses and investors are all pushing for low-cost air travel. On the other hand, the emergence of so many new carriers could revive profit-killing price wars.

Certainly the budget airlines are getting the business. Looking at the 2015 new-route providers, Ryanair, whose digital turnaround strategy has been well-documented, has traditionally been the one to start more new routes than any other carrier; it’s also usually been the one to drop more routes.

In spite of its digital turnaround, it could only tie for top place. With 99 new routes launched in 2015, the Irish ULCC only (just about) matched numbers from easyJet, which also launched almost 100 new routes last year.

Maybe most surprising another European LCC, Vueling (controlled by IAG), was not far behind, having launched 90 new routes of its own. And yet another of Europe’s pan-European (U)LCCs, Wizz Air, was also busy expanding its network, having launched 85 new routes in 2015.

Wizz Air is another company that has attracted top funds at its IPO, which came last year. The low-cost central and eastern European airline wanted €150 million for expansion as well as equipment. The issue of 23 million shares was six times oversubscribed and brought a market capitalization of around a €600 million. Wizz, like Vueling, and Norwegian Air Shuttle, is thriving as passengers switch from the legacy airlines. The company has doubled in value since its stock market debut last February.

Norwegian Air Shuttle has been around much longer and, while growing fast (with 4 million passengers last year), is struggling a bit to carry out its strategy (it wants to take on the legacy airlines with a cut-price US to Europe fare, and is talking around $69.) Its profits and debt record has also been a bit bumpy. This has been reflected in its share price, down 9% last year.

Routes to the US from London Gatwick have been added to its Scandinavian-based long-haul operation. It has waited for more than two years to receive a US foreign carrier permit but has not met with a friendly reception from the US Department of Transportation. Ever innovative, Norwegian is now having another go, making an application for a permit via another subsidiary!
Let’s hope, however, that this does not makes the case put by Buffet and another well-know investor, this time Ricard Branson. “If you want to be a millionaire, start with a billion dollars and launch a new airline.”

Don’t miss regular monthly columns from EyeforTravel guest columnist Tom Bacon who shares ways that airlines can remain competitive