Sometime this spring, U.S. Global Investors is going to launch The U.S. Global Jets ETF that is an index fund for airline companies. The ticker symbol will be the cutesy JETS and it’s something you will be able to buy in the next month or two. Of course, if you’ve been reading my work for a while, you already know what I’m going to say: Stay far, far away from this creation.
Famous investors have long pointed out that long-term investing in the airline industry is not a reliable way to make money. Some say it in a matter-of-fact way—when Donald Yacktman was asked what airline stocks he owns, he responded, “Zero. Clients invest with me because they expect me to make money for them.” Even Richard Branson, who started Virgin Airlines, stated that the “fastest way to become a millionaire is to buy a billionaire his own airline.” When Warren Buffett invested $358 million in USAir Group, he had to write off the entire investment as a loss and later said, “If a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down. The airline industry’s demand for capital ever since that first flight has been insatiable. Investors have poured money into a bottomless pit.”
The reason why airline stocks, in aggregate, cause so much trouble for investors is that (1) fixed costs are high, with fuel being an important input cost that can only be controlled in a limited way through hedging, and (2) the ability to raise prices is nearly non-existent, leading to unreliable revenues as bankrupt airlines are permitted to continue operating while in bankruptcy and forcing the solvent airlines to compete with them on cost. The numbers bear this out. From 1934 until March 2009, airline indices actually made 0% over eight decades of investing. That end point was the market low of the last recession, but it is still quite telling that airline investors had nothing to show for it after a lifetime of investing. From 1934 to 2014, the numbers are better: Shareholders have compounded at 3.6% annually owning an airline index.
The little wealth created by airline investing is the result of two outliers. Southwest Airlines, since 1980, has compounded at 16.8% annually to turn $10,000 into $2.4 million. You also have niche airline Alaska Air returning 21% annually for shareholders since 2004. The distinguishing characteristics of those two companies are that: (1) they have lower costs by focusing exclusively on profitable routes rather than empire-building and they do not carry significant legacy costs such as pensions, and (2) they offer minimal services so that they have higher profit margins per flight. They don’t have any magic formula for achieving pricing power that the other airlines lack, but they have been able to keep costs lower than their peers.
They have done things like operate Boeing 737 aircraft exclusively, so the replacement parts and employee training costs are less diverse, and consequently, lower. It avoided meals, assigned seats, and anything that would take up time and require money to execute. People tend to speak out against this type of treatment—saying they don’t like to be treated like cattle—yet they vote with their dollars differently, often turning towards Southwest in markets where it is the low-cost carrier even if they say they prefer more amenities (when it comes to decide, airline customers tend to choose cheapness).
I would regard Southwest and Alaska Air as statistical outliers—my take-home conclusion isn’t that investors should rush to pour their money into these two successful companies in the airline industry—because it requires constant excellence of execution by management to be a continued success. There is little brand equity, moats, or permanent paths to revenue growth. The sustained ability to be a low-cost carrier, and expect fuel prices to be low relative to ticket prices, is a necessary condition for these stocks to make great investments going forward. The probability that this is a place worth investing isn’t high enough for me—you could just take your money and put it into Nestle, and even if management is mediocre over the coming half century, shareholders would still compound wealth at 7% or 8%. I have a strong preference for industries that nearly guarantee investment success, rather than finding exceptions in terrible industries that have to perpetually get things right to work out for shareholders.
Regarding the new JETS fund being launched by U.S. Global Investors, the timing of the airline ETF is also unfortunate. Last year, Southwest Airlines was the best performing stock in the S&P 500 Index. It doubled its profits from $1 billion to $2 billion. These profit gains in the airline industry haven’t really been the result of revenue growth—revenues have only grown 5% total over the past 30 months, but rather, a 40% decline in fuel costs that has seen airline operators now pay only $1.90 per gallon for fuel. This figure varies by company throughout the industry because of hedging. But still, it is important to recognize that there is an illusory component to current airline profits because of fuel prices recover to 2014 summer levels, a good chunk of that profit will disappear. They aren’t entrenched as a permanent base going forward.
In short, my reasons for encouraging you to avoid this JETS ETF are two-fold: One, airline stocks are notoriously poor long-term investors with essentially no wealth being created over the long haul in aggregate because the economic cycle takes many airline players bankrupt as the fixed costs are high and the pricing power is nearly nonexistent. In addition to this, making long-term airline investments now is especially poor timing because fuel costs are unusually low and airline profits have been propped up (and so have their valuations, too). I can’t imagine someone buying JETS shares in 2015 having much to show for it in 2035.
Originally posted 2015-04-08 09:49:31.
