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Q2 2020 hedge fund letters, conferences and more
Even before the coronavirus my firm were not big fans of the airlines business. Planes are expensive. Airlines have to pay for them whether they are fully occupied during normal economic times or when they are half-loaded during recessions. Their other big cost is fuel – airlines have little control over it. If they hedge the oil price and it goes up, they are heroes. If they hedge oil and it declines, their unhedged competition will have an economic advantage. It is very difficult to develop competitive advantage; customers usually have very little loyalty and price is the deciding factor for most buying decisions.
Warren Buffett invested in the airlines industry in the 1980s, lost money, and swore he’d never invest in it again. However, after the Great Financial Crisis the industry went through significant consolidation by mergers and attrition, leaving four carriers controlling the bulk of the market. Fewer competitors made competition more rational and turned these airlines into much better businesses. So Buffett changed his mind and bought a 10% stake in all four of the largest U.S. airlines. For a few years it seemed that he was finally right about the airlines.
Airlines were never our cup of tea. The high fixed-cost structure of the industry and its past history of going bankrupt every other recession made our EQ when it comes to airlines very low. When Buffett bought them, for some value investors, the airlines had been blessed by the high priest. We are agnostic (growing up in Soviet Russia has its rare benefits) and have to own our decisions, so we passed on the airlines without spending much time thinking about them.
Typically, when you go into recession you can look at the rear-view mirror earnings for a cyclical company and that becomes your goalpost for future earnings power within a year or two, max. We don’t know how long it will take until we’ll again see the 2019 earnings power of airlines and the travel industry in general. Here is what we know. Though it is hard to imagine this today, the fear of COVID-19 will eventually go away, either because there is a vaccine or a cure, or because the virus is gone, or because we will simply adapt to its existence.
But even in absence of a vaccine or cure, we’ll change our behavior, and that will happen slowly on the margin. After being locked up for a few months, not seeing friends and relatives except on Zoom or Facetime, we’ll timidly visit their houses and sit six feet apart on their porches. (My family did this on Mother’s Day.) Then we’ll invite very close friends – the ones who stuck religiously to social distancing – to our homes for dinner. Then we might chance visiting a restaurant with outdoor seating. Then, on a rainy day, we’ll go inside the restaurant and find that it now has huge spacing between the tables. We’ll make a lot of small incremental decisions; each will be a tiny compromise that will nudge us out of our fear.
Of course, each time we read about serious virus flareups, we’ll take one step back.
Flying is at one extreme in the spectrum of social distancing. It requires finding your way through airports packed with people and then getting on a plane that, even after the middle seats are removed will still have a higher density than a packed bar on Friday night in Manhattan. Thus flying will require a great many little, incremental, marginal decisions before we overcome the fear of boarding a plane.
Vaccine availability would instantly vanquish fear, and our behavior would come back to normal. Well, almost. There will be scar tissue on the economy – trillions in government debt and persistently high unemployment – that will take time to clear up. People are not flying today because we are in lockdown; they’ll be flying less than they used to after lockdown is over because they are still afraid; and after their fear is gone they’ll still be flying less because they cannot afford the flights.
Read the full article here by Vitaliy Katsenelson, Advisor Perspectives
