First Free Story (1 of 3)Join Skift Pro
Warren Buffett’s Berkshire Hathaway Inc. has made a big bet on the U.S. airline industry. European carriers shouldn’t hold their breath for the Sage of Omaha to come knocking here too.
A 22 percent slump in yearly net profit at EasyJet Plc shows the prospects for Europe’s airlines remain pretty dismal because of a capacity glut that’s eroding fares. Buffett has a kindly public image, but one reason why Berkshire might like airline stocks is pretty worldly: U.S. airlines are making strong profits thanks to a lack of competition. By contrast, their European peers are fragmented and undisciplined.
After a wave of mergers, the four airlines backed by Berkshire — American Airlines Group Inc., Delta Air Lines Inc., United Continental Holdings Inc. and Southwest Airlines Co. — have a more than two-third share of their domestic market.
Less competition means planes take off with fewer empty seats, while airlines make more money from ancillary services such as extra baggage and food.
Of course, with fuel prices tumbling, U.S. airlines have added capacity this year, putting pressure on fares. Even so, they’re showing signs of being more disciplined, as Gadfly colleague Tara Lachappelle explains. Combined with the absence of competition on some routes, that’s prevented a ticket price rout.
Consider Delta. It’s lifted capacity about 2.4 percent so far this year but expects that growth to fall to about 1 percent in 2017, very conservative by European standards. Unit revenue — an indication of fares — fell 6.8 percent year-on-year in its most recent quarter. That’s not great but no disaster. Part of the decline came from Delta’s computer system meltdown.
Contrast that with Europe, where Deutsche Lufthansa AG, Air France-KLM, International Consolidated Airlines Group SA, Ryanair Holdings Plc and EasyJet together have only a 47 percent market share. Here, lower fuel costs have tempted airlines to add new routes far in excess of demand, with no end in sight to the foolishness.
EasyJet’s capacity expanded by 6.5 percent in the 12 months to September, and it’s planning another 9 percent increase in the new fiscal year. With rivals doing similar, yields are plunging. Ryanair expects average fares to fall as much as 15 percent in the second half of its fiscal year. Great for passengers, but not for profit or the returns on capital from the new jets ordered by Europe’s finest.
Little wonder that U.S. airlines can again expect to make most of the industry’s profit this year.
While most airlines trade on pretty low earnings multiples, the better U.S. outlook explains why investors like Buffett will pay up for those stocks.
In a 2007 letter to Berkshire Hathaway shareholders, Buffett wrote:
“The worst sort of business is one that grows rapidly, requires significant capital to engender growth, and then earns little or no money. Think airlines.”
While that may no longer apply in the U.S., it’s spot on for Europe. Buffett’s wise to steer clear.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
To contact the author of this story: Chris Bryant in Frankfurt at email@example.com.
To contact the editor responsible for this story: James Boxell at firstname.lastname@example.org.
©2016 Bloomberg L.P.
This article was written by Chris Bryant from Bloomberg and was legally licensed through the NewsCred publisher network.