Warren Buffett famously said when others are fearful it's time to get greedy. The COVID-19 coronavirus has sparked a wave of selling through the airline industry, with investors terrified today's industry leaders will soon go the way of Pan Am, Braniff, or TWA.
Buffett's Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) reacted in the early days of the sell-off, buying up 976,000 shares of Delta Air Lines (NYSE:DAL) in late February. But the airline stocks have fallen significantly further in the weeks since.
Could the Oracle of Omaha soon aim his legendary "elephant gun" at the airline industry and buy an airline outright? And if so, what company is the most likely to be acquired?
One last big deal?
Berkshire Hathaway has more than $128 billion in cash on hand, and Buffett appears to be looking for one more big deal before he retires. He's shown an interest in transports and aerospace in the past, adding Burlington Northern Santa Fe railroad in 2010 for $26 billion and Precision Castparts in 2016 for $37 billion.
Buffett downplayed the talk of buying an airline outright during a Feb. 26 interview on CNBC, noting the high level of regulation in the industry and saying that creates "complications" in transactions. But that's not a firm denial. Buffett is a value investor at heart, and shares of the four airlines currently in his portfolio have fallen an additional 12% to 26% since he gave that interview.
Buffett has been known to change his mind about airlines in the past. In his 2007 letter to investors he called the airline sector un-investible, famously saying "if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down."
Thirteen years later, the four largest U.S. airlines make up a sizable part of the Berkshire portfolio.
Which airline would Berkshire buy?
Most of the parlor talk about Buffett and the airline business in years past has focused around Southwest Airlines (NYSE:LUV), a longtime industry maverick that has matured into one of the "big four" dominating the U.S. domestic industry. Berkshire is the second largest holder of Southwest shares.
Southwest offers simplicity, flying only one type of aircraft to mostly domestic and Caribbean destinations. It eschews the complexity of international alliances, has a reputation for not nickel and diming customers, and is the closest thing in the airline industry to the folksy-feel that Buffett tries to cultivate.
But Southwest is also expensive relative to its peers, trading at 10 times trailing earnings when Delta, American Airlines Group (NASDAQ:AAL), and United Airlines Holdings (NASDAQ:UAL) are all trading closer to five times earnings.
Southwest also has potential headwinds on the horizon, as its future growth is tied to Boeing's troubled 737 MAX. Furthermore, Southwest is showing signs of maxing out the growth potential of its simplified route structure, meaning it might be forced to adopt some of the more complex operating procedures of its rivals in the years to come.
Delta, meanwhile, is the only airline position we know Berkshire has been adding to, and Buffett has professed his admiration for the company in the past.
Buffett typically keeps Berkshire's holdings to below 10% of shares outstanding to avoid more onerous disclosures and regulations. Berkshire's stake in Delta crossed the 10% threshold last year due to the airline's stock buyback program, and Buffett told CNBC not long after that he'd decided not to sell the stake down because of the quality of the company.
In Delta, Berkshire would get a company that has led an industrywide transformation that has positioned the airlines to survive this downturn and has given Berkshire the confidence to buy into the sector. It is a best-of-class business trading at just over five times earnings and 0.5 times sales.
American and United are also possibilities. However, American has an industry-high debt load that would need to be addressed, and United has been a chronic underperformer until recently, though it has made great strides under its current management. Although United has a less-than-stellar reputation due to some high-profile customer service snafus, it does have close ties to the energy sector Buffett knows well thanks to its Houston hub.
Will Warren pull the trigger?
I think Berkshire Hathaway will announce a major acquisition sometime during the first half of 2020. Buffett has cash to deploy and has shown an eagerness to do one last deal but has complained about valuations in recent years. With every passing day, valuations are beginning to look more reasonable.
Two weeks ago, I would have discounted the chance that deal is for an airline. Buffett is correct in flagging the potential regulatory headaches, including the potential conflicts that would arise from Berkshire owning or investing in both an airline and its credit card partner a la Delta and American Express, for example. And buying one airline would force Berkshire to sell down its stake in the other three it currently holds, potentially at a loss in some cases.
If forced to predict, I'd still bet against it simply because it seems likely there are a lot of other, less complicated options.
But the airlines, despite the negative momentum, are much healthier than markets are making them out to be. And until the coronavirus is contained it is going to be hard for these stocks to find a bottom. If they do keep falling, at some point the opportunity to buy one of these airlines on the cheap might be too good of a deal for Buffett to pass up.