Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) has waved the white flag on its bet on airlines, announcing over the weekend that it sold its stakes in the four largest U.S. carriers in response to the COVID-19 pandemic.
Even though Berkshire cut its losses on airlines, Warren Buffett's conglomerate still has significant commercial aerospace exposure thanks to its ownership of Precision Castparts. Bought in 2016 for $37 billion, Precision Castparts is a massive supplier of aircraft and engine components used both on new planes and as spare parts.
With airlines slashing schedules and grounding planes, there is going to be less demand for new planes... and less demand for parts. During the company's virtual annual meeting Saturday, Berkshire officials confirmed that Precision Castparts is feeling the pinch, with Buffett saying "the real question is whether you need a lot of new planes or not, and when you're likely to need them, and it affects a lot of people."
With the Oracle of Omaha clearly souring on airlines, what is an investor to think of his continued ownership of a key part of the airplane supply chain?
There's an important difference between airlines and manufacturers...
In explaining his decision to sell airline stocks, Buffett said, "the world has changed for airlines," and indeed it has. With travel demand all but vanishing overnight, the carriers have had to shift from expansion mode to survival mode, cutting flights, grounding planes, and raising cash in hopes of riding out the storm.
When the pandemic is finally over, we will likely be in a recession. If history is a guide, airlines fare poorly in a recession, with past downturns littered with airline bankruptcies and failures.
It might seem dangerous to make a bet on whether individual airlines can survive, but it seems a much safer bet that air traffic demand, eventually, will recover. Arguments can be made about how much videoconferencing will replace business meetings, and, if so, what it will mean for more lucrative business fares. Nevertheless, with the world growing ever smaller by the day and a growing global middle class, it seems likely that there will be an increasing number of planes in the skies in future years.
Viewed in this lens, by selling its airline stocks while retaining its ownership of Precision Castparts Berkshire is keeping some exposure to this long-term trend while divesting away the riskiest part of that exposure. Airlines might go bankrupt, but their assets, the planes, will fly on well after equity values are wiped out.
... But if Buffett's airline sale taught us anything, it is we should never assume
Going into the annual meeting we knew Berkshire had trimmed its airline holdings, but conventional wisdom assumed that the company had not completely sold down its stakes: it would be rather un-Buffett-like to sell low and when others were feeling fearful.
In hindsight, that was a poor assumption. In a similar vein, perhaps we also shouldn't read anything into Precision Castparts still being part of the Berkshire portfolio. Selling a wholly owned business of that size would take considerably more time and effort than selling individual stocks does. It is possible that Berkshire has decided to pull the plug on its large aerospace investment but has not yet found a buyer.
Should Berkshire seek to sell the business, there likely would be ample interest despite the current market conditions. When it was acquired by Berkshire, Precision Castparts was considered to be a top operator. While the outlook for new plane and spare parts sales is bleak for the next year or two, long-term global demand for new airplanes, especially in Asia and developing economies, should survive.
Shares of much of the commercial aerospace supply chain are off 50% to 70% year to date. If Berkshire decided to sell Precision Castparts today it would likely have to accept a similar discount to the company's book value just months ago, but as we have just seen with airlines, that is not necessarily a dealbreaker.
Given Precision Castparts' size, potential buyers are few and far between, especially in this environment. However, it's not so big that a deal couldn't get done, especially if a private equity buyer was able to get it at a fire-sale price.
I see long-term potential. Does Warren?
Of the two scenarios, option one, that Berkshire recognizes the long-term value in aerospace even if it is worried about the future of the individual airline operators, seems more realistic. I believe the purchase of Precision Castparts was a wise one, although admittedly the price looks wildly high today relative to current demand.
As a Berkshire Hathaway shareholder I'd rather see Buffett hold onto the asset and ride out the storm than sell on the cheap and move on. Either way, there is no doubt that Precision Castparts will weigh on Berkshire results for the rest of 2020 and into 2021, if not longer. Precision Castparts is one part of the sprawling Berkshire Hathaway portfolio to watch closely in the quarters to come.