The airline industry has been hit hard by the coronavirus pandemic. Among those suffering are FTSE 100 carriers easyJet (LSE: EZJ) and International Consolidated Airlines (LSE: IAG). Should investors sell their IAG and easyJet shares? Or is this a great opportunity to buy?
Warren Buffett’s oft-quoted advice is “be greedy when others are fearful.” However, he told us last weekend he’s just dumped all his airline stocks. I’ve written about Buffett and airlines a number of times over the years. Here, I’ll put his latest move into context, and tell you whether I’d personally buy or sell IAG and easyJet shares today.
Buffett’s changes of heart
Back in January 2016, I was telling Motley Fool readers about how Buffett reckoned he “got very lucky” managing to exit an investment he made in US Air in 1989. And how, ever since, he’d considered airlines a “death trap for investors.” He bemoaned their “huge fixed costs,” “commodity pricing,” and lack of economic “moat.”
Yet before 2016 was out, he was investing in airlines again. Speculating on Buffett’s change of heart, I suggested American Airlines’ chief executive Doug Parker may have been an influence. Parker was arguing consolidation had ended the boom-and-bust cycles that had plagued the industry for decades.
I found some support for Parker’s idea in the average operating margin of the US’s big four carriers. This had expanded from a low single-digit percentage in 2011 to a high-teens percentage by 2015. And I found a similar story of expanding margins for the UK’s easyJet and IAG. The former’s margin had reached a mid-teens percentage by 2015. And the latter’s hit double digits for the first time that year.
Reversal
As you can see from the table below, 2015 turned out to be the year the average operating margin of the big four US airlines peaked. As did easyJet’s. And while IAG’s continued to expand from its lower 2015 level, it reversed last year.
|
|
2015 |
2016 |
2017 |
2018 |
2019 |
|
US 4 |
18.1 |
16.1 |
13.0 |
10.8 |
11.5 |
|
EZJ |
14.7 |
10.7 |
8.0 |
7.8 |
7.3 |
|
IAG |
10.7 |
11.5 |
11.9 |
15.2 |
10.2 |
Source: morningstar.com
Looking at the margins over the past five years, the erosion has been somewhat mixed. However, overall, there’s clearly been erosion. I think it’s fair to say that even before the coronavirus pandemic, the 2019 margins were suggesting airlines had become less attractive businesses than they appeared from their margins five years ago.
IAG and easyJet shares in the market crash
As I’m writing, the FTSE 100 is 24% below its pre-market-crash high of earlier this year. However, IAG and easyJet shares have slumped 70% and 65% respectively.
Clearly, these airline stocks have substantial potential upside. And I see some merit in the argument that as relatively strong players in the industry, they could consolidate their market positions in a post-pandemic world.
Would I buy or sell IAG and easyJet shares?
My immediate concern is that both companies may have to conduct dilutive equity fundraisings to get through the crisis, if it drags on. Or come out the other side with crippling debt and financing costs.
In the longer term, the margins of 2015 appear not to have signalled a permanent change for the better in the profitability dynamics of the industry. I think it’ll forever remain capital-intensive, competitive and cyclical. As such, on both the near-term and longer-term outlooks, I’d personally sell IAG and easyJet shares today.