December 10, 2011

Why I will never buy an airline stock ?

The short answer to this question is – Most companies in this industry never make any money ! Sure they make money once a while, but over a period of time most airlines loose money. As a whole the industry has lost money for its investors over a period of time.
If you don’t believe me, following is the list of airlines since early 90s, which closed down or got bought out by other airlines.
Air Deccan , Air Sahara , Archana Airways , Crescent Air,  Damania Airways , East West Airlines , Himalayan Aviation, Indian , Indus Air , Kalinga Airlines , MDLR Airlines , ModiLuft , Paramount Airways , Skyline NEPC , Tata Airlines , Vayudoot.
Do you think the airlines which have survived such as jet airways or kingfisher are making money ? Kingfisher’s troubles are in the news and jet airways has lost money in aggregate over the last 5 years. The other airlines are not doing much better.
If the above reasoning is not sufficient, read on
Let’s look at the competitive structure of the industry
Entry barriers
There are some entry barriers in the industry in the form of capital requirements and license. These barriers make it difficult for a small time entrepreneur to start an airline in India, but any one with deep pockets and a desire to burn money can get the required permissions to start an airline.
The entry barrier may be tough, but the exit barriers are even tougher. Once you start an airline , it is not easy to unwind it. It is difficult to layoff the employees and sell off the planes.  In most cases, airlines have generally been sold off to competing airlines for a fraction of the cost of setting it up.
Pricing and competition
Competition in the airline industry across the world is Kamikaze  behavior. It is generally a race to the bottom  as airlines compete on the basis of price. The majority of an airline’s costs are fixed  - cost of an airplane, fuel and salaries  do not vary with the number of passengers flown.
In addition the perishable nature of the product (an empty seat on a flight is a lost forever), the incremental pricing is generally based on the marginal cost of revenue which is  the cost of the peanuts or snacks on the flight.
So an airline looses money whether it flies a half empty plane or drops the ticket price to fill it up. Finally in times of peak demand, a hike in the ticket prices has led to a lot of howling and pressure from the government  to cut down the price hike.
In such an environment, is it a surprise that most airlines in india loose money ?
Power of suppliers
Who are the suppliers to this industry ? They are the aircraft manufacturers, the fuel providers and finally the unionized pilots and other employees.  I don’t think most airlines have much leverage with the aircraft manufacturers or can negotiate the price of fuel . In addition pilots and other personnel are unionized, so airlines really cannot fire them or reduce their pay easily.
In terms of the cost  structure, airlines are pretty much stuck between a rock and a hard place
Irrational behavior of the largest airline in India
I now come to an emotional topic (atleast for me ) – Air india !. You will have to excuse me for the rant and can choose to skip the next few paragraphs.
<start rant > Why the ***@@ is the government running an airline ? We are not a rich and developed country with too much money lying around. Air india has always lost money and now has accumulated debt of 45000 Crs and operating loss of 22000 Crs (there is no typo in these numbers !). The government is planning to pump in 10 billion dollars over the next 10 yrs into airindia !
Can you imagine the waste? . In a poor country like india this money can be spent on infrastructure (roads, schools)  healthcare or education. Heck, even if the government decided to just give away this money to people below the poverty line, I would be fine.
The government in its infinite wisdom continues to run the airline run for politicians and babus. At the same Airindia  prices tickets below cost on several route to increase the utilization factor (on which it is measured) without concerning itself with the profitability of such a decision. This kind of behavior has caused losses for the entire industry which has to match the pricing of  the most irrational player.
By the way, an airticket priced below cost is an indirect subsidy to people like me (who don’t need it). < end of rant J >
Future of airlines in india
Any industry with such poor economics is bound to loose money. This has been the case for airlines in the US and other countries. In addition, we have the largest airline in india (air india) which is not run with any profit motive. In such a situation it is difficult to imagine if any airline will consistently make money over the next 10 years .
In investing, sometime discretion is the better part of valor. I will buy a ticket to fly  (kingfisher is my favorite J ), but will never invest in an airline.
Atleast when I fly by  jet or kingfisher the flight is good and the airhostesses are pretty J .  That is money well spent !


Dhwanil said...

Hi Rohit,

Very true! I Agree with you completely that it's a race to bottom indeed. What perplexes me is why in the world would any smart businessment want to own an airlines? I am still searching for an answer.

Only company that I know of who has made tons of money for investors/shareholders is Southwest Airlines in US. IT has delivered postive cashflows/NP (and growing) for consecutive 32 years! A great achievement in an airlines industry! It has bucked the trend through diffentiated strategy/work culture/cost control.


In addition to your comments, Air India also keeps the price of its tickets at artificially low levels (as you mentioned subsidizing the rich) which makes it even more difficult for other airlines to raise their prices and they are left with no other option but to incur operational losses.

Kiran said...

Very good article!

It also helps to read this article by the brilliant Saj Karsan on Airline investments -

Also, although I understand your anguish with Air India (and I am with you), here's an interesting profile of someone who drove the Airlines to bankruptcy (it seems they were making profits before he took over - can't confirm though; nevertheless, an interesting perspective on Air India and what ails it) -

Anonymous said...

Investing is all about buying at a price significantly lower than its intrinsic value.

any investment which has sufficient margin of safety will deliver returns .

and about airline they have huge growth coming . i heard similar arguments about telecom in 2003-4 and heard they reduce the prices every monthly how they can make money see bharti airtel . people said it has 183 cr. shares and to have 1 rs eps is very tough. and now bharti is at 400 rs.

so my logic says that at current prices spicejet looks to be great investment. it is no nonsense , no frills product which will have low cost structure compare to others

and at cmp of 20 ur paying 900 crs for airline that will have @6000 cr of sales in fy14

so its a buy from my side , lets us see the time can only tell

Happy Value Investing

By Kunal Shah

Ansh said...

Why do business groups or businessmen start an airline at all? If the aviation industry makes losses worldwide, then why are new airline set up at all.

Spicejet's current market cap is 902 crores, it has a 16% market share. That implies that the entire civil aviation sector is valued at 5640 crores, or 1.1 - 1.2 billion dollars.

This seems to be out of whack and there seems to be some disconnect somewhere, Can investing in some airline stock be a contrarion investment at this point of time.

Rohit Chauhan said...

hi dhwanil
you are right is southwest and virigin airlines alone which have done well. In both cases, you have fantastic managers who have developed a one of a kind company and distinctive culture.
however the overall results have been very poor. If one has to bet money, the odds would be of losing money than making in case of airlines


Rohit Chauhan said...

Hi rajshaker
thats true i said in the post, airindia is measured on utilization and not profits. you and me as tax payers fund this white elephant


Rohit Chauhan said...

hi kiran
very interesting link. the best of managers cannot run an airline profitabily ..without our politicans running it ..less said the better


Rohit Chauhan said...

Hi kunal
airlines and telecoms are not strictly comparable. telecoms have economies of scale and their marginal cost is close to zero. once you have invested in the infrastructure ..the cost of addition one more customer is not high and quite often close to 0.
as a result, upto a certain point bharti was able to drop price and still increase profits

Inspite of this all telecom companies other than bharti have lost money and the sector as whole is not doing too well

in comparison, the cost of running an airline is very high and costs fixed with severe price competition, so most airlines dont make money. also they cannot drop prices and still hope to make money

on the second point of growth - yes growth will come, but then profitless growth is worse than no growth.

In case of spice jet, i am not denying that the service is good ..even jet and kingfisher are good for customer. but the numbers for spicejet are not really inspiring. they have lost money in the last 5 years in aggregate, again in the current year and have negative networth. maybe you have an insight into the business and you are right. lets see how it plays out

Rohit Chauhan said...

Hi ansh
what valuation do you give a business which is losing money overall or in 3 out of 5 years ?

have a look at the sugar industry ..that industry has poor economics and has done badly too.

In a short or medium term you can take a contrarian view and when the industry stops bleeding moeny, you could get a bounce in the stock price. you can exit at that time. however that is a speculative game.

again if the industry has lost money in india and in general in other countries ..why should the future be so different in india now ? what has really changes in the airlines business ? planes are more expensive, fuel costlier and pricing power weaker due to the internet


Manjunatha said...

Hi Rohit.

Interesting points, agree with you.
Not only Air India, Lot of State and Central PSUs are making very huge loss.


Sarang said...

Completely agree with you Rohit... about a year back I got tempted to buy SpiceJet (when it was around Rs 80+) but didn't because of my 'negative bias' towards airline industry.
I think airlines is an industry which is first to get affected by a slowdown and last to recover!

Vic said...

Thanks Rohit for another timely article..:-)

I was going to mention Virgin (different from other airlines) but you already answered it.

What's easiest way to become a Millionaire?

Become a Billionaire and then start an airline, you'll automatically become a millionaire..:-)


Venkata Srikanth S said...

Its a nice article...I agree with all the points mentioned above..but i also have one more point i.e in a country like india where infrastructure development takes a lot of proper addition of trains as per capacity...huge migration to metros...the latest love volvo is inching closer towards airlines in terms of costs....airlines have an edge to improve margins might be in the next coming years since flights are easier to add and its private i would like to see how spice jet performs....

fat cat said...

i know this is kinda a mot point but occasionally if u can find a fearless genius this biz might make u cash at the right price....just chek out the ryan airlines ceo...a true cost cutters cost cutter....the dude has managed above average profitability (4 an airline)...for those of u interested chek out geoff gannon s twitter account..he posted a link to o'leary s profile....p.s nice to c dat u n barel karsan r on each others blog roll...maybe some day you ll do a post on unleveraged ,high promotr holding wala wi growth prospects financial stock
take care

Anonymous said...

Hi Kunal here

Now what is the case with airlines in india and spicejet is that couple of large players KFA and AI were pricing tickets lower than cost . But now that has corrected otherwise spicejet was profitable (check out annual report of 2010 and 2011 )

But due to lessors and OMC putting them on cash and carry i do believe that irrational pricing is no more there.

And in case of spicejet it has lowest cost per seat km and it is very efficient and it can make profit at 80% loads if pricing is right.

And no business can survive if it does not make return so if AI and KFA fails and there is no one else daring to jump into airline business it will be good for incumbent like Spicejet, jet & indigo .
And one more thning earlier airline was capital intensive but no it is like service industries where they get planes on lease and operate so they don’t need too much capital to run airline and passengers do pay money and the cost are supposed to paid from passengers money .

My exp. from spicejet is to have 6-8% margin that can be easily done.

By Kunal Shah

green investing said...

Airlines have to be the amongst the single worst businesses to ever be involved in. Speaking from an American perspective, all of the major airlines have been through bankruptcy at least one, and many multiple times. Labor and union costs are a killer, as is the fact that airlines are at the mercy of energy prices (although of the two, I think labor costs and union rules are the worst by far). Just on Friday as I was driving home there was a report on the business radio about American Airlines and bankruptcy. Actually, all of these value-killing airlines like United, American etc. make you appreciate how amazing a company like Southwest Airlines is!

Ashwini Damani said...

But Rohit tell me something, why would then an entrepreneur invest in an airline business. I mean dont the Goyal's and the Branson's know their business better than us.

My logic was that Indian's have really started to fly like anything and surely the way everyone is predicting doomsday for all Airlines (KF, Jet, Indian Airlines) is not justified. India cant have no airlines..

Let me know if I am wrong

Ashwini Damani

Anonymous said...

Rationally, one would short airlines & buy air india tickets.