Dear Mr. Berko: I have a large portfolio of conservative issues that pay good dividends. Now I'd like to be more aggressive and own some issues that could improve my portfolio's growth better than the dividend stocks I own. I just want some more upside in my portfolio.
The economy is improving, and that's good for the airline industry, so I am thinking of buying 400 shares of American Airlines. I'd appreciate your thoughts on this stock and the industry. — CC, Port Charlotte, Fla.
Dear CC: In a 2007 letter to shareholders, Warrant Buffett told investors the following: "The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. Think airlines. Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers. Indeed, if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down." Just a few years earlier, Buffett's Berkshire Hathaway had lost $40 million investing in airline issues.
Airlines are not attractive long-term investments, because airline industry profits reflect the ups and downs of our economic cycle much more acutely than profits of other industries. But for the near term, the outlook seems positive. The industry expects robust demand in passenger traffic as economic growth and consumer sentiment improve. And carriers in the shipping business expect to gain new revenues from a general improvement in the economy. Meanwhile, the recent tax cuts are a positive, especially for airlines that generate most of their business in the U.S. Finally, most carriers have fairly good cash positions and strong balance sheets, thanks to eight years of low interest rates.
But remember that at one time, Eastern, Braniff, Pan Am, Republic, TWA and National were 24-karat gold names and enjoyed healthy balance sheets. Today those carriers are romantic memories of yesteryear. Be mindful that Delta, Northwest, United and others also declared bankruptcy. They were able to restructure, but their shareholders and bondholders lost billions.
American Airlines (AAL-$50.41) — after years of labor and management strife, cost cutting, huge losses, and declining revenues — declared bankruptcy in November 2011. Bondholders lost a fortune as debts were settled for pennies on the dollar, and shareholders ate dirt. Investment bankers eventually restructured AAL and merged it with US Airways in 2013. In December of that year, the merged company came public as American Airlines Group at $25. And in November 2016, Buffett's Berkshire Hathaway bought 50 million shares of AAL.
For reasons mentioned earlier in this column, AAL could be a fair short-term (meaning a few years) investment. AAL has a fleet of 1,000 aircraft and operates 6,700 flights daily to destinations in 54 countries. Since exiting bankruptcy, AAL has had a so-so load factor of 82.4 percent, versus an industry average of about 84 percent. I'm also disappointed that AAL's 4.8 percent net profit margins are lower than the industry average of nearly 9 percent. On the positive side, the tax cuts (the effective tax rate should fall from 38 percent to 24 percent) may improve profits by 65 cents a share. This might allow AAL to report 2018 earnings of $4.85 a share on $44.5 billion in revenue, up from $3.90 and $42.2 billion in 2017. Still, that ain't no box of chocolates. If you look closely at those numbers, you'll recognize that 65 cents of those earnings would account for 70 percent of the 2018 earnings increase. However, AAL's capital building program has been a potent force for shareholders. Since 2014, AAL has returned $11 billion of capital to stockholders, and the company's outstanding share count has fallen by more than 35 percent. But I'd rather management use some of that money to increase its Scrooge-like 40-cent dividend, which yields a mingy 0.74 percent.
I'm neutral on the stock, but Buffett's 50 million-share position suggests he has more relevant information than I do. Follow him!
Please address your financial questions to Malcolm Berko, P.O. Box 8303, Largo, FL 33775, or email him at [email protected] To find out more about Malcolm Berko and read features by other Creators Syndicate writers and cartoonists, visit the Creators Syndicate website at www.creators.com.