Updated: April 29, 2013 5:59PM
Dear Mr. Berko: Now that American Airlines is going to merge with US Airways Group Inc., do you think the resulting company will be a good investment? I have almost $9,000 in my individual retirement account to put to work, and if you think this merger, which will create the largest airline in the world, will be a profitable company, I’ll invest half of this money in the new airline. Also, please tell me what you think about Martin Midstream Partners LP. I would invest the remaining half in this one. Please let me know quickly.
— K.D., Moline
Dear KD: A friend of mine recently asked whether I thought airlines would be a good investment, and I responded with a caustic “no,” commenting that airlines are difficult businesses to manage because they have so many moving parts. That’s true, but the reason is a little more complex than my short-shrift answer.
Do you remember the names Eastern and Braniff? How about Pan American, Ozark, TWA and Allegheny? And can you recall the TV adverts sponsored by Northwest, Continental, Midwest and Aloha? How about regional carriers that no longer have wings — such as America West, Hooters, People Express, ValuJet and Skybus?
None of those once-proud sky travelers is still in business. Airlines don’t make money; they lose it and declare bankruptcy. Then their debts are restructured, or they merge with an equally weak competitor and declare bankruptcy again. Then Wall Street finds other suckers to invest in a new airline, presenting the same wine in a new bottle, and they go bankrupt again.
It’s a very profitable charade for the financial community. Basically, only bankers, traders, investment bankers, lawyers and accountants are allowed to make money on the airline stocks. The good folks, the believers, the small investors and Mrs. Jones, who bought airline bonds for income, almost always lose.
And I’m willing to wager $3 to a road apple that if you purchase the newly minted shares of the American-US Airways alliance, they will be worth less a year from the date of your purchase than the price you pay today. Airline stocks since 1978 have been speculations, not investments.
Before Congress passed the Airline Deregulation Act in 1978, this industry was in the pink. Flights were on time; baggage was seldom lost; the attendants were attractive; seating was OK; there were no baggage fees; the food was fine; planes didn’t get stuck on the tarmac; passengers were happy campers; carriers always earned a profit; and investors made money. However, when deregulation opened the skies to competition, the fit hit the shan. Ticket prices crumbled; management did everything on the cheap; the unions went bonkers; and managing an airline became like minding an asylum of loonies. Now nothing makes sense.
For example, United Continental Holdings Inc. (UAL) and Delta Air Lines Inc. (DAL) have lost more than $50 billion since 2007, and their balance sheets have been as porous as Swiss cheese. But UAL and DAL trade at $25 and $15, respectively. Lousy companies and lousy investments.
And in the same time frame, US Airways and American have lost billions, and now the merger is being touted by Wall Street. However, Southwest Airlines Co. (LUV) makes money every year and never has posted a loss.
A dozen years ago, LUV earned 51 cents a share, and the stock traded at $23. Today, with expected record profits of $670 million and an impressive balance sheet, LUV trades at $11 a share. A great company but a lousy investment. Go figure.
I should have told my friend that since deregulation, airlines have become speculations. Their balance sheets, with debt representing an enormous 85 percent of capital, are so highly leveraged that small increases in operating costs can create large decreases in earnings.
I should have said that with the exception of Southwest, there’s not an American airline management team capable of earning consistent profits. And I should have said that competition among carriers for passengers is so severe that carriers have flown passengers at losses to generate cash flow.
The industry will feast for a couple of years. Then it may be famine again.
Address your financial questions to Malcolm Berko, P.O. Box 8303, Largo, FL 33775, or e-mail him at email@example.com