Billionaire investor Warren Buffett is no fan of the airlines.
In 1989 Buffett made in investment in U.S. Airways for approximately US$350 million in convertible bonds with a 9.25% interest rate. After a few years of the stock basically staying stagnant, he cashed out, getting his principal and interest. On the surface, this looks to be a fairly agreeable result. I think most people reading this would gladly take 9.25% annually on an investment in 2015.
Buffett came out of the experience with a sour taste in his mouth. He said to a newspaper in 2002, “if a capitalist had been present at Kitty Hawk back in the early 1900s, he should have shot Orville Wright. He would have saved his progeny money.”
Ouch. Those are harsh words.
With respect to Buffett and everything he’s accomplished over the years, I disagree with his opinion on the airline industry. I think there are certain stocks in the sector that have the potential to be wonderful investments. Here are three reasons why I think WestJet Airlines Ltd. (TSX:WJA) could be a great long-term hold.
WestJet is obsessed with saving money without sacrificing its level of service.
The company has taken many key steps to keep costs down. It has great relations with labour, knowing that a happy and prosperous employee isn’t going to be interested in unionizing. It also keeps its fleet simple, flying just two different types of planes. This keeps the cost of maintenance down.
This focus on expenses continues to pay off. Based on a per-mile-flown perspective, WestJet’s costs are about 25% less than Air Canada’s. Low costs make it much easier to expand into new markets, since WestJet can afford to undercut its competitors for a while to gain market share and jack the prices back up once it gets established. It’s a smart strategy.
WestJet is also creating demand with its new regional airline, Encore. Air Canada previously had many of these routes alone, leaving it free to raise prices. WestJet has been able to bring costs down while still making money, which created demand from business travelers who were unwilling to pay the higher prices.
Because of Buffett’s famous stance against airlines, many value investors stay far away from the sector. Which is somewhat ironic, considering there’s a strong case to be made for WestJet as a value investment.
Look at it this way: WestJet is continuing to grow its market share and overall revenue, even though western Canada is looking particularly weak. Yet it only trades at 7.4 times trailing earnings. That makes it one of the cheapest stocks on the TSX.
WestJet also has a solid balance sheet, which is doubly important in the airline industry. Yes, the company does owe $1.2 billion in long-term debt, but that’s more than offset by the $1.4 billion it has in cash. And because WestJet has one of the newest plane fleets in North America, it won’t be forced to start replacing planes for years.
Millennials are an odd generation, at least from the perspective of baby boomers. They value things like independence, freedom, and travel, while the boomers value stability, material wealth, and real estate.
This all means one thing–millennials are traveling as much as they possibly can. I’ve seen polls where millennials value travel even higher than having a secure retirement. This attitude will ensure strong travel numbers even if the overall economy is sputtering.
The other trend is the airlines are moving away from being a commoditized business. WestJet is a terrific example of that. It gets revenue from folks who sign up for the WestJet branded credit card, from checked bag fees, from upgrade fees, and from selling stuff while in the sky. Revenue from ancillary sources has surged over the past few years from approximately $6 per guest to $16. With the roll out of WiFi on its planes in 2016, WestJet hopes to keep this trend going in the right direction.
WestJet is perhaps Canada’s finest airline. Shares are cheap, it has a great balance sheet, and its non-unionized workforce is a huge advantage over Air Canada. For those reasons, I think the stock is a great buy at today’s prices.