Warren Buffett astounded investors on Saturday by announcing that Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B) had dumped its entire stake in U.S. airline stocks. Berkshire owned considerable +10% stakes in the four major U.S. airlines. The fact that they were sold at a painful loss came as quite a surprise to the market.
What does this mean for Air Canada (TSX:AC) stock? I think it means a lot. As a popular Canadian stock, investors need to be very cautious about buying it now. Mr. Buffett’s trade explains three reasons why the stock should be avoided.
Institutional capital will be hard to come by for airlines
First, if Warren Buffett is clearing house on the airlines; other value investors are likely doing the same. This is a very bad technical and economic signal for the sector. At a time when airlines need capital the most, it may also be the most elusive.
Airlines like Air Canada have very high fixed operating costs (maintenance, airport fees, regional contracts) and significant debt burdens (airplanes are expensive). Air Canada was forced to reduce its flying capacity by 80% or more when the pandemic hit. This left it strapped for working capital to cover its fixed expenditures.
Capital injection by a company like Berkshire Hathaway would be a perfect lifeline for this industry. However, Mr. Buffett’s selloff indicates that institutional investors are just too wary to invest in such a risky industry. Going forward, airlines may seriously struggle to attract life-saving institutional capital.
Warren Buffett suggests travel trends are changing
Second, Warren Buffett noted that “[t]he world has changed for the airlines.” He implied that people’s long-term habits are shifting as a result of the pandemic. The crisis has a created a new wave of doing business, which has called into question the need for business travel.
Today, businesses are collaborating across the globe through cloud-based platforms, like Zoom and Microsoft. Extensive business travel may no longer be necessary. I don’t think person-to-person meetings will disappear; however, business travel is less a necessity than it once was.
Likewise, leisure travel is going to be a challenged segment. The coronavirus is still a major public danger. Without a cure, people are not going to be too eager to hop on a tightly packed airplane just to get their beach tan on.
Air Canada has significant exposure to international and vacation-related travel (especially with its deal to buy Transat), so it is particularly vulnerable right now.
Warren Buffett may believe the worst is still ahead for airlines
Third, I believe Warren Buffett sold his entire airline stake because he still sees significant downside for the industry. Mr. Buffett is best known for being a long-term value investor. Why else would he sell at a serious loss? His impression of the next few years must be so poor that he figures it is better to take the lesser loss now rather than a worse loss later.
This concern can be seen in Air Canada’s recent first-quarter results. Air Canada saw its EBITDA drop by 88%, and it incurred an operating profit loss of $433 million. This quarter did not even encapsulate the worst of this crisis!
Management’s outlook is pretty dire. Its operational capacity will be lower by 85-90% in Q2 and 75% in Q3. Management added on nearly $3 billion of debt just to shore up its working capital. This rising debt level is concerning considering Air Canada might not see a recovery to normal (2019) operational capacity for at least three years. Air Canada is one of the best airline operators in North America, but if this is a picture of the future, it is worrisome.
The bottom line
Warren Buffett is one of the smartest investors on the planet. If he is selling his airline stocks, I wouldn’t touch Air Canada. There are too many short-term risks that make the outlook for Air Canada impossible to predict. Perhaps you shouldn’t avoid Air Canada forever, but today’s damage is done, and it is significant. Only time can tell if the stock can recover.