Making Hay Monday - June 3rd, 2024
High-level macro-market insights, actionable economic forecasts, and plenty of friendly candor to give you a fighting chance in the day's financial fray.
Charts of the Week
Have U.S. Treasurys (USTs) become instruments of return-free risk? Thanks to their miserable performance since the summer of 2020, one could persuasively argue this is the case. After-inflation, or real, returns from USTs now approximate zero over the last 20 years. (In gold terms, the returns would be deeply negative.) Perhaps this indicates they are poised to generate strong returns going forward. That may be the case during a rally triggered by a weakening economy, that may tip into recession. However, U.S. policymakers are unlikely to sit back and let a recession occur with deficits already at levels normally associated with near-depression conditions. The preventative measures necessary to avoid a severe downturn are highly probable to be inflationary, possibly considerably so. Accordingly, bond bulls should have realistic expectations about how much rates can fall, even assuming a recession.
Oil investors have not fared much better than UST investors, at least since crude peaked in 2008. Adjusting for inflation, oil is down from the equivalent of almost $200 per barrel back then to around $80 today. Using 2000 as a starting point, however, it has doubled on a real basis. Over the last 20 years, there have been few times when crude has traded this inexpensively on a real basis other than briefly during the Great Recession and, more persistently, since the twin oil busts of 2015 and 2020. In gold terms, crude is extraordinarily depressed. Since the start of this century/millennium, gold has risen by approximately 700% while oil is up “only” around 300%. This means oil has depreciated by some 64% when priced in gold, the de facto currency that governments can’t debase
“Luck has a longer reach than wisdom.” -James Lendall Basford
Luck of the Irish
When one of the greatest investors of all time says things like: “If a far-sighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down”. Then, for good measure, he repeatedly stated that he belonged to AA, as in Airlines Anonymous. Consequently, it would be hard to miss his disdain for that industry.
Unfortunately for Berkshire Hathaway’s portfolio, Warren Buffett eventually ignored his own advice. He not only bought one airline stock, but four: American, Delta, Southwest, and United. He began this accumulation spree in 2016 when these companies were, and had been, generating consistent excess, or free, cash flow. They were also using that abundant incoming cash to buy back their own shares. That’s a behavior of which the Oracle of Omaha has long been a big fan.
Unfortunately, that’s not always the best use of funds in a highly cyclical and capital-intensive industry. Even a garden variety recession can expose the flaws in this approach. When a cataclysm like a global pandemic strikes, it can leave the most exposed victims fighting for their existence.
In the case of American Airlines, it increased its shares outstanding by 50% to stay alive in 2020 and 2021. Most unfortunately, these equity raises were at prices far below where it had been repurchasing its shares a few years earlier. In the case of United, the extra issuance was “only” about 30% but, once again, at deeply depressed valuations. It also more than doubled its debt outstanding to weather the worst storm to ever hit that industry. Fortunately, its balance sheet was in decent shape prior to the apocalypse. (American also took on copious amounts of debt to survive the Covid lockdowns.)
Delta and Southwest were in stronger shape; their debt levels going into the pandemic paralysis were commendably debt-lite. The former was about $9 billion while the latter had a miniscule $1.8 billion of long-term obligations. By the end of 2020, those numbers had soared to $27 billion and $10 billion, respectively. Neither, though, resorted to distressed sales of equity.
Very uncharacteristically for Mr. Buffett and his investment team, on or around May 1st, 2020, Berkshire declared May Day on their airline holdings, exiting all four of these positions. While that might superficially seem to have been a misguided move, the results since then were decidedly mixed. While Delta and United have doubled, American has been essentially flat and Southwest is actually down from that point. However, had the Berkshire brain trust waited only until early 2021 and exited all four at that point, it would have been up 100% from 5/1/2020. Ah, the wonders of 20/20 hindsight, especially when looking back to the unprecedented conditions of another 2020… as in, the year.
It's unlikely that Mr. Buffett will, at his age, buy another ticket to ride on any airline stock. Chalk it up to dumb luck, but I’ve had decent success with this group over the years. A key part of that was my willingness, and that of my team, to buy them on the cheap and sell them when perceptions improved, as they did so dramatically from the spring of 2020 to the winter of 2021. Recently, I have to admit to a special fondness for Delta, though it seems to me to be at another profit-taking point. Basically, in my view, these are vehicles to lease and not to own (which is perhaps not a bad idea for the equipment these companies use to transport their customers… unless they have the type of balance-sheet strength we'll soon see in this week’s showcase name.) It’s now time for me to make the case for why there may be an exception to this fidgety approach to airline investing. Behind the paywall, I’ll do my best to elucidate why this company might be a name for you to carefully review.