Saturday, April 05, 2008


SKYBUS is ceasing operations. For the first time in 30 years, there has been a steady stream of bankrupted discount airlines. The business has finally turned. Since the airline industry was deregulated in 1978, the bone yards have been filled with quite a number of hub and spoke carriers. The names include the former Titans of the industry, TWA and Pan American. The list also includes many other major carriers such as Eastern and Braniff. Other carriers that survived only after going through bankruptcy reorganization include the likes of DAL, NWA, CAL, and UAUA. Several carriers have gone through bankruptcy more than once and sometimes they have emerged as part of new entities. Piedmont Airlines became a part of US Airways which was latter purchased out of bankruptcy by US West. The causal observer will read about the four carriers that have gone bankrupt in the past week or two and conclude that nothing is new. The observation would be dead wrong.

What is new is that the hub and spoke carriers are putting the point to point discounters out. The competition is falling like flies. Each time a competitor falls, the demand for fuel goes down at the same time that the demand for a seat goes up. My great grandpa was fond of saying that the time to get into the chicken business is when everyone else is getting out. Grandpa understood that the price of chicken feed would go down and the price of chicken would go up soon after a lot of people quit the business.

My daughter flew to LA this weekend partly because she and her fiancee were able to purchase extraordinarily cheap tickets. Now that SKYBUS has flown its last flight, what do you suppose her one way ticket back home will cost relative to the price she expected? She is caught in an unusual circumstance but she and others will think twice about flying on the cheapest carrier in the future.


I have already mentioned that CAL and DAL are two of the carriers that have more cash in the bank than the value of all shares outstanding. The professor who taught Warren Buffet at Columbia University lived during the time when one could occasionally find companies that could be bought for less than their cash value. Since then, the markets have lived through the Go-Go Years and the Technology Bubble. If you are less than 60 years old, you have never seen true value investing at work. Today, there is truly a rare opportunity available. One can buy CAL or DAL at a price below cash in the bank value at a time when the pressure is coming off fuel costs and when pressure is on ticket prices.

The current situation is like the discount movie is being run in reverse. For the past 30 years, discounters have expanded into market after market. If CAL was flying profitable route from city x to city y, the discounter could enter the market and fly full planes at substantially lower ticket prices and turn a substantial profit. CAL might match the new low price but with its higher overhead, it could not push the invader out of the market. CAL might have to lose money on certain flights to maintain its feeder traffic system to its hubs. Profits had to come from the long haul flights, particularly international flights, where the discounter would not or could not go. This picture changed dramatically three years ago when the overhead costs at the legacy carriers was slashed. CAL cut a billion dollars a year in labor costs and realized another billion dollars of savings through technological advances. Most importantly, the legacy carriers contracted with non unionized airlines to match the discounters on the feeder routes. By providing the planes, fuel and other services to the contract carriers, the legacy carriers have given the contract carriers the ability to go toe to toe with the discounters and turn a profit. Since contract carrier passengers earn frequent flier miles on the legacy carriers and because they receive other perks, such as the use of Club Facilities, they have every reason to fly the contract carriers rather than the discount carriers. When this movie is run forward, we see a huge drop in ticket prices each time a discounter enters a market dominated by a legacy carrier. Running this movie backward, we see the discounter being chased away from one market after another and a subsequent jump in the ticket price.

Investors have been disappointed by the failure of DAL and NWA pilots to agree to a merger deal. One could still come to pass, but it does not really matter. There is more than one way to "consolidate or to rationalize" the industry. With the small to medium sized carriers dropping like flies, the "big boys" are going to be able to fly profitable routes.

The current US economic slow down is already old news. By the time the story of economic slowdown or recession is being told daily during prime time, the slow down or recession has historically been already over or nearly so. Friday's payroll numbers tell the story well, a long term chart of the unemployment rate shows that by the time the unemployment rate rises 1.1% the stock market takes off and the recession is soon declared to have happened. Of course the official announcement of the recession is all the more disconcerting to the investing public. The stock market continues to rise while the public bemoans the fact that times are terrible.

The stock market made an inter-day bottom on January 21 and it later tested the bottom. Now, we have day after day of bad news but by the end of the day and the end of the week the market is up. The market backs and fills, partly because of the still unsettled situation with Iran, but on balance it goes up.


It was only a few months ago when airplanes were constantly being forced to wait and wait and wait to land or to takeoff. There was simply too many flights to handle. The current scaling back of flights is a good thing in many ways. The remaining flights will be more likely to be on time and the cost in fuel and time spent waiting will be reduced. The experience for the passengers will be improved. The ticket prices will be higher but the passengers will be willing. Financiers will think long and hard before bank rolling the next new attempt to start a new discount carrier. Existing carriers will gobble up the best of the terminals and landing slots being turned lose by the failing carriers. If Grandpa was around, he would surely suggest that the best time to get into the airline business is when others are getting out.

Last week, the two most significant oil and gas discoveries were in Quebec and the Gulf of Mexico. The find in Quebec is estimated to be at least 4 trillion cubic feet of gas and the find in the Gulf is believed to be at least 500 million barrels. The last discovery in Brazil has not yet been probed enough to make an estimate but the prior discovery was 5 to 8 billion barrels of oil. The invention of new technology has created a shale gas field stampede. There is a frenzy of activity in shale fields in Texas, Pennsylvania, Montana and North Dakota. These shale fields were once believed to be too expensive and too risky to explore. One recent well in Montana that cost almost 4 million dollars to drill hit a pool that will yield at least 700,000 barrels. Sure, a conventional well would have cost only a million dollars to drill but the oil found is probably worth much more than $70 million dollars. An upcoming geological survey is expected to report that the recoverable reserves in the shale field that covers most of North Dakota, much of Montana and significant portions of two Canadian provinces, are between 150 and 500 Trillion Cubic Meters of natural gas!

You do not need to believe that the price of fuel is going to come down to make the case for buying airline stocks. However, if you believe the price will come down, you should quadruple your estimate of profits to be realized by the airlines.


I would appreciate your trying to find another pair of companies like CAL and DAL that can be purchased for less than cash value. Ask around. If you know an investment broker, banker or advisor, tell them you are interested in buying at an extremely low price to sales ratio, price to book ratio and price to cash ratio. I would love to see the list!