If you must buy a commercial airline stock, buy WestJet for its dividend

There are better investment choices in the transportation industry than a commercial airline for your portfolio. But many investors still seem to be captivated by the notion of glamour attached to flying and crave to be part of the industry. (Perhaps they just haven’t flown enough lately to divest themselves of that notion of glamour!)

Successful investors such as Warren Buffett and Peter Lynch have pointed out that commercial airlines are, by and large, unprofitable. This shows that selling necessities doesn’t guarantee profits. Things such as competition get in the way of making money. Sooner or later, most airlines find themselves in trouble and often go bankrupt.

In 2000, billionaire Warren Buffet said, “Here’s a list of 129 airlines that in the past 20 years filed for bankruptcy. . . .The money that has been made since the dawn of aviation by all of this country’s airline companies was zero. Absolutely zero.”

This is true of other countries as well. For instance, we counted 83 Canadian airlines that went defunct over the years.

Peter Lynch was the successful manager of Fidelity’s Magellan Fund. In his book Beating the Street, Mr. Lynch writes, “In the 1980s, what business was worse than the airline business? Eastern, Pan Am. Braniff, Continental, and Midway went bankrupt, and several others were on the verge of doing so.”

The eccentric, very rich Howard Hughes wanted to be the world’s greatest pilot. He was fascinated by airplanes and built the largest airplane in his time. Mr. Hughes, however, became involved in Trans World Airlines. Mr. Hughes’ financial wizard, Noah Dietrich, recounted how TWA threatened to bring down Mr. Hughes’ empire. Fortunately, Mr. Hughes extricated himself from disaster and the subsequent bankruptcy of TWA.

Selling necessities can prove unprofitable

Most people today consider airline travel a necessity. The recent FIFA soccer tournament in Brazil would have suffered from poor attendance without airplanes. With airplanes, of course, hundreds of thousands of people from around the world went to Brazil. The earthquake in Haiti several years ago would have killed many more people without airplanes to deliver supplies and personnel to the devastated Caribbean island.

Selling a necessity, however, is not enough to ensure a company’s success. Many other factors come into play. Airlines, for instance, are likely to face more demand when the economy is strong. The trouble is, that’s when the prices of oil and jet fuel are likely to be much higher. Prior to the financial meltdown of 2008, for instance, oil went up to over US$150 a barrel. Airlines also face large capital expenditures that can eat up a lot of their cash flow.

Then there’s competition. Air Canada faces successful domestic competitors. In 2000, it acquired arch-rival Canadian Airlines International. At that time, an Air Canada executive scolded us, saying “You’re doing your readers a disservice by telling them to sell our shares. We are the airline industry.” We never heard back from him after Air Canada went bankrupt. The “new” Air Canada has lost more money than it has ever made and now faces successful domestic competitors such as WestJet Airlines and Porter Airlines. Both are expanding.

WestJet looks better than Air Canada

One hallmark of successful companies is that they pay dividends. WestJet has raised its dividend each year since it introduced them in 2010. Air Canada fails to pay dividends. As a result, with WestJet, you can profit even if the share price goes nowhere. You can’t profit from Air Canada unless its shares rise in value. Yes, Air Canada’s shares have risen substantially this year and they may still have some upward momentum. But a long-term rise in Air Canada’s shares is uncertain. It’s possible that all the ‘easy money’ from Air Canada has been made. Speculators who buy now may be left holding losses when the shares ultimately fall.

Furthermore, the whole Canadian airline industry faces competition from U.S. airlines. Many Canadians go south of the border for significantly cheaper flights. Even the decline in the loonie relative to the greenback wasn’t enough to keep Canadians from driving to the U.S. to fly from a U.S. airport. This hurts Air Canada more than WestJet because Air Canada serves far more U.S. and international destinations in competition with U.S. carriers.

 

 

The Investment Reporter, MPL Communications Inc.
133 Richmond St. W., Toronto, On, M5H 3M8, 1-800-804-8846

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