Air Canada (TSX:AC) is ready to make moves. Warren Buffett’s recent words and actions make this clear.
But will this stock move up or down? Let’s find out.
How to think like Buffett You can never get directly inside someone’s head, but you can monitor their actions and heed their words.
Over the last four decades, Buffett sounded off on the airline industry multiple times. Some of his most famous quotes are about how terrible airlines are when it comes to profitable investments.
“The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money,” Buffett once remarked.
It turns out that this comment perfectly describes airlines. Over the past 20 years, airline passenger traffic has more than doubled, yet dozens of carriers have gone bankrupt. The ones that did survive have lagged the market in terms of stock performance.
Why do airlines continue to struggle, even though demand keeps rising?
Take a look at the Buffett quote again. Pay close attention when he says these businesses require “significant capital to engender the growth.”
Think about how an airline makes money. If you fill a plane and want to grow sales, you need to buy another plane to fly more passengers. To grow, you need to spend millions to keep buying more airplanes. In other words, it’s expensive to grow.
But that doesn’t mean airlines are always bad investments. From 2012 to 2019, Air Canada shares rose 50 times in value! The price potential goes both ways.
Here’s what comes next What does the future hold? Will airlines like Air Canada explode in value, or will they continue their multi-decade malaise?
When Air Canada stock rose 50 times in value, a specific dynamic was at play. Competitors stopped buying new planes, meaning capacity utilization rose. This boosted pricing, generating sustainable long-term profits for the first time in airline history.
Buffett knew the secret to airline success a long time ago. It’s simple: profits push airline stocks higher.
The question today is whether airlines can produce sustainable profits. That’s a dicey bet. Air Canada, for example, is losing millions of dollars per day. In 2020, it’s set to lose more than half its market cap.
Like Buffett explained years ago, the issue is that growth is expensive. Airlines purchased hundreds of planes to support of a 2019 world, but 2020 has been a very different story. Passenger traffic remains 90% below last year’s levels.
These planes don’t disappear when demand falls. The companies that own them still need to pay lease payments, plus storage and maintenance costs. Dramatically lower revenue combined with a static cost base is a recipe for disaster.
Bottom line Air Canada stock won’t remain at these prices for long. If profits re-emerge, expect shares to surge, similar to past environments. But if profitability remains elusive in 2021, expect shares to sink further.
What would Buffett bet on? Considering he sold all of his airline stocks in May, he doesn’t appear overly confident about profits re-emerging.
The post Warren Buffett: Air Canada (TSX:AC) Stock Is Ready to Move appeared first on The Motley Fool Canada.
Fool contributor Ryan Vanzo has no position in any stocks mentioned.
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