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Dec 21, 2016

S3 BLACKLIGHT: Short Sellers Eject After Buffett’s Airline Investments

With revenues surpassing October guidance, the major U.S. airlines are experiencing higher than initially expected revenues per unit sales. Higher seat prices, although partially offset by higher fuel costs, have positively affected 4th quarter margins. The airlines are looking to maintain these airfares through the yearend holiday season. As a result, stock prices in the airline sector have continued their rally which began in the middle of this year. With stock prices rising, short sellers have started covering some of their positions with short interest in the sector down $544 million in the last month.

Warren Buffet, of Berkshire Hathaway (BRK/A US), recently invested in four airline stocks and now owns $1.1 billion of American Airlines (AAL US), $344 million of United Continental (UAL US), $322 million of Delta Airlines (DAL US) and a yet to be disclosed amount of Southwest Airlines (LUV US). Warren Buffet has not been a fan of the airline sector after his 1989 investment of $358 million of USAir preferred stock lost 75% of its value before netting him a 70% return. His bullishness may be a signal that he expects oil prices to remain stable or more likely decrease in the future which would lessen the airline’s largest expense item and widen their margins even more. In addition, after the airlines grew their capacity at a faster rate than the U.S. economy, Buffett may be looking for a significant increase in business activity and GDP to allow airlines to reverse a yearlong drop in airfares and boost revenues. Consolidation has also minimized competition for many routes, which lessens the cannibalistic nature of airfare pricing. Greater margins and increased gross revenues in the concentrated, almost oligopolistic, airline industry may mean that the top players are finally in a position to thrive.

One interesting side note, according to the Harvard Business Review, is that several large institutions hold large positions in multiple airlines. Prime Capital Mgt, Berkshire Hathaway, Vanguard, Blackrock, State Street, JPM Asset Mgt, T Rowe Price, PAR Capital Mgt, BNY Mellon Asset Mgt and Fidelity are all major holders in several or all of the four major airlines (American, Delta, Southwest and United). The cut throat price war competition that slashed profits across the entire airline industry may be a thing of the past as these large multi-airline institutional shareholders will be more interested in finding a way to increase industry wide profits rather than any one individual airline succeeding at the cost of the others.

Since Berkshire reported their airline holdings, short interest in the airline sector is down $544 million in the last month. Short interest has decreased from $6.62 billion to $6.08 billion with most of the short interest concentrated in the top four airlines. $4.3 billion, or 70%, of airline sector short interest is in American, Delta, Southwest and United airlines – the same four airlines that have large common institutional long shareholders. With the top six institutional holders of these airlines owning over 40% of the common stock this is no longer a stock picker’s market segment. Investors like Blackrock, Vanguard, Prime Capital and Berkshire do not invest in one hit wonders, they invest in industries that are poised for longer term growth and price appreciation. Short sellers have noticed and have begun trimming their exposure – we can expect more buying to cover in the near future.

For more information on the above analysis, please contact:
Ihor Dusaniwsky, Head of Research, S3 Partners, LLC     Ihor.Dusaniwsky@S3Partners.net
The information herein (some of which has been obtained from third party sources without verification) is believed by S3 Partners, LLC ('S3 Partners') to be reliable and accurate. Neither S3 Partners nor any of its affiliates makes any representation as to the accuracy or completeness of the information herein or accepts liability arising from its use. Prior to making any decisions based on the information herein, you should determine, without reliance upon S3 Partners, the economic risks and merits, as well as the legal, tax, accounting and investment consequences, of such decision.

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