Tom A's Stock Picks

What the Cost of Oil Might Do to Airline Stocks

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Warren Buffett is famously averse to airlines. You can't help but wonder if the cost of oil has something to do with his sentiment. He said that between the first flight at Kitty Hawk and the present day, the net return from money spent on airlines is zero or less than zero.

After a misadventure investing in an airline, he declared himself an "aeroholic" and claimed to have an 800 number he can call so someone will talk him out of buying another airline if he ever gets the urge again.

American Airlines (AMR) recently announced they are reducing flights by 10% or more and plan to retire 75 aircraft. They maintain that the airline industry is not built to withstand the rising cost of oil. AMR stock is off 25% today. Other airline stocks have been hammered.

I don't follow the airlines very much - at one time I took an interest in Southwest Airlines (LUV) and came close to buying it. Their operating philosophy at the time involved hedging most of their fuel exposure, and their financials included figures that took you past the gain/loss on hedging fuel and got you to the actual operating gain/loss. Analysis of today's price action in airline stocks focuses on the extent to which they have hedged their exposure to fuel price increases.

Hedging is always a two-edged sword. If it works as planned, it can be a tremendous business edge, as it once was for Southwest Airlines. Hedging, if done poorly, can become ineffective and exacerbate an already bad situation. With the amount of speculative activity in the whole oil, gas and distillates market, it must be a nightmare to control this cost - especially with the rising cost of oil. If I were in airline management, I would resist hedging too much of my fuel exposure for fear of getting caught when the bubble bursts.

With the wisdom of 20/20 hindsight, shorting the airlines would have been a good way to play the oil bubble. Perhaps now there's a good way to play it in the other direction. If oil prices drop, airlines should go up.

Maybe it would be a good idea to back up the truck and load up on the discount merchandise. Or you could just call that 800 number and see if anyone talks you out of it.