It's a great airline… shame about the shares
Way back in November last year, I suggested "I wouldn't want to be an airline CEO (https://www.smh.com.au/business/motley-fool/rearranging-the-qantas-deckchairs-20121130-2akx4.html) for quids". That's probably putting it mildly. The article was – correctly, as it turned out – titled 'Rearranging the Qantas deckchairs'.
A year earlier, I wrote 'Nightmare for Qantas shareholders to continue' (https://www.fool.com.au/2011/10/31/nightmare-for-qantas-shareholders-set-to-continue/), noting that the global airline industry was effectively running at a loss, in aggregate, over the previous decade.
You're probably seeing a pattern – and you're right.
Hope springs eternal
For some reason, it seems that for airline investors – like those who buy mining hopefuls – hope springs eternal. They desperately hope that 'this time it's different'. As an investment thesis, that's not a great idea, unfortunately.
It should come as no surprise, and won't to regular Motley Fool readers, that Qantas (ASX: QAN) is having trouble. But the commentary from Alan Joyce at Qantas is nicely hiding the real problem. Joyce complains that Virgin Australia (ASX: VAH) has an advantage because it has access to overseas investors who are prepared to inject cash into the company.
He's right about that – but the very need for a fresh cash injection is the problem, not the solution. Virgin Australia shareholders were diluted by a very significant 35% when it raised more equity recently. For shareholders, the question isn't whether they can find an additional equity injection, but whether the companies can be self-sustaining enough to not need more cash!
But Qantas' problem isn't with Virgin, and it's not limited to Australia.
Irrational competition
The international airline industry is one that is plagued with excess capacity, enormous fixed cost and very little in the way of brand differentiation. It's a vicious cycle, excess capacity (more seats than passengers) means airlines lower their prices in an attempt to keep the planes full. Of course, when everyone does that, prices fall to uneconomic levels – and profits are hard to come by, especially when new airlines pop up like weeds.
Most of the major US airlines have been in and out of bankruptcy protection – some more than once – and others require low cost financing or government subsidies to remain in operation.
But here's the thing – nothing about that is new. Investors have had decades to get used to the dynamics of the airline industry – the chronic overcapacity, the continually falling prices and the irrational business decisions by management, and those problems have only been exacerbated by the new airline entrants who – unencumbered by legacy costs and old ways of doing business – have further pushed prices down.
If that description sounds like the automotive industry or the steel industry, that's far from coincidental – each has come under threat because of high fixed costs, an inability (or unwillingness) to change and little in the way of genuine differentiation. Of course there are exceptions – like there are in the airline industry – but they're the exceptions that prove the rule.
Government support won't save investors
As the generations of failed government support for the automotive industry have shown, governments have no place getting involved in industries just because they have "poor economics, irrational competitors or a lack of differentiation" (https://www.fool.com.au/2013/10/08/dont-ever-buy-these-3-asx-shares/).
At the time, those calls for subsidies, investment and other regulatory interventions seem to make sense, but when they persist for decades and the eventual outcome is the same, it's hard to escape the conclusion that the medicine would have been best taken at the time, rather than kicking the proverbial can down the road, replete with many millions of dollars in support along the way.
A company like Qantas has responsibilities to its shareholders; to grow shareholder wealth. Injections of funds – from overseas airlines in Virgin Australia's case, or the federal government, as Qantas would have it – dilute current shareholders. The survival of the company matters little if its owners are significantly diluted in the process.
Foolish takeaway
Qantas' share price has varied widely over the past few years – and will likely do so in future. Despite those movements, the underlying business remains poor, despite management's best efforts.
Investors would be wise to remember Warren Buffett's sage advice: "When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact."
I enjoy flying with Qantas. I wish Qantas management and staff all of the success in the world. I just won't be investing alongside them.
