Caution: even Warren Buffett loses money in airline stocks

Airline stocks like China Eastern Airlines (CEAquote) and Tam SA (TAMquote) may look attractive to emerging market investors, but consider the economics of the industry first. Even the big players can get burned.

Image courtesy Pablo CM: need for caution buying airline stocks was underscored by a recent study conducted by consulting firm Oliver Wyman for the Wall Street Journal.

After working with US Airways to examine airline costs, the firm found that the only thing tighter than the profit margins for a major airline are the seats in the economy section of a regional discount carrier.

Long story short: for a flight carrying 100 passengers, all of the profits are provided by a single passenger. It takes 29 passengers to pay for the fuel for the flight, by far the biggest cost component. Fuel is an even bigger portion of long international flights; about one-third of the total cost.

Next after fuel is personnel expenses: 20 passengers are needed to cover the salaries of the pilots, flight attendants, ground crew, etc. Unions make it difficult to get around this factor. Even discount airlines end up having to raise salaries if they do not want to risk losing experienced personnel or having strikes or other profit-draining labor problems.

On the revenue side of the income statement, about 80% comes from ticket sales. The rest comes from fees for checked baggage, ticket penalties, and other surcharges. That is not an insignificant amount: baggage fees alone accounted for $3.4 billion in the U.S. airline industry. Ticket penalties amounted to $2.4 billion.

The tight margins, needless to say, turn up on the balance sheet and income statement of all air carriers. The profit margin for China Eastern Airlines is only 5.55%. For US Airways, it is only 1.75%. Tam loses money with a negative profit margin of 2.21%. TAM and CEA’s heavy debt load makes them even more uncomfortable for investors in airline stocks.

This is why it’s so hard for investors to make money in airline stocks. Even Warren Buffett has lost heavily from his investment in US Airways, which has filed for bankruptcy twice. (That’s twice as often as all the other legacy carriers.)

For those emerging market investors seeking airline stocks to round out their portfolio, Ryanair (RYAAY, quote), a discount carrier based in Ireland, has a very strong balance sheet (plenty of debt though) and an income statement with a 12.76% profit margin. Year to date, Ryanair Holdings is up 11.56%.

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