Airline stocks have long served a useful purpose: For decades, their losing ways helped us understand why some sectors just don't work in long-term portfolios.
But look what's happening now. North American airline stocks, including Air Canada, are on fire and the sector has become far more efficient and profitable.
Some long-term investors, such as Warren Buffett's Berkshire Hathaway Inc., are moving in, raising a question that would have sounded funny just a few years ago: Have airline stocks become buy-and-hold investments?
The thought of sticking with the likes of Air Canada, American Airlines Group Inc. or Delta Air Lines Inc. for longer than a few days would have looked awfully reckless just five years ago.
Airlines' exposure to volatile fuel prices, their absurdly large fixed costs and vulnerability to cheap competition made their results fluctuate wildly, even during good times. During bad times, when the economy deteriorated, they frequently wiped out shareholders with bankruptcy filings.
American Airlines filed for bankruptcy protection in 2011, Delta filed in 2005, US Airways Group Inc. in 2004 (for the second time in two years), Air Canada in 2003 and United Airlines in 2002 – to name just several examples.
But their reputation for teaching investors some painful lessons is now falling apart.
For one thing, share prices have been dazzling. Air Canada shares rose 34 per cent in 2016. The S&P 500 airline index has surged nearly 60 per cent over the past six months and is up about 250 per cent over the past four years.
Sure, there has been enough volatility here to challenge anyone to stay put.
But the nice thing about the recent rally is that it has followed steadily improving underlying performance that suggests today's airlines are in far better shape than they used to be.
Mr. Buffett, who had sworn off airlines for decades following a 1989 investment in US Airways Group Inc., confirmed in November that Berkshire Hathaway – the definition of a long-term investor – had taken stakes in the major U.S. carriers: American Airlines, United Continental Holdings Inc., Delta and Southwest Airlines Co.
Observers noted that the famed investor may have changed his view on the sector following a round of consolidation that reduced the number of major U.S. carriers to four from nine.
The airline sector had begun to resemble the railroads, David Kass, a professor at the University of Maryland's Robert H. Smith School of Business, told Bloomberg News.
That is an important comparison, given that Mr. Buffett agreed to pay $26.5-billion (U.S.) for Burlington Northern Santa Fe in 2009.
As well, new planes and a proven determination to drive down costs make airlines look far more viable.
Air Canada provides a good illustration of what's going on. It claims that its latest-generation Boeing Co. long-range airliners are 30-per-cent better than the aircraft they replaced, in terms of fuel and maintenance costs.
Squeeze in a few more customers into those economy class seats (breath in, value investors!) and beef up its Rouge discount airline, and efficiency improves even more.
Air Canada's cost per available seat mile, a metric that compares an airline's operating costs to its passenger capacity, has been heading down at an impressive clip. The cost fell from 17.7 cents (Canadian) in 2013 to 13.6 cents in 2015. It fell again to 12.5 cents in the third quarter of 2016.
The airline expects costs to fall another 5 per cent to 6 per cent, year-over-year, when it releases its fourth-quarter results next month.
Even though Canadian economic activity has slowed with weak commodity prices, Air Canada's cost-consciousness has translated into higher profits. Net income in the third quarter rose to $768-million or $2.74 a share, up 85 per cent year-over-year.
Investors aren't embracing these results, just yet, though. The shares trade at less than 4-times trailing profit, an ultra-cheap valuation that implies the airline sector continues to attract more skeptics than fans.
That, too, will change.
David Berman