The Oracle of Omaha made one heck of a case to raise cash right now after the strong — yet head-scratching — April rally in equities markets.
But it wasn’t the Andrew Cuomo presser-like slide Warren Buffett presented during his annual Berkshire Hathaway shareholder meeting Saturday showing he sold $6.5 billion in stock (he exited big stakes in the nation’s four major airlines) in April that should trigger the sell orders. No, it was actually the explanation as to why he exited shares in American Airlines (AAL), Delta Air Lines (DAL), Southwest Airlines (LUV) and United Airlines (UAL) that best serve as a wake-up call to the rose-colored glasses wearing bulls on the Street.
“It’s obviously changed in the fact that the four companies are each going to borrow perhaps an average of at least $10 or $12 billion each,” Buffett noted. “You have to pay that back out of earnings over some period of time.” He then briefly praised the executives leading the airlines before adding this nugget of wisdom, “The airline business has the problem that if the business comes back 70% or 80%, the aircraft don’t disappear. You’ve got too many planes.”
Buffett also voiced a great deal concern on the pace of recovery for the airlines in the post COVID-19 afterlife.
The thing is what Buffett just called out doesn’t necessarily only apply to the airlines. It in fact applies to a large swath of Corporate America that has seen the fundamentals of their businesses blown to pieces because of the COVID-19 pandemic.
Let’s start on the top line, or revenue as it’s more commonly called.
For example, sales have effectively dried up for hotel chains and when it comes back full force is anyone’s guess. Who will want to pay extra to eat at a hotel buffet? There are germs on those serving spoons, right? Will the buffet be gone for good? Who is rushing to belly up at a hotel bar for a few beers with someone sitting five inches away? That’s lost revenue.
Those mall retailers that don’t go out of business will reopen soon offering appointment-only shopping and curbside pickup. What does that mean? Fewer opportunities for up-selling customers inside a physical store. That’s lost revenue.
Or let’s look at consumer products makers that will now have to invest more in capacity to supply the new living habits of humans. They will also have to adopt new cleaning procedures for manufacturing plants and devise even quicker supply chains. That will come at the expense of another item further down the income statement, otherwise known as profit margins.
Then let’s keep in mind the lasting impact from the pandemic: profit-busting debt. A record-breaking $234.7 billion of investment grade debt was issued in March, according to Refinitiv. More than $200 billion was issued in April. This is debt that wasn’t on the books of companies in January. And it arrives to balance sheets amid a considerable amount of concern on the pace of the economic recovery.
After-effects of pandemics
In all these examples, the fundamentals of companies have been drastically altered similar to the airlines that Buffett has vacated. It signals a 3-, 5-, 7-, 10-year future of less productive companies, fewer dividend raises (or payments) and a hesitance to buy back stock as cash coffers are rebuilt for a rainy day (or another pandemic).
Pandemics aren’t recovered from overnight, and returns for risk takers historically have been sub-optimal.
“Great historical pandemics of the last millennium have typically been associated with subsequent low returns to assets,” wrote researchers at the San Francisco Federal Reserve in a March paper. The paper studied 15 major pandemics going back to the 14th century, where more than 100,000 people died. “Significant macroeconomic after-effects of the pandemics persist for about 40 years, with real rates of return substantially depressed.”
And where are stock valuations currently? At above historical average levels from the perspective of trailing and forward price to earnings multiples on the S&P 500. In other words, valuations don’t reflect the new reality for businesses in the post-pandemic world.
Bottom line: Buffett has the best investing insight in the game, no? Isn’t that why we all spent over four hours on a Saturday afternoon watching the live-stream of Buffett (and that Greg Abel fella) exclusively on Yahoo Finance? That’s why I did. And in doing so, I was reminded that it will take some time for the fundamentals of business to return to the pre COVID-19 days.
Do with what you may from that Buffett investing wisdom.
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