Is Aero Industry Business Advantage exist? Seven years ago, at the Berkshire Hathaway annual meeting, Warren Buffett said, “the airline industry is a death trap for investors”.
In 2020, Warren Buffett recorded a loss for his airline investment. The world becomes wingless once the pandemic hits the travel industry, shutting every place to lockdown and isolation. This post will try to find if there is a “hidden value” of one of the most hated industries in investor’s eyes.
Aero Industry Business Advantage: In This Issue
- Crafting The Sky
- The Jet Maker
- The Loser: Airlines
- Aero Industry Business Advantage: Airport
- Aero Industry Business Advantage: Key Takeaway
The aero-related1 business has a long process. From the aircraft production to the airport operator. Here we try to identify each business node and finds the best ones with a strong and sustainable competitive advantage, a characteristic that Warren Buffett really loves
We begin with those who inherit Wright’s2 spirit. They who craft the flying machine.
Crafting the Sky
We have Airbus and Boeing. Shortly speaking, their business is manufacturing and designing an aircraft. Both companies dominate the market share of airliner manufacturers. I believe that this oligopoly will last for a long time due to the complexity and cost to make an airplane.
Talking about complexity, the making of the airliner is begun with software simulation to make sure the aerodynamics work: that is, to make sure your aircraft could fly through the wind. The next phase is designing which is take most times, four years. This long journey is because the construction design has to meet one of the strictest standards on the planet3 which include:
- Control of that quality
- Insurance for that quality
With regard to cost, the cheapest Boeing is a 737 model that costs almost 90 M, while their flagship product 787-10 comes with a 338 M price tag. Buying 1,000 units is equal to a whole Walmart business.
Assuming 15% Gross Profit Margin, to make one unit of its flagship, Boing needs around 287 M. This sky-high capital makes this industry set a very high barrier for a new entrant – like Wall Maria and Rose in the Attack on Titan series. Another barrier is their scale. Both Airbus and Boeing are capable to produce aircraft on a massive scale – 40 aircraft per month for Airbus – thus bring the cost of production down.
But even with all that massive scale of production, Airbus and Boeing still can’t catch the demand – especially Airbus. This is a game with only two sellers, serving a large group of buyers.
The Jet Maker
Another elite, oligopolistic group. General Electric Aviation, Rolls Royce, and Pratt & Whitney. The three is the supplier of a jet engine for both Boeing and Airbus. So this is an oligopolistic to oligopolistic market. To give the reader perspective, GE Aviation control about a 70 percent market share of the narrow-body jet.
If manufacturing an airliner is difficult, so we will say that making a jet airliner is absolutely at another level. Building airliner is construction things, It is about mechanical. Building a jet engine is far more complex.
A jet engine actually a blade or turbine. It works under a high amount of spin, high pressure, and high temperature. Imagine working under 2000 Fahrenheit, you need a material that can withstand that heat but at the same time could deliver power and efficiency. And oh, don’t forget the complexity of maintenance.
Along with the risk, complexity makes the airliner maker like Boeing and Airbus doesn’t want to produce the jet engine in-house. Here we find that jet makers enjoy a critical business advantage due to scale as well as switching costs.
Moving to another vendor is risky. Once a model uses a certain jet, it will lock forever since the jet maker has to know-how and familiarity with that type.
More detail on The jet maker business advantage you could visit here
The Loser: Airline operator
Now for the loser. The airline is the cash cow in the entire aero-related industry. They buy planes from Boeing or Airbus (who buy jets from GE Aviation or Rolls Royce) and need to tank the high-quality fuel to fly.
When an airplane flying in the sky, surely it faces serious risks. Flying is never a human habit and never will be, so the circumstances will be very challenging. Sometimes your plane faces a volcano, cloud, or turbulence. And all of that bad luck has to be burdened on the airlines’ shoulders. If the plane fails or gets into an accident, airlines have to be responsible for it: paying high compensation, all passengers.
Risk not only exists in the sky. Delay happens often. And airlines take the cost. Broken suitcase, airlines take the cost. They need to have a backup plane and the airport charges for parking it.
With all that high fixed cost: fuel, plane purchase, crew, pilot, cabin attendant, maintenance, and all risk: delay, crash, broken suitcase; the profit turn to be cyclical. It peaks when holidays and good weather but quiet on normal days.
Know the saddest things? Once an airline makes mistake, it runs a whole reputation.
As you see, the aircraft maker has only 2 players and the jet maker has 3. It is far different from airlines. It is not monopolistic. It is a royal rumble. We have too many players, several notable to mention: Singapore Airlines, Qatar Airways, Emirates, the latter two have their brand printed in FC Barcelona jersey and Manchester City. Two of the best Football Clubs in the world. Imagine how expensive just to keep survive.
Aero Industry Business Advantage at the most: The Airport
We come to the industry with the natural competitive advantage, something that inherited, not created, something like Julia Roberts beauty. The airport. The business advantage comes from its protection, usually, one city only has one airport and it is subsidized by the local government.
Unlike jet makers and aircraft makers which barrier to entry comes from the engineering aspect, the airport business advantage comes from limited market share, especially for “non-megacities” locations.
Several notable names to mention are:
- Shanghai Airport (600009 CH). As the operator of Pudong International Airport in Shanghai, it has advantages not only by its protection characteristic but also growth from one of the most populous nations in the world.
- Ferrovial. It has London’s Heathrow airport.
- Pacifico the operator of Gudalajara airport.
The business model is simple, the airport builds a facility then charges everything. Airplane parking, landing fees, all airline facilities from the entrance to the departure area, ATM, portion of sales, rent for shop, car parking. This is the rest area for airplanes.
Aero Industry Business Advantage: Key Takeaway
- Mapping the industry we get that all of the aero-related business has a very strong business advantage or economic moat. The airlines are the exception.
- Another name worth knowing is Precision Cast part, a Berkshire Hathaway (why I’m not surprised?), this is a supplier of the supplier. Precision Castpart is a supplier for GE aviation jet turbine also Pratt & Whitney.
- Great economic moat means nothing if management does miserably. I will prefer to hold Airbus than Boeing. Also, I only buy GE aviation if it is spun off from the parent.