Quick Write-Up on Southwest Airlines (NYSE:LUV)

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(photo source: http://mommasays.net/)

A well-articulated article (click here!) on Southwest Airlines. It deserves a read. I am amazed that Southwest has a ROE of 30.1%. However, we all know that oil is roughly 30% of an airline total operating costs and it can be erratic.

What happened to turn Buffett from a seller into a buyer? In a word: consolidation.

When Buffett invested $358 million in USAir, the airline industry was highly competitive. There were no fewer than 10 U.S. airlines referred to as “major carriers,” the Big 10 as they were known. Profits were elusive and hard-won. The consumer was king.

Today, following years of bankruptcies and mergers, 80 percent of the country’s domestic air traffic is controlled by just four airlines: American, Delta, Southwest, United. The balance of pricing power has shifted from the consumer to the airlines.

(source: http://www.businessinsider.com/why-warren-buffett-buying-airline-stocks-is-bad-news-for-travelers-2016-11?IR=T&r=US&IR=T)

From an investor’s point of view, industry consolidation is always beneficial because this reduces choices for consumers. Why? When there is no choice available to the consumers, the bargaining power is shifted and it enables higher pricing. I’ve seen how companies go around acquiring similar businesses and I could not understand why. Later, all the business did was to switch up the prices and the profit zone was lifted immediately.

Why? The company consolidated the fragmented industry and it has the ability to charge higher now.

Industry consolidation can be either a player acquiring smaller players or a natural economics at work forcing out weaker players to maintain an equilibrium of profits, given the supply and demand of the industry.