Warren Buffett was born in Omaha, Nebraska, and after finishing graduate school at the University of Columbia in 1951, he started his investment career (Steinberg, n.d.). Following a series of successful partnerships, he took over the failing textile manufacturing company Berkshire Hathaway in 1962 and eventually molded it into a holding company for numerous investments. Buffett's savvy investments over the years led to him becoming the wealthiest man in the world by 2008 with a net worth of USD 62 billion (Miller, 2008), and Berkshire Hathaway had large holdings in multiple successful companies, including Coca-Cola, Goldman Sachs, and General Electric. Berkshire sold class A and B stock, and the class A stock price had risen tremendously during Buffett's tenure, with prices exceeding USD 300,000 per share (Data 1) (Caplinger, 2019). Buffett had spoken out against airline investments for years, describing the industry as having margins that were too tight due to the extreme costliness of jet planes and the price wars between airlines driving down revenues. Despite this seemingly negative view of the industry, in 2016, Buffett bought massive stakes in Southwest Airlines, United Airlines, American Airlines, and Delta Air Lines, with Berkshire's total stake in the four companies reaching USD 8 billion (Wise, 2020). As the pandemic dragged on, Buffett had already decided to divest from United, American, and Delta, but Southwest had been a premier low-cost carrier for decades, and Buffett was reluctant to let go of all his airline stock. Now that the coronavirus pandemic was driving airline stock to unprecedented lows, Buffett had a looming decision to make about his Southwest holdings.

Southwest Airlines

Southwest Airlines was founded in 1966 in Dallas, Texas, and found its niche in the airline industry as a low-cost carrier with an emphasis on no frills and low fares through standardization of its aircraft and processes (Southwest Airlines Co., n.d.). Southwest was unique in that its fleet consisted entirely of Boeing 737 models, allowing it to save costs by establishing processes and routines centered around one type of aircraft. Southwest went public in 1971 for USD 11 per share ("Investor FAQs," n.d.), and since its IPO, the company experienced a tumultuous stock price history (Data 2; "Southwest Airlines stock forecast," n.d.), as the airline industry can be cyclical in nature. During the eleven-year U.S. bull market in which Southwest's stock price steadily climbed towards USD 70 per share, the airline industry experienced a travel boom, with global passengers climbing from 2 billion to 4 billion between 2005 and 2018 (Data 3; "Air transport, passengers carried," n.d.).

Response to COVID-19

In an industry with tight margins, Southwest had been performing well, with yearly net income of USD 2-3 billion since 2017 (Table 1; "Southwest Airlines Co. 2019 annual report," 2020). However, once the coronavirus pandemic struck in early 2020, airline industry growth came to a screeching halt as people began to omit travel from their lives, and Southwest was not spared. Southwest shares had fallen to nearly USD 30 apiece by the beginning of April, and with no end to the pandemic in sight, the company had a long road ahead. The U.S. federal government had recently provided multiple airlines, including Southwest, a bailout package totaling USD 25 billion to help out with payroll and keep them from collapsing (Rappeport & Chokshi, 2020), but how long that package would help the airlines stay afloat was yet to be determined. Consumer demand needed to return to previous levels for these airlines to realize profits, and it looked like that demand could be potentially years away.

Southwest CEO Gary Kelly worked to alleviate investor and passenger concern by taking a 10% pay cut ("Southwest Airlines CEO Gary Kelly," 2020) and boosting the sanitation standards of every plane in the fleet to six hours of deep cleaning per night (Wood, 2020). By taking these and additional safety measures, such as keeping all middle seats open to promote social distancing, mask requirements on all planes, etc., Kelly worked to make all passengers feel as comfortable and safe as possible while traveling. These precautions also aimed to make investors feel secure that Southwest was doing everything possible to maximize its troubled revenue while making safety its top priority.

Airlines in Times of Crisis

Since the rise of commercial airlines, there had been a few large drops in consumer demand that caused severe losses for the industry, and the coronavirus pandemic of 2020 was looking to be quite similar. The airline industry was very cyclical—it picked up steam during periods of economic fortune as people were more prone to spend money on travel, and it took nosedives during economic downturns when people stayed home and saved money. Over the previous 20 years, there had been two periods when commercial air travel experienced swift, sustained declines in demand: after 9/11 in 2001, and after the Great Recession of 2008. After 9/11, airlines experienced a 30% decline in business (Elkind, 2020), and it took 22 months to reach pre-9/11 passenger levels. A similar decline took place after the Great Recession in 2008, and it took two full years for airlines to reach pre-2008 passenger levels (Smith, 2020). After both events, multiple airlines failed or filed for bankruptcy. After 9/11, U.S.-based airlines United, US Airways, Northwest, and Delta all filed for Chapter 11 bankruptcy (Seawright, 2006), and at least 14 carriers went out of business in 2008-09 in the midst of the financial crisis ("Major airline casualties in 2008 and 2009," 2008). If these previous circumstances were any indicator, then Southwest would have at least a two-year climb to get back to 2019 levels of consumer demand. That being said, none of the major airlines failed after these crises, and if Southwest could successfully pull out of the coronavirus carnage, investors could reap the rewards of buying low and watching the stock gain momentum as the economy returned to normalcy post-shutdown.

Coronavirus Pandemic of 2020—Market Implications

While the exact origins of the coronavirus, now called COVID-19, are unclear, it first appeared in Wuhan, China in late 2019 (Westman, 2020) and quickly spread throughout Hubei province where Wuhan is situated. The virus then spread throughout the world and had a confirmed presence in at least 170 countries by mid-April 2020 (Vara, 2020). In the United States the virus first spread in the western states of Washington and California before ravaging New York, which quickly became the epicenter of the U.S. pandemic. As governments and health authorities imposed shutdowns across the world, global industry took a gigantic hit, and some of the world's largest economies experienced huge downturns. The United States suffered a 4.8% decline in real GDP for the first quarter of 2020 (Data 4; "Gross Domestic Product," 2020), and some forecasts were predicting up to 34% GDP declines for the second quarter (Winck, 2020). The sudden halt in industry caused a steep drop in the stock market, with the S&P 500 and the Dow Jones Industrial Average experiencing their worst-ever first quarters, dropping 20% and 23.2%, respectively (Imbert & Li, 2020). It was a time of high uncertainty for investors, and the weight of Buffett's decision on Southwest loomed large.

 

Discussion Questions

Buffett needed to weigh all of the factors that went into his Southwest investment before making a decision. Buffett knew his Berkshire Hathaway investors would be intently watching his annual meeting, and he pondered over how to approach his stake in Southwest.

• 1.How long would this coronavirus pandemic last? Would the general public be eager to resume traveling once the shutdowns were eased, or would consumer demand for commercial travel return slowly?
• 2.Have Southwest's management team done a good enough job navigating the crisis so far, or have they led investors astray?
• 3.What is the long-term outlook for the airline industry, and how will its financial metrics look post-shutdown? Some metrics to focus on include total passengers, total revenue, and stock price.
• 4.In April 2020, should Buffett sell his shares in Southwest Airlines or buy further stock at the new reduced price?
• 5. Reflect on what you learn using finance terminology