Warren Buffett's Warning about Airline and Cruise Line Stocks

Hey guys, welcome back to the channel! In this video, I'm going to be talking about a massive trap that, in all honesty, a lot of investors have been walking into in the past, say, three months or so. And it's really sad to see because most people just don't know that they're walking into this trap. So hopefully today I can shine a bit of a light on the issue, and hopefully, maybe that saves some of you guys from making the same mistake that a lot of people are making right now when it comes to stock market investing. Let's get into it.

What is the trap? Well, I first of all want to start out big picture thinking, and then we're going to narrow it into more specific examples. Really, the main issue, what the trap is, is it's a value trap. A value trap is essentially people seeing a stock going down 50, 60, 70, 80 in price and thinking that that stock's a bargain just because the share price has come down that far. This is definitely flawed logic. As I said before, it's called a value trap, and it's essentially where you think you're getting a fantastic deal on a company, but you don't actually understand what you're getting yourself into.

It looks like on paper you're getting the best deal of the century, but what you're actually doing is you're buying into a company that's just in dire straits. So that's the overarching trap that a lot of people are falling into. But I also wanted to talk about how I've seen this play out over the last few months. The first thing I want to talk about, for instance, is how many YouTube videos have you seen from various people all around the world saying, "This is why I'm now buying the cruise line stocks," or, "This is why I just bought into the airline stocks." These investors are just falling into that exact same value trap.

They think they're getting a fantastic deal, but they don't quite get exactly what they're buying into. They aren't buying because, say, the long-term prospects of the business look absolutely fantastic and thus worth our investment. They're just buying simply because the share price has gone down by 80, and that makes them believe that they are getting a discount, even though they may not be.

For example, if we just look at the four main U.S. airlines, on average, those companies have gone down 68%. If we look at the three biggest cruise line companies in the world, their stocks have gone down on average 77%. There are so many people buying shares in these companies because the share price has gone down 60, 70, 80, but the problem they're going to run into is that there is a reason why the share price has fallen that far.

The reason is because of the pandemic. These companies are now in dire straits and are having to take drastic, really drastic measures just to keep their business alive. Now, here's the real problem. These companies have been rocked so quickly that they haven't been able to prepare for what's coming. For example, it's a pandemic—it's not like we have seen this coming for the past two years. It just happened.

So the companies haven't been able to anticipate this happening, and they haven't been able to implement changes or bolster their balance sheets in preparation for this event. Essentially, it's gotten really bad over the past two or three months. That's very, very fast in terms of, you know, how a company can move and change. So essentially, whatever condition these companies' balance sheets were in at the start of the year, they're just stuck with their balance sheets like that.

That’s just the reality. And, okay, the balance sheet is what it is, and now they have to make drastic changes because what we're seeing is that the balance sheets, the cash on hand, the reserves that they had just weren't anywhere near adequate. Their balance sheets were simply too weak to sustain a long period of reduced revenue.

So what happens next? Well, they have to get their hands on more money just to survive, right? So that's exactly what they've done. There are two main ways that these companies can get their hands on more money. The first is they have to take on huge amounts of debt just to stay afloat, or the second is that they have to sell new shares. They have to find new investors, they have to sell new stock, and dilute their pre-existing shareholders.

So they're the two different options that these companies were looking at to ensure that their balance sheet could handle a period of time where their revenues were substantially lower. There is one positive to these actions. Obviously, it means that the companies will avoid bankruptcy. Yes! And how many people have you heard saying, "You know, I'm buying Carnival Cruise Line," or, "I'm buying Delta Airlines because they're not going to go bankrupt," and "The pandemic is probably only going to last like one or two years, so therefore in three or four years, these companies will be back up to full strength operating just like what they were before?"

Now, that seems logical, but unfortunately, it isn't. And I think that's the reason why so many people are falling for these value traps because yes, while the company may not go bankrupt, the reason they're not going bankrupt is because either they are heavily diluting their shareholders or they're borrowing huge amounts of debt. So while the pandemic might be gone in two years, the financial impact to these companies certainly won't be gone.

If a company borrows money, remember, they're borrowing from their future self. So some way down the track, they have to give that money back, and in the meantime, they have to pay interest. Interest is a very real expense that has to be paid out of the company's future earnings, and a lot of these companies are not currently borrowing under favorable conditions either.

For example, Carnival Cruise Line, they recently raised 6.25 billion dollars, consisting of four billion dollars of bonds maturing in 2023 at an eleven-and-a-half percent coupon. This article even goes on to say that they were able to raise 600 million euros not six months earlier at just a one percent coupon. All of that debt needs to be paid back eventually, and in the meantime, they've got that big interest expense.

So that's really why these companies are trapped. Yes, while they're taking drastic measures and they may not go bankrupt now, they are doing that at the expense of the company flourishing over the next five years. That's why they're traps because even though the share price of these companies has come down 70, 80 percent, we have to remember that these companies are now very different from what they were even six months ago.

That cruise line company you bought six months ago is now a very different company financially and has a very different future outlook. You know, Delta Airlines is not the same company financially as what it was six months ago. Even the CEO, Ed Bastian, has come out and said Delta Airlines will be changing. It is going to be a smaller airline for some time, and it will take them years and years to get back to where they were.

These companies weren't prepared for the pandemic, obviously, because you can't predict it. Bang—the pandemic hits, and all of a sudden these companies are in a really tight spot financially. They have to take drastic measures now just to stay afloat. So they have to do things like take on massive chunks of debt. They're borrowing from their future self, and that definitely changes the future outlook for these companies.

As I said before, they're basically sacrificing the idea that this company could flourish over the next five years just to stay alive now. Overall, that is why, in my opinion, these companies are just classic value traps right now. And to be honest, even if you don’t trust my opinion, Warren Buffett has weighed in on this situation very recently when he was saying why he decided to sell at a massive loss.

He sold his entire positions in all four of the big U.S. airlines, and this is his reasoning: "The airline business, and I may be wrong and I hope I'm wrong, but I think it changed in a very major way. It's obviously changed in the fact that their four companies are each going to borrow, you know, perhaps an average of at least 10 or 12 billion each. While you have to pay that back out of earnings over some period of time, I mean, you're 10 or 12 billion dollars worse off if that happens. And of course, in some cases, they're having to sell stock or sell the right to buy a stock at these prices, and that takes away from them the upside.”

But something that was a low probability event happened, and it happened to hurt particularly whether it's the travel business, the hotel business, the cruise business, or the theme park business. That's the world's best investor telling us that these companies have turned into value traps.

The world looks very different now for these companies. Six months ago, these companies were in a much different position than where they are right now. They've had to borrow huge chunks of debt, which is going to affect their future earnings. So that takes away from the upside if you're a long-term shareholder, or they have to sell heaps of new stock, which dilutes the shares of the pre-existing shareholders. That's not fun; that takes away from the upside of being a shareholder in these companies.

So, overall, the moral of the story really is don’t buy a stock just because it's gone down 50, 60, 70, or 80%. There's always a reason as to why that's happened. So do your research and make sure that you don’t fall into a value trap. Another takeaway is that even though a company may not go bankrupt, that doesn't necessarily mean that the company will just return back to its former high. Because the reason that company is no longer going bankrupt might be at the expense of the future success of the company.

And lastly, remember if a company takes on huge chunks of debt, that changes the intrinsic value. That changes your estimations as to how much cash, as a shareholder, you will get back out of that business into the future.

Anyway guys, I hope that makes sense. I hope I've kind of explained myself well. I think that this is a big issue at the moment. I think a lot of investors are falling for that classic value trap, but I'd love to hear your opinion. You know, what do you guys think of the cruise line stocks or the airline stocks? I know certainly if you're kind of like a Warren Buffett long-term kind of value investor thinking about cash flows out of the company, then you probably are not looking at these industries too much.

But you know, I'd love to hear what your investing strategy is, and maybe there is some investing strategy where these companies do fit into your portfolio. Anyway, I'd love to hear from you guys, so leave that stuff down in the comment section below. Leave a like on the video if you found it useful or if you enjoyed it. I really appreciate it, as always, and subscribe to the channel if you haven't done so already. I really appreciate you guys that have subscribed, but it turns out I actually looked at this stat the other day. Most of my views come from people that aren't subscribed, so if you've made it this far through to the video, hit the subscribe button, hit the notification bell.

But that'll do me for today, guys. Of course, check out Profitful if you’re new to investing and want a step-by-step guide as to how to get started investing in the markets through that Warren Buffett style approach, or if you want just through passive investing. We've got two courses, one for each of those different strategies, so check out the links in the description if you want to learn more about that. That'll take you over to Profitful, but that will do us for today, guys. Thanks very much for watching, and I'll see you guys in the next video.

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