How Warren Buffett Vindicated American Airlines CEO Doug Parker
Warren Buffett/Doug Parker

For more than two years, American Airlines (AAL) CEO Doug Parker has been proclaiming that airline shares -- particularly shares of his airline -- were undervalued.

Last week, Parker's view got an endorsement from Warren Buffett, the country's most famous value investor. Curiously, Buffett has spent the past 25 years decrying airline investing, even though he either broke even or made money on his best-known airline investment.

In a Securities and Exchange Commission filing on Nov. 14, Buffett's Berkshire Hathaway (BRK.A) disclosed that during the third quarter it acquired airline shares valued on Sept. 30 at about $1.3 billion. American shares accounted for the lion's share, about $800 million.

American shares closed Friday at $46.26 and have risen 9% year to date, while the S&P 500 has gained 7%. American shares have risen about 7% since the SEC filing.

Parker has repeatedly had to defend himself since American started to buy back shares in mid-2014. Since then, American has repurchased about $8.4 billion of stock for an average price of just more than $39.

As of Friday's close, the gain on investment has been about 19% or $1.6 billion.

Last January, on American's fourth-quarter earnings call, Parker said most investors didn't understand what is happening in the airline industry.

"In the almost 30 years now that I've been in this business, I can't remember a bigger disconnect between what we're seeing in our airline and in our forward prospects and how the market is treating our stock," Parker declared.

"The airline is throwing off a lot of cash {and} the market cap doesn't seem to be anywhere close to what the airline's generating {in} cash, so we'll use the excess cash to repurchase shares and that will be a good thing for our investors as we move forward," he said.

"There are investors who get it and we think they'll do well," he added. On Jan. 29, the day of the earnings call, American shares closed at $38.99 a share.

On March 8, when American shares opened at $41.30, Parker reiterated his views at a JPMorgan investor conference, saying, "The airline business has been fundamentally and structurally transformed. And the valuations do not reflect such a transformation. They're not even close.

"Investors have not taken a leap," he said. "Fair enough. You'll get there eventually. Because I know I'm right on this. This isn't something {where} I think, 'maybe things are different, maybe they're not' -- I'm positive. {And} one day, everyone's going to figure it out."

Parker reiterated a favorite metric: In 2005, with oil at $55 a barrel, the airline industry lost $28 billion. But in 2015, with oil at $54, almost the same price, the industry made $19 billion.

What changed? "The industry has been restructured," Parker said. "It was fragmented, it was inefficient, it was unfocused. And now it's efficient. It's focused on demand. We have networks that can actually deliver what people want, instead of a much smaller group of networks that couldn't do that in the past. And the difference is night and day."

As for Buffett, in 1989 he bought $358 million worth of USAir debt at 9.25%, convertible in two years to stock at $60 a share, above the trading price of $52. The shares represented about 12% of the company. Buffet subsequently served a few years on the USAir board.

The shares never appreciated, and Buffet never converted. "He wrote down his investment at one point, and he cashed out as soon as he was able," said Ed Colodny, former USAir CEO, in an interview for the book "American Airlines, US Airways and the Creation of the World's Largest Airline," which I co-authored.

"I think at the end of the day {Buffett} got all his dividends paid and his principal back," Colodny said. Nevertheless, Buffett has regularly panned airline investing, calling it "a deathtrap for investors" at the 2013 Berkshire Hathaway annual meeting.

Parker has long been regarded as a smart airline guy, probably the most important player in triggering the round of consolidation that was key, along with lower fuel prices, in creating the modern, profitable U.S. airline industry of the 21st century.

Working closely with American's labor unions, particularly with Laura Glading, former president of the Association of Professional Flight Attendants, Parker was able to convince Wall Street dealmakers that they ought to let him and his America West management team take over the world's largest airline in 2013.

But since March 2015, when shares reached a peak of $56.05, before falling to $24.85 in May 2016, support from investors has been tenuous.

Until now.

This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.

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