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3 Stocks I Wouldn’t Touch With a 10-Foot Pole

As a long-term investor and independent analyst, I’m always on the hunt for great businesses that are available for cheap prices.

After all, there is no other way I know of that can help my wealth (whatever little I have currently) compound over the years.

Anyways, my search for such companies involves a lot of hard work. I screen for companies that have had very good past track record. I look for businesses that are easy to understand. And I look for stocks that combine these strengths and are still available for cheap.

But then, as I search for the best businesses, I come across a lot of bad businesses – some that are difficult to understand, and some that are…just bad.

Here are three companies that I believe are really bad businesses to own for investors.

But before I reveal the name of these companies, here are some charts that display their last 5 years’ financial performance.

1. Sales: The only respectable number…


Data Source: Ace Equity

2. Operating margins: Here’s where the first signs of trouble emerge…

Data Source: Ace Equity

3. Profit after tax: Nothing to show here, expect deep losses…

Data Source: Ace Equity

4. Free cash flow: No profit, so no cash to show…

Data Source: Ace Equity

5. Debt to equity ratio: No cash, so how to grow? Borrow, borrow, borrow!

Data Source: Ace Equity

Well, here I reveal the name of these three companies whose performance I’ve shown in the charts above…



I will never buy Jet Airways.

I will always stay away from Kingfisher Airlines.

I will always avoid Spicejet.

My reason for staying away from these stocks: These companies, in my judgment, have maintained some of the worst balance sheets in India….consistently.

That Kingfisher Airlines is asking the government (and the other group companies owned by its chief Vijay Mallya) for a bailout package is not something strange.

“In India, airlines are over-taxed and over-charged. Wonder why?” read a recent tweet from Mr. Mallya.

I, for once, agree with Mr. Mallya here.

One of the root causes of the current crisis in the Indian airlines sector lies in bad policy of the government.

India’s airlines are not allowed to fly international routes unless they have five years of operations. On the other hand, international airlines are freely allowed to fly to India. This shuts out lucrative routes for our airlines and allows overseas airlines to charge outrageous prices to Indian consumers.

Then, fuel cost is around 60% of an airline company’s operational cost, which is very high, thanks to the monopolistic pricing from oil companies. And if this wasn’t enough, airline companies also pay high taxes on fuel, levied by both the Centre and States.

So I agree with Mr. Mallya that a lot of the current crisis his company is facing is not of its own creation.

But then, you knew this sir, didn’t you? You knew about the ills of an airline business when you entered the aviation sector in 2003.

Airline, globally, has never been a profitable business.

In fact, when someone once asked Sir Richard Branson, the much-acclaimed chief of Virgin Airlines, how to become a millionaire, he replied, “That’s easy. First you become a billionaire and then you buy an airline.”

Also, here is what the legendary investor Warren Buffett wrote in his annual letter to Berkshire Hathaway shareholders in 2008:

“The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. Think airlines. Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers. Indeed, if a farsighted capitalist had been present at Kitty Hawk (where the first flight was tested in 1902), he would have done his successors a huge favor by shooting Orville (one of the Wright brothers) down.”

Ever since the invention of the airplane, the industry has been one of the world’s most eye-catching.

The appeal of global air travel has always drawn capital to the industry. So finding money has never been the problem – making consistent profits has always been the challenge.

The industry is much better known for losing money than for making it.

When trying to understand what’s wrong with airlines, it’s important to remember that the industry is:

  • Highly capital-intensive – Needs consistent inflow of money for expansion.
  • Heavily dependent on economic cycles – Every bad phase is the worst phase.
  • Hamstrung by high fuel (oil) costs – Can’t do without it.
  • Selling what is essentially a commodity (airline seats) – No one has reasons to ask for a higher price than competitors.
  • A real bankruptcy risk – What we are seeing now.

This all adds up to create a pretty unattractive picture. Essentially, over the course of multiple economic cycles, these companies can’t earn more than their costs to operate.

And as an investor, over many years, it is tough to make money holding onto airline stocks.

You can’t sleep at night if you are an investor in such stocks.

Just look at the chart below to gauge the amount of wealth destroyed by Indian airline stocks over the past 5 years!


Data Source: Ace Equity

So what’s the point of investing in them?

Instead search for companies that:

  1. Have pricing power,
  2. Generate a lot of free cash flow, and
  3. Reward shareholders with consistent dividends

…in short, the Chairmen of whom will never extend their arms begging for bailouts!

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About the Author

Vishal Khandelwal is the founder of Safal Niveshak. He works with small investors to help them become smart and independent in their stock market investing decisions. He is a SEBI registered Research Analyst. Connect with Vishal on Twitter.

Comments

  1. So, this is an example of business that we understand but not worthy of investment at any price. We are pointing fingers at Mallya today but next could be his competitors. Government and Oil companies needs to take equal responsibility for this. We need flights, in today’s world, we can’t live without it. If none in this industry is making money, then there is something wrong fundamentally.

    • The industry will be better off with a few less players (the inefficient ones must go!) and of course, the government needs to provide some support in terms of reduced taxes on fuel. Or the industry, while it will continue to survive, will continue to remain like a parasite on the society’s wealth.

      And yes Mansoor, there are some fundamental reasons why airline will rarely be a profitable business, like the ones I mentioned in the last part of the above post (capital-intensive, commodity, etc.)

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