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Is It Worth The Risk For Investors To Invest In Airlines?

2014 has not been a great year for the aviation industry. Across the causeway, Malaysia Airlines suffered two major incidents in that year. Taiwan’s TransAsia Airways encountered one accident which killed 48, and Air Algerie crashed in Mali, causing the deaths of 116 people. Most recently, Airasia Indonesia flight QZ8501 was found to have crashed into the Java Sea last month.

Without downplaying the severity and gravity of the tragic loss of innocent lives in these accidents, the affected airlines would likely also suffer huge reputational and financial damages. Malaysia Airlines is a good example – it was teetering on bankruptcy after its two incidents and had to be privatized by Malaysia’s sovereign wealth fund, Khazanah Nasional Berhad, in order to be saved.

These examples highlight the operational risks that airlines face, despite air travel still being the safest mode of transport globally. And for me, it also raises the question – given such risks, is it still justifiable for an investor to invest in airlines?

Singapore is home to two air travel companies, Singapore Airlines Ltd (SGX: C6L) and Tiger Airways Holdings Limited (SGX: J7X). The former is a world class premium carrier while the latter is a struggling regional budget airline.

It might not be a surprise to find Tiger Airways struggling financially. But consider this: Despite its reputation as one of the best-managed airlines in the world, Singapore Airlines has still only managed to earn a meagre return on equity of not more than 4% over the past three years. That’s a dismal economic performance.

But that’s not all. Singapore Airlines’ net profit margin has never exceeded a razor-thin 3% during that period and its profit had actually shrunk at an annualised rate of -19.5% over the past five years.

Yes, it’s common knowledge that airlines are a commodity-like business (meaning to say airlines often compete on price). Yes, many investors should know well that Warren Buffett has publicly stated that airlines often make for bad investments. But, could an investment in airlines actually be even worse than we imagine it to be?

With the recent string of aviation disasters, I think the answer is: Yes. Airlines run on low profit margins, earn low returns, and require intensive capital investments. And they also face huge reputational risks and unforeseen financial obligations in the event of disaster-related compensations – these are things which we have no way of predicting. With so many other investment options in the market, I think investors would need a really good reason to even start looking at airlines.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Stanley Lim owns Airasia Berhad