Investments You Might Want to Avoid: The Airlines Industry

Historically, participants of the airlines industry have found it tough to operate in.

To understand the dynamics of this industry, we can use Porter’s Five Forces, a framework widely taught in business schools and commonly used by analysts, developed by Michael Porter, a Harvard Business School professor.

One of the elements in the Porter’s Five Forces framework is the level of competitive rivalry within an industry.

Competitive jockeying

The airlines industry can be an intensely competitive environment. Furthermore, the high cost for purchasing new airplanes also makes it even tougher for its participants to earn consistent profits.

Take Tiger Airways Holding Ltd (SGX: J7X), for instance. My Foolish colleague Stanley Lim has pointed out that the low-cost carrier has not been able to consistently generate earnings and operating cash flow since 2007.

tiger airways tug

Source: S&P Capital IQ; *FY2015 is only for the first nine months of the financial year

Tiger Airways is not alone in this predicament.

Another fellow Fool, Ser Jing, had talked about the patchy track record of Singapore Airlines Ltd (SGX: C6L) in generating free cash flow over the past decade. He also pointed out the carrier’s declining returns on equity for the same period. You can see these in the chart below:

ROE and FCF for Singapore Airlines

Source: S&P Capital IQ

The lack of earnings and cash flow that plagues both Singapore Airlines and Tiger Airways could be due to the level of competition within the industry.

Another good example for the competitive rivalry within the airline industry was on display recently. When the price of oil fell sharply late last year, it appeared that airlines had earned a reprieve (lower oil prices would mean lower fuel costs for airlines). But, as Stanley had pointed out, a price war may have already broken out earlier this year:

“Over the past two weeks, many airlines across the Asia-Pacific region – such as Japan Airlines, Qantas, Virgin Australia, and Airasia – have all announced the removal or reduction of their fuel surcharges. What this means is that savings the airlines could have been enjoying from lower fuel prices are now being transferred to travellers.”

It would appear that high capital expenditures, coupled with intense competition for sales, would make the airlines industry a less desirable place for long-term Foolish investors.

Check back in the coming days for the other elements of Porter’s Five Forces.

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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 contributor Chin Hui Leong doesn’t own shares in any companies mentioned.