Our thesis on the airline industry is working out and the stock prices have demonstrated strong momentum of late.

There were two important themes to our purchase some time ago – falling oil prices and capacity cuts. We wanted to own companies whose earnings were sensitive to falling oil prices (as opposed to those who hedge). This has worked out and every 5$ drop in crude adds significantly to the earnings for many carriers. It is ironic but it was actually high fuel prices that put the airlines in the more favorable position they are in now. They forced the carriers to cut capacity, right-size their fleets which lowered their overall cost structures and firm up pricing.

These tough measures were all being implemented before the economy turned down. Additionally, as the economy really started to decline, oil prices fell even faster than anticipated which helped out even more.

As an added bonus, many companies have successfully embarked on various cost cutting initiatives. These are making meaningful improvements to the bottom line. The rough environment experienced over the last few years have forced the carriers to be disciplined in capacity and cost cutting, and they’ve made meaningful strides.

Now, volumes have either stabilized or increased. That’s a combination which creates a tremendous amount of earnings leverage – particularly as the companies swing to profitability. We still recognize these are extremely risky companies with weak balance sheets, but believe if their fundamentals continue to stabilize they may still have some additional appreciation potential.

Disclosure:

Berkshire equity portfolios and Berkshire employee accounts have long positions in airline stocks.

The views expressed in this commentary reflect those of Berkshire Asset Management, LLC (Berkshire) as of the date of the commentary. Any views are subject to change at any time based on market or other conditions, and Berkshire disclaims any responsibility to update such views. These views are not intended to be a forecast of future events, a guarantee of future results or investment advice. Because investment decisions are based on numerous factors, these views may not be relied upon as an indication of trading intent on behalf of any portfolio. The information contained herein has been prepared from sources believed to be reliable, but is not guaranteed by Berkshire as to its accuracy or completeness.

References to particular securities are intended only to explain the rationale for the portfolio manager’s action with respect to such securities. Such references do not include all material information about such securities, including risks, and are not intended to be recommendations to take any action with respect to such securities.

Investment Risk: All investments are subject to risk, including possible loss of principal. Because Berkshire Asset Management, LLC’s investment style expects to hold a concentrated portfolio of a limited number of securities, a decline in the value of these investments would cause the portfolio’s overall value to decline to a greater degree than a less concentrated portfolio. Our equity investment style may focus its investments in certain sectors or industries, thereby increasing the potential vulnerability to market volatility.

For stocks it sure seems like it. On the front page of today’s (12/20) Money & Investing Section of the Wall Street Journal, there is a great visual bar chart of stock market returns by decade. Guess which one ranks dead last? The 2000′s ending December 15, 2009. Its annualized decline of -.5% per year so far eclipses even the declines of the 1930′s! Similarly, the November 24th issue of Time Magazine ran a cover story called “The Decade from Hell.”

We’d like to think with improving (but not great) fundamentals and lower (but still not screamingly cheap) valuations, stocks are set up to do better in the next ten years than the last ten (not a high bar!). So if ever there was a time to say  “out with the old and in with the new”, this would be it!