I just read Maybank Kim Eng’s recommendation with the above title to buy regional airline shares at bargain valuations. I am not convinced with all the accounting jargon. As I am not a qualified accountant, I always take a rational approach based on economic fundamentals.

One line of simplistic thinking is that there is a bright and profitable future for airlines the number of air travelers continues to increase by about 5-7 percent per year.

But if you look at the history of airline industry profitability, this is not the case for airlines worldwide.  The fact is the airline industry requires huge capital and produces poor returns on capital employed. Hence, year after year, many airlines produce poor profit margins or outright losses.

Why you might ask is it that an industry with year-on-year rises in sales cannot generate good returns to shareholders?

It all comes down to the economic structure of the industry.  One of the forces that limit profitability is the intensity of the rivalry between the leading airlines. There is over-supply leading to pressure on prices. This is exacerbated by a high degree of freedom for new competitors to enter the industries. 

If, say, an airline route between two destinations is found to be reasonably profitable it is not long before new entrants move in or current airlines simply move their planes to this profitable route. 

It is truly an industry governed by the principle of “survival of the fittest”.

The ego and elections factor

It would seem that every developing nation wanting to show off to the world its progress MUST have its own airline, regardless of the impact on an industry already grossly over-supplied, and regardless of whether they have the ability to manage efficiently. So there is a regular stream of announcements of new airline ventures.

Now that Malaysia has also done it and failed dismally, the next logical question to ask is why doesn’t the Malaysian government allow MAS to fold up or go under?

There are two main reasons:  Firstly, the perennial optimism of managers and shareholders. “Just one more chunk of money will see us break through into profitability as we rout the opposition!” seems to be the credo of these parties based on their self and not national interest. 

Secondly, there is government interference. This factor however is less found now as many governments have learnt not to come to the rescue of their airlines.

Malaysia has not learnt these lessons – initially for reasons of national pride tied to the ego of leaders but now increasingly apparently to save jobs and to prevent the retrenched employees from voting for the opposition. This may make sense politically but it is poor economics.