The Difference Between Airlines and Drug-Makers September 25, 2002January 24, 2017 CAESAR A lot of you have probably seen this passage (thanks to Vince DeHart for passing it on), and I am not suggesting that Shakespeare knew the perils of chemical and biological, let alone nuclear, warfare. Still, he was a pretty bright guy, and it’s worth considering whether his words have any application today. [Except that it turns out this is a bogus quote — see tomorrow’s column.] You may well conclude not; but they are still worth having as one point of reference: Beware the leader who bangs the drums of war in order to whip the citizenry into a patriotic fervour, for patriotism is indeed a double-edged sword. It both emboldens the blood, just as it narrows the mind… And when the drums of war have reached a fever pitch and the blood boils with hate and the mind has closed, the leader will have no need in seizing the rights of the citizenry. Rather, the citizenry, infused with fear and blinded with patriotism, will offer up all of their rights unto the leader, and gladly so. How do I know? For this is what I have done. And I am Caesar. – William Shakespeare PLEASE – NO CALLS BETWEEN 9 AND 11 TONIGHT It’s the two-hour season premiere of The West Wing! AIRLINE AND DRUG STOCKS I am venturing into deep waters when I presume to tell you which market sectors will do well and which won’t, so take this one with an even larger than usual grain of salt (i.e., sea salt or kosher salt, which are actually a lot better than the fine-grain stuff anyway). But I’ve been thinking about these two sectors, airlines and drugs. Their stocks are so low and I like to buy stuff no one else wants. But they are very different animals. I checked with a very smart airline analyst who told me that, yes, the big traditional carriers could all go bankrupt, and the shareholders be left with nothing. They would likely keep flying, and our frequent flyer miles might remain good on some basis, but the bondholders would emerge as the new owners of those airlines and their aircraft. The point is, these companies’ stocks really could go to zero. If I owned them, I doubt I’d sell, because the fear of losing the last few dollars would be less than the fear of selling, only to find some sort of massive government bail-out that sent the stocks soaring. But it’s looking grim. And the real problem is that this is a terrible business. Without price regulation, or the ability to collude, it is a business model doomed to failure, because the fixed costs are so high – the planes and payroll – and the variable costs are so low. What extra does it really cost to fly one more passenger cross country if the plane is going anyway? Thirty bucks for fuel and a meal? As a result, the tendency toward price competition is fierce. The temptation is great to sell a seat for $99 when the variable cost is only $30. That’s a $69 ‘profit.’ But it doesn’t begin to meet the payroll and the cost of the planes and ground equipment and so on. So it’s not profit at all. Only on routes where you have a virtual or complete monopoly can you price for real profitability. In the drug business, by contrast, the model IS monopoly. Yes, the fixed costs are very high (the cost of researching a drug and bringing it to market) and the variably costs are very low (the cost of actually making the pill) – just as with the airlines. But for a not trivial period of time, the duration of your patent, you are the only game in town. What’s more, the demographics look good. First, there are going to be a lot more seniors in the U.S. and probably around the world as time goes by, and they need more drugs than younger people. Second, as the world tends toward ever greater prosperity (let’s hope), and it becomes easier and easier to pay for basics like food, one thing people will want to buy with their extra discretionary income is health care. Yes, there’s a push on to cut costs on prescription drugs, and that may be one of the things depressing some of these stocks. But it seems to me one plausible long-term outcome is a win-win. Namely, if we ever do get serious prescription drug benefits for our senior citizens, at a cost of perhaps $60 billion a year, that will be $60 billion a year more (or some good fraction thereof) for the drug companies! So, yes, the deal might be that on THAT portion of their sales, the companies would have to agree to accept a low profit margin. But even a low profit margin on $60 billion in new sales isn’t a bad thing for investors. As I say, I’m way out of my depth here. But where I haven’t bought the super-low-priced traditional airline stocks (hey, I also missed Chrysler at $3 a share before it was rescued – could I be making the same mistake twice?) . . . I have been buying a couple of beaten-way-down speculative drug and bio-tech stocks that, perhaps promising at $20, seem even more promising here at $3. I’ve even bought a couple of the larger, less speculative ones. (Remember: free advice is what you pay for it.) A paradox of capitalism is that it rightly trumpets the benefits of competition, yet directs most of the spoils to the least price-competitive industries.