Malaysia’s AirAsia, the continent’s biggest discount airline, is looking to buy a stake in the Serbian JAT airways after a very good 2^nd quarter put it in a comfortable position to expand its regional carrier business.  The Serbian government has been looking for a buyer for their unprofitable carrier since 2008 and both the President and Prime Minister are in Russia looking for buyers there as well, despite the failure of Aeroflot’s acquisition attempt four years ago.

AirAsia (AMEX:$EWM) on the other hand, has been a consistently strong performer in the growing Southeast Asian air carrier industry.  Net profits jumped an eye-popping eleven times to $381.1 million in Q2 as compared to last year due to reducing its equity stake in its Thai unit, Thai AirAsia, to 45% from 49% and listing it on the Thailand Exchange where the fair value of the unit rose significantly.  So, in effect, 87% of their earnings for the quarter came from an accounting profit which adds to the company’s asset portfolio, but not its free cash flow.  Revenues increased by 9.3% from $347 million to $379 million, but between rising fuel costs per passenger, +3%, and foreign exchange losses due to a weak Ringgit during the quarter, operationally, AirAsia had difficult quarter, year over year.  Net operating income actually slipped from $43.4 million to $42.1 million.  

However, from an industry perspective, AirAsia is one of the few carriers that is actually making money in a very challenging environment where competitors are piling up losses.  Its main rival, Malaysian Airlines, reported a sixth consecutive quarterly loss of $111.7 million. Singapore Airlines’ Silk Air Division is gearing up for a major expansion of its capacity, a 23% expansion this year and similar expansion rates through 2021 as it integrates its recent order of 54 Boeing (NYSE:$BA) single-aisle 737’s and 737Max’s, but the parent company is still struggling with its global business model.

AirAsia is preparing for the increase in RPMs in the region as well, pulling forward some of its order for new Airbus A320s, as it adds more routes and looks to acquire other carriers.  It currently has 58 new Airbus A320s on order while delivery of four new jets is expected in the coming month, as it sheds itself of its Boeing planes completely.   

In August, it also announced it intended to acquire a 49% stake in Indonesia’s Batavia Air for $80 million, its biggest acquisition to date.  AirAsia Indonesia already enjoys a 41% market share in Indonesia’s international passengers but it is looking to grow its 3% domestic passenger share. Batavia is a government-owned airline and this deal may hit snags along the way.  Malaysia and Indonesia are not on the best of terms; AirAsia is already a well-established in Indonesia and has an Indonesian partner, PT Fersindo Nusaperkasa, which should be enough to close the deal.

It has also established a new joint venture in Japan (AMEX:$EWJ), AirAsia Japan, as it looks to fully compete in the low cost South Asian airline market with the dominant low-cost carriers in the region, Tiger and JetStar.  Moreover, it is expected to make a 100+ unit order for Airbus A320s at this year’s Berlin Air show which kicks off on September 11^th. The negotiations between the two organizations are already underway.  AirAsia is moving completely to AirBus as its supplier of planes as it divests itself completely from Boeing.

While AirAsia has Malaysian roots but it has established its head office in Jakarta, Indonesia, realizing that Jakarta is the traditional hub of travel for the region and will be again.  The Malaysian economy is showing surprising resilience but it cannot be compared to what’s occurring in Indonesia, which is nearly 9 times the size of Malaysia’s population and is growing faster, 6-7% GDP growth versus 4-5% for Malaysia.  The country is a hub of regional economic activity and therefore a natural choice for the headquarters of Asia’s largest low-fare airliner.   The future of ASEAN GDP rests in Indonesia. 

Although AirAsia will experience the rise in demand due to the expansion in operations, but the future outlook in this industry is dependent upon oil prices and aviation fuel. Brent Oil (AMEX:$BNO), currently hovering around $82.50, has fallen by 4.5% since the beginning of year but has recovered off the June lows of $63.45 and while some are expecting oil prices to stay under pressure I’m convinced that $100-$120 Brent is the new normal minimum price range given the amount of QE the Federal Reserve and the rest of the Western Central Banks will have to engage in.  This will make it easier for SE Asian companies as their economies decouple from the U.S. and Europe and their currencies strengthen in relation to them; putting companies like AirAsia and Silk Air is a good position with respect to fuel.  Q3 foreign exchange adjustments for AirAsia will mitigate part of the fuel cost rise given the Ringgit’s drop from $3.20 back near $3.10 USD.

As AirAsia expands their operations, I would use them as a weather vane on the ASEAN regional economy.  For those interested it trades on the Bursa Malaysia and will soon be accessible through the Singapore (AMEX:$EWS) exchange as well because the ASEAN equity markets are moving towards full integration.  

But I would stay away from airlines in general.  The Guggenheim Airline ETF (AMEX:$FAA) will likely not be a good investment here as air travel worldwide will be a low-margin affair at best and will be dragged down by a number of poor performers.  However, the earnings for companies like AirAsia, being a low-cost regional air carrier, can be used as proxies for the general state of economic growth in the region; helping investors make good choices about when and where to invest in the single country Asian ETF’s like EWM and The Market Vectors Indonesia Index ETF (AMEX:$IDX).  Specific companies will have to be approached carefully and for U.S. investors who don’t have direct access to the Asian exchanges, the ETFs are the only game in town.