David Fickling is a Bloomberg Gadfly columnist covering commodities, as well as industrial and consumer companies. He has been a reporter for Bloomberg News, Dow Jones, the Wall Street Journal, the Financial Times and the Guardian.

(Corrected )

How do airlines make money?

You might be tempted to answer, "by selling plane tickets." But it's rarely as simple as that. Take AirAsia Bhd., the Malaysian budget carrier that reported third-quarter results Thursday.

It's become so dominant in Southeast Asia that rivals have started ganging up on it. Yet you have to go back as far as December 2010 if you want to find a quarter when seat sales covered operating expenses. Costs have exceeded ticket revenue by an aggregate 4.94 billion ringgit ($1.1 billion) since then.

Ticket to Ride
AirAsia consistently loses money on seat sales, then makes it back on ancillary revenues
Source: Bloomberg data, company reports, Gadfly calculations
Note: Calculated by subtracting operating expenses from ticket revenue, then adding back categories such as baggage, charges and ancillary earnings. Ancillary revenue includes charges for assigned seats, freight, cancellations, documentations, and on-board meals and merchandise sales. Since the March 2016 quarter, it also includes surcharges and fees.

Perhaps it's all those outrageous baggage and other random fees where AirAsia's making its money? Not really. Adding in such charges certainly improves the picture, but still leaves the company posting losses in all but three quarters of the past five years.

In fact, AirAsia only breaks even when you factor in passengers' spending on in-flight meals, duty-free, reserved seats, cancellations and other sundries. If you're looking to see where the serious money is made, you're better off regarding the entire enterprise not as an airline per se, but as an unusual segment of the aircraft-leasing business.

The way this works is relatively simple. AirAsia is the single largest airline customer of Airbus Group SE, with 575 planes ordered. Some 401 of them have yet to be delivered -- the second-biggest outstanding request after India's InterGlobe Aviation Ltd., or Indigo -- giving AirAsia huge bargaining power in negotiating prices and tailoring aircraft to meet its requirements.

Buying Power
Airbus's 10 largest customers by outstanding orders
Source: Airbus, Gadfly calculations

All that makes for a rather neat source of additional revenue. Aircraft lessors such as General Electric Co.'s GECAS and BOC Aviation Ltd. typically can't get the discounts that airlines can screw out of the big manufacturers, so whenever AirAsia feels it's got too many planes on its own balance sheet, it can sell them to a lessor, lease them back, and book the premium over its own purchase price as income.

Net out AirAsia's expenses on such operating leases against its income from selling its order book over the past few years, and you'll notice that even after all those charges for in-flight trays of Hainanese chicken rice, the company as a whole typically makes more money from selling and leasing aircraft than it does from flying them.

Lessee is More
AirAsia loses money at the operating level on ticket sales, just about makes it back on ancillary revenues, but makes its real money from selling and leasing back its own aircraft
Source: Bloomberg data, company reports, Gadfly calculations
Note: Profit on aircraft operating leases calculated by subtracting operating lease expense from operating lease revenue. Other profits and losses calculated by subtracting operating expenses (less operating lease costs) from different categories of revenue.

That makes plans by Group CEO Tony Fernandes to sell this golden goose rather unsettling. The unit could be separated as soon as December, he said earlier this year, and may fetch as much as $1 billion.

There would be some definite benefits. Investors have often looked askance at AirAsia's leasing business, particularly because many of its sale-and-leasebacks have been not to lessors but to its own affiliates in Indonesia, Thailand, the Philippines and India. AirAsia's stock shed more than half its value in less than three months last year after GMT Research issued a report criticizing the accounting used in such deals, though it has since more than recovered what was lost and has more than doubled this year.

Up and Away
AirAsia shares have more than recovered the ground they lost since GMT Research's June 2015 report
Source: Bloomberg

Putting the leasing unit at arm's length will both help Fernandes pay down debt, and remove the shadow GMT's report cast. While AirAsia's return on equity of 26 percent is close to its low-cost peers Ryanair Holdings Plc and Southwest Airlines Co., on 29 percent and 30 percent respectively, its blended forward 12-month price-earnings ratio of 6.88 is barely half their 12.48 times and 12.90 times valuations.

Leasing also looks a lot less attractive when considered in relation to the amount of capital that gets tied up in the business -- a situation that will only worsen as international accounting standards for operating leases change.

Still, any sale won't come without risks. Investors who've become accustomed to the comfortable cushion provided by all those lease earnings will find the business has less to fall back on if times grow leaner.

AirAsia's profits have been relying more heavily on ancillary and baggage revenues in recent quarters in preparation for this change. The 642 million ringgit of operating income from non-leasing businesses over the past three quarters is a larger sum than the 614 million ringgit posted in the previous three years, showing the airline can run perfectly well without lease income. But that ultimately means driving up costs to customers, which will weaken AirAsia's ability to undercut its rivals.

In addition, the leverage AirAsia has had over Airbus will diminish. With an arm's-length leasing business, it'll just become one of half-a-dozen smaller customers again.

Being lean and transparent is all very well, but sometimes it's better to be powerful.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

(Updates with share price performance in 10th paragraph. An earlier version of this column was corrected to fix erroneous time reference in 14th paragraph.)

  1. That's a more common situation in aviation than you might think. Take a look at operating profits per available seat mile -- ticket revenue, minus operating expenses, divided by the number of seats on an airline's planes and how far they flew. Leaving aside carriers that are failing to return their costs of capital (which may be posting operating losses because of general poor performance, rather than a sustainable business model), out of 46 airlines globally, only 18 had an operating profit per available seat mile in the most recent period.

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David Fickling in Sydney at

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