The aviation industry is one of the most unique industries. It has very high capital costs, operates frenetically from day to day and it is difficult to to make profits in.

But Australia’s market is unique. While Europe and America have several carriers and competing transport options, Australia relies on aviation for tourism, business travellers and FIFO.

But if you thought large caps Qantas (ASX: QAN) and Virgin Australia (ASX: VAH) were the only aviation stocks, think again. There are two aviation small cap stocks: Alliance Aviation (ASX: AVQ) and Regional Express (ASX: REX).

In some respects they are similar to their larger peers and most other airlines globally. But in other, key respects, they are different. Here is what you need to know.


Regional Express (ASX: REX)

Regional Express flies various short-haul routes across Australia with a fleet of 55 Saab turbo-prop aircraft. It flies to smaller destinations that lack facilities for larger aircraft such as Cooma in New South Wales, Ceduna in South Australia and Tasmania’s King Island.

In addition to passenger aircraft, REX bid for tenders last year to provide fast jet support for the Australian Defence Force and the Victorian Police.

While Rex is a minnow compared to Qantas, it is also profitable, recording a $15.8 million profit last year.

Alliance Aviation (ASX: AQZ)

Alliance Aviation offer charter flights, mainly FIFO as well as wet leasing, usually for Virgin Australia in Queensland through a 41-member fleet of Fokker aircraft. It serves a mixture of destinations from capital cities to towns too small for 737s.

Despite the deal with Virgin, Qantas bought a 20 per cent stake in the company back in February. In the long term Qantas intends to gain majority control of the airline; yet for now it’s keeping quiet.

Alliance is up 45 per cent in the last 12 months and has made an $18 million profit after tax, two years running.

The most important factors for profitability

There are three major concerns from a financial stand point – fuel prices, passenger yields and maintenance costs.

Fuel prices are determined by oil prices and these fluctuate heavily on various factors from the global economy to OPEC’s latest production targets. Since October crude oil prices have been low but there is always the chance they could rise again.

Foreign exchange rates are critical too because fuel is bought in US dollars. To protect themselves, airlines engage in hedging, which is using futures contracts to set costs in stone irrespective of current prices.

Second, passenger yields. It is common knowledge that it’s better business to take less passengers and make more money from them. Hence business class is getting better and better while economy class remains stagnant at best.

While Alliance and REX only have economy, they have small aircraft and can charge higher prices because on many routes they have a monopoly. Alternatively, they may have corporate contracts – where large firms buy a certain number of seats per day whether or not they use them.

Couldn’t Qantas or Virgin just break their monopoly? Theoretically, yes – but practicality is preventing them from it. They lack the aircraft small enough to land at many of the smaller airports they serve.

Idleness is money-draining

Third – maintenance costs. A well-run airline does not just have spare aircraft to use ‘just in case’. They’re expensive to own and maintain so the best place for them is in the air, where they’re making money.

While Qantas can get maintenance or painting of its larger aircraft done overseas such as in Korea, it is more practical for Alliance and REX to have maintenance done here because it would take too long to get their aircraft overseas.

Even if aircraft don’t need work it’s expensive to have planes sitting around, not making money. Airlines have to pay for airport slots and to keep their aircraft parked at airports. London’s Heathrow Airport charges 52.49 pounds ($95.53) per 15 minutes to park aircraft and that doesn’t include multi-million pound landing slots.

The 737 MAX grounding is costing operators around $2,000 per month per plane. While no Australian airline has the jet, Virgin Australia had it on order to arrive this year and have delayed it by two years.

These examples illustrate the importance of keeping the fleet in the sky. Although, of course they’re also expensive to keep in the air; but then they are making money.

But what about passenger sentiment?

Ten years ago, the only way to make public airline disputes is to ‘go to the papers’. These days you just go on Twitter. And if you see an incident onboard now we record it with our phones and put it on social media.

You may recall two years ago Kentucky doctor David Dao was dragged off a United flight and the way he was treated went viral in a way it would not have in the pre-smartphone era.

Ironically United’s stock rose in the days after and currently is 11 per cent higher than two years ago. Investors rarely care about incidents unless they cause aircraft to be out of service – like Qantas with the QF32 incident.

While some refuse to fly 737 MAXs, JP Morgan has told its clients it was “simply not in the camp that the MAX program has been materially impaired long term”.

Three things did worry it. First, the lack of a time frame to return to service; second, the new training regime for 737 MAX pilots and third, if other countries would recognise US safety standards. Seemingly it thinks people will say one thing and do another.

Of the seven listed US airlines, it predicted six to rise and the standout was ironically the one highly regarded with consumers – Southwest.

The very things consumers like Southwest for, having free checked bags and same day changes, are hardly penny-pinching.