Qantas dreams of a dwindling dollar

A US80 cent Aussie would significantly reduce Australia’s attraction to the airline’s international competitors, while boosting Qantas’ international revenues.

Why would the chief financial officer of an airline with a fuel bill heading towards $5 billion a year want a US80 cent dollar? Because the prospective longer term structural gains would outweigh the short-term impact on costs.

Qantas’ Gareth Evans, in an interview with Dow Jones this week, noted that the fall in the dollar over the past week and a half had pushed up its fuel costs, yet again. Last financial year Qantas’ jet fuel bill was more than $4.5 billion, a $253 million increase on the previous year.

Qantas would still, however, prefer to see the dollar continuing to fall to around US80 cents, he said, because of its impact on the group’s foreign competitors.

Qantas’ challenge -- reflected in the $497 million its international division lost (at an underlying earnings before interest and tax level) last year -- has been the dramatic growth in competitors’ capacity on its international routes since the financial crisis.

Where Qantas once had a market share of about 35 per cent on the routes into and out of Australia, that share has more than halved as its competitors have increased their capacity on those routes by about 45 per cent even as Qantas itself has been reducing the routes it flies offshore.

Alan Joyce has explained the drivers for that rise in competitor capacity in the past as a response to the strength of the Australian economy and dollar during a period when the European and US economies and currencies were weak.

The influx of new capacity from mainly hub-based competitors in the Middle East and Asia with newer fleets, better product and more extensive route networks has been a significant element in the destabilising of Qantas and the underlying pre-tax loss of $646 million the group incurred last year.

The impact of the strength of the Australian dollar on the international business was exacerbated by the reality that the bulk of its cost base -- its fleet, its facilities and its workforce -- is in Australian dollars but its revenue was in weaker currencies offshore.

A lower dollar does mean potentially higher fuel costs, although Qantas does hedge almost all of its fuel requirements and about three-quarters of its currency exposures. Oil prices have fallen by more than 10 per cent in the past three months and jet fuel prices have edged down over the course of the year, so that would help blunt the inflationary impact on fuel costs.

The bigger picture, however, is the impact of a lower dollar on competitor revenues and ultimately capacity.

In the 2014 financial year Qantas’ international rivals added 9.5 per cent to their capacity on the Australian routes. In its results presentation, however, Qantas referred to “capacity moderation” and forecast first-half competitor capacity growth of a more modest 2.4 per cent this financial year.

There’s something of a ‘triple-whammy’ in a lower dollar for Qantas.

Less competitor capacity means less pressure on yields and load factors.

A weaker dollar means higher revenues, given that Qantas would be generating a significant proportion of its international revenues in foreign currencies, including the US dollar.

It also probably means some switching from international travel to domestic travel and, with a market share of just under 65 per cent and the dominant frequent flyer program, Qantas could be expected to grab the majority of that incremental domestic revenue.

At US90 cents to the dollar Australia probably still remains relatively attractive to Qantas’ competitors. A US80 cent dollar would significantly reduce that attraction while improving Qantas’ international revenues relative to its costs at the same time.

Further falls in jet fuel prices in the medium term would be a bonus but it isn’t hard to see why Evans and his boss would prefer to live with an increased fuel bill in the near term if the trade-off is a structural improvement in the competitive settings for their international arm.

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