High Dollar Good for Australian Airlines On Wednesday I attended a speech in which Qantas chief Alan Joyce presented a view that a high Australian dollar was bad for the airline. There were two main takeaways from the speech, and the question and answer session that followed. The first is that Joyce is better at speaking off the cuff. This is not to say the speechwriters at Qantas are bad - I know them well and they are very good at what they do. The second is that he appears to be receiving the wrong advice about the impact of the Australian dollar on the airline's business. A strong Australian dollar is unambiguously good for Qantas. Exchange complexities The wrong advice Joyce has received, I suspect, is a function of the very complex impact that the exchange rate has on the airline's business. And I suspect he is not the only CEO who has received wrong advice on the impact of exchange rates. To unravel this exchange rate complexity, one must not only know and understand the revenue and cost streams that are denominated, directly or indirectly, in foreign currency, but also the extent to which the exchange rate exposure is interconnected with other exposures, such as energy prices, the economy and interest rates. Revenue effects Let me set out the complexity. First, a strong Australian dollar reduces foreign currency-denominated revenue. Qantas sells to passengers from all over the world and they typically pay in their home currencies. As long as these home currency airfares are not adjusted for exchange rate movements, and generally they aren't, a strong Australian dollar against those currencies will result in lower Australian dollar revenue. Qantas' international freight business generates revenue that is almost exclusively in US dollars or in currencies heavily tied to the US dollar. A strong Australian dollar therefore also results in lower freight revenue. The exchange rate has very little impact on the airline's domestic and regional revenue streams, and the revenue generated from international airfares paid by Australians. The adverse revenue effect is therefore limited to just one segment of the international business. Cost effects A strong Australian dollar also reduces costs denominated in foreign currency. The biggest foreign currency costs are in US dollars and include fuel, operating leases, capacity hire, spare parts and aircraft purchases. These costs are born by all segments of the business, including international, domestic and regional. There are also port and route-related costs denominated in foreign currency that pertain to the international business only, including those attributable to ground handling, station engineering, airport charges, route navigation, catering, use of overseas airspace and running overseas offices. Qantas also enjoys indirect cost benefits from a strong Australian dollar. Many costs are paid for in Australian dollars but are affected by currency movements because the airline's suppliers pay for them in foreign currency. These include the cost of road vehicles operated by Qantas, and IT, communications and other electronic equipment. When the Australian dollar is stronger some of the benefits of that strength are passed through into lower Australian dollar prices. Overall, a stronger Australian dollar unambiguously results in Qantas group costs falling by more than revenue, leaving the company better off. This is mainly because the favourable cost effect impacts the whole business, while the adverse revenue effect impacts a much smaller segment of the business. Passenger mix A strong Australian dollar generally does not affect the total number of passengers travelling by air, only the mix of passengers. When the Aussie dollar is stronger there are more Australians travelling abroad than foreign passengers travelling inbound. As Qantas has a dominant position in the Australian market, a strong dollar that raises outbound and reduces inbound travel is good for the Qantas group because it strengthens the demand segment in which it has the greatest revenue penetration. About the only negative on the passenger mix front is that strong outbound travel may come at the expense of domestic leisure travel. Qantas is in a superior competitive position domestically than internationally, and so would prefer strong domestic demand over international. Interdependent exposures The Australian dollar is high because the oil price and other commodity prices are relatively elevated; our economy is outperforming most others; Australia attracts foreign capital because our interest rates are expected to be higher in the immediate future; and it appears that the Australian dollar's status as a currency from which to flee when global financial risk is heightened has weakened. What this means for Australian airlines is that the exposure to the exchange rate is inextricably linked to fuel, interest rate and real economy exposures and that there are considerable opportunities to take advantage of the natural hedges generated as a result of these linkages. In a world that appears to be experiencing significantly greater volatility in financial and commodity markets, this presents Australian carriers with an enormous advantage - one that they can use to overcome the fact they are at a considerable unit labour cost disadvantage.