Sydney Airport flying high, but is it a Buy?

Strong international traffic growth of 4.3% has helped Sydney Airport achieve a decent full-year result, with revenue increasing 5.6% to $1.2bn. Some 39.7 million passengers passed through Sydney Airport’s gates in the year to December, a 3% increase on 2014.

Demand from China, India and the USA was given a boost by a number of airlines increasing seat capacity.

The continued trend towards less restrictive international air rights was also a net positive by loosening the passenger caps on particular regions. Bilateral Air Service Agreements between Australia and other countries regulate the amount of traffic flying to the gateway airports: Sydney, Melbourne, Brisbane and Perth.

In early 2015, a new agreement was penned with China, which allowed for 53,000 weekly passengers to fly between the gateway airports and China – more than double the previous allowance of 22,500. The allowance for major Chinese cities specifically (Beijing, Shanghai and Guangzhou), however, was increased a more modest 18%.

Sydney Airport was quick to take advantage of the extra capacity with the number of Chinese passengers increasing 17.8%. Chinese nationals are now the airport’s largest foreign market by residency.

What’s more, the new agreement allowed for an additional 8,000 weekly seats to and from China as of Oct 2015 and a further 6,000 to be granted in Oct 2016. Strong Chinese passenger growth is likely to continue.

The number of passengers on routes to India and the Philippines was also high, increasing 16% and 37% respectively.

The strong growth in international passengers is important for a couple of reasons. Firstly, it offsets sluggish domestic growth, which was only 2.3% in 2015 (though thankfully an improvement on last year’s 1.2%).

Secondly, international passengers are roughly seven times more valuable to the airport than domestic passengers because they’re big spenders in the retail precincts. On average, a domestic traveller spends 40 minutes in the domestic terminal, compared to nearly two hours for international passengers.

Retail revenue (22% of the total) increased 3.3%. That’s nothing to write home about, but was a fairly good showing given 2015 was a ‘period of material transition’ as the major duty free contract was handed to a new operator, requiring significant refurbishments.

Aeronautical revenues (50% of the total), on the other hand, increased 7% to $607m. We expect the strong growth to continue given that a new five-year pricing agreement was recently finalised with international airlines, which allows for a 4.8% price increase in 2016 (being a monopoly has its perks).

The best performing division, however, was the Car Parking cash cow, which increased revenue 8% to $151m. Online bookings were particularly noteworthy, increasing 20% on 2014. We’re pleased to see that 1,600 new spaces are to be added over the next 12 months, which will increase capacity by 10%.

The costs of running the airport are mostly fixed, which means that, as revenue grows, operating profits grow faster than revenue and costs. Earnings before interest, tax, depreciation and amortisation (EBITDA) increased 5.8% to $1.0bn, while operating cash flow per stapled security increased 9.7% to 26 cents.

Management expects 2016 distributions of 30 cents per security – an impressive 18% increase on 2015. So, all good then?

Chief executive Kerrie Mather seems to think so. 'Our business strategy remains on track, and we’re well positioned to continue to deliver EBITDA and cash flow growth well above passenger growth ... The macro environment is supportive, and operationally we continue to capitalise on aeronautical and commercial opportunities through investment and innovation. We’re in excellent financial shape, with a strong balance sheet and financial flexibility to support the ongoing delivery of business expansion and ultimately cash flow growth'.

If this result shows anything it’s that Sydney Airport is a formidable asset, arguably one of the best in Australia. But with the stock up 73% since we upgraded it in December 2013, the investment case is shifting.

Sydney Airport is on the expensive side. If the stock forms a large portion of your portfolio, you should consider taking some chips off the table as the share price rises to maintain a maximum portfolio weighting of no more than 8%.

This is a great business but not a great opportunity.

With a forward unfranked dividend yield of 4.5% we’re sticking with HOLD.

Disclosure: Intelligent Investor staff and our Equity Income and Growth portfolios may own the stocks mentioned.