Auckland Airport: a property developer's dream

Auckland airport comprises 1,500 hectares of waterfront land – an area three times larger than downtown Auckland itself. And it's just a 25 minute drive away.

What's more, some 230,000 tonnes of air freight move through Auckland Airport each year as well as 16 million passengers.

Management are well aware of these convenient facts. 'We call the land around the airport The District. It is growing and fast becoming
 a community hub with businesses, shops, hotel accommodation and recreation 
facilities. As the airport continues to grow, The District will become a destination in itself,' said management in the airport's 30-year masterplan.

Only 12% of Auckland Airport's revenue is currently from rental income, but that huge land bank could be a honeypot of future value if developed correctly. Better yet, shareholders own the land – it's freehold – unlike Sydney Airport's 99-year lease (of which 81 years remain).

Around 443 hectares is available for development, roughly matching the size of the Auckland CBD. One 120-hectare block is being developed as a business park and already boasts many large tenants including Coca-Cola Amatil's local manufacturing plant and DHL, the world's largest logistics company. Closer to the airport, two hotels have been built with a third on the way.

To see just how rapidly the value of Auckland Airport's vast site is growing, you have to dig deep into the notes of the financial statements.

In 2011, the land was independently valued by Colliers International at NZ$1.9bn. It was then re-valued in 2014 at NZ$2.6bn – a NZ$737m or 39% increase in 3 years. To put it in perspective, the airport only earned NZ$536m in net profit from its operations over that time.  

Interim result

The District provides a nice option to grow rental income, which increased 16% to NZ$28m in the six months to December thanks to various recent developments.

Revenue from the airport's car parks increased 11% to NZ$26m, while retail income rose an even more impressive 21% to $NZ79m following a two-year redevelopment to increase retail space and fill the airport with more high-end local brands.

Auckland Airport is heavily reliant on international passengers. They constitute around half of total passengers, compared to a third for Sydney Airport. However, it hasn't done well leveraging their typically higher spending habits. New Zealand residents sill contribute 80% of retail revenue. Management hopes to improve this by changing the product mix and recently switched up the duty free offering with two new operators taking up the lease last July.

If things go to plan we expect passenger spend rates to increase, which should also be enhanced by the booming Chinese market. A new Air China route to Beijing means the airport now has direct flights to all major cities.

A 7% rise in international passengers helped the airport increase total revenue 12% to $280m. Because many of the airport's costs are fixed it benefits from significant operating leverage, leading to a 19% rise in underlying net profit to $104m.

Option value

Airports are stable and high-quality assets and Auckland Airport, in particular, should benefit from a steadily increasing number of international travellers.

What's more, New Zealand's gateway airport should get a boost from the lower New Zealand dollar making holidays to the country cheaper. The local currency has fallen roughly 15% compared to the US dollar and euro over the past year.

We also wouldn't be surprised to see a short-term kicker from cheaper airline tickets as the oil price falls. Fuel costs as a percentage of an airline's operating costs are disproportionately high for long-haul flights and typically exceed 30%. Auckland Airport relies on long-haul flights for 55% of incoming passengers, so should benefit from lower fuel costs more than Sydney Airport.

Unfortunately, this hasn't gone unnoticed by Mr Market. Auckland Airport's share price has risen 41% over the past year. Management expects net profit of between NZ$200m and NZ$206m in 2016, putting the stock on a forward price-earnings ratio of 37 using the mid-point of that range.

After adding in $1.8bn of net debt, the company now boasts an enterprise value to earnings before interest, tax, depreciation and amortisation ratio of 21 (see The case for essential infrastructure for why we use this metric). The board declared an 8.5 cent interim dividend, for a yield of 2.5% after taking into account the 1.5 cent supplementary dividend Australian investors get to compensate for a lack of franking credits.

That's a high price, even for a high-quality asset. Still, we're beginning to look at Auckland Airport through a different lens. It isn't just an airport – it's one part airport, one part property developer. We expect it will be able to grow rental income from its investment properties quickly as it implements its masterplan, so it isn't hard to imagine long-term profit growth in the mid to high single digits after we add in that wonderful cocktail of passenger growth and operating leverage.

We're raising the price guide and making a step-wise adjustment to our Sell price from $4.50 to $6.50 to account for the optionality inherent in Auckland Airport's huge undeveloped land holding. Nonetheless, Auckland Airport is still one very pricy stock and there are better opportunities on our current Buy list. We highly recommend you take profits as the share price rises and maintain a portfolio weighting below 6%. HOLD