Auckland Airport: Result 2016

This is what a tourist flood looks like: The local population of Auckland, New Zealand is around 1.5 million people yet, over the past year, the number of passengers moving through its main airport increased by that same amount to 17.3 million. Side by side, those extra 1.5 million seats would stretch from Sydney to Melbourne.

As with most big numbers, China has something to do with it. The number of passengers arriving from the country in 2016 was just under 360,000 compared to 292,000 in 2015. To put it in perspective, that one-year increase almost matched the total arrivals from Germany, the airport's sixth largest market.

The international market has always been Auckland Airport's bread and butter. International passengers account for around 54% of total passengers, compared to around 33% for Sydney Airport.

So far, that extra exposure to foreign travellers has been a blessing. International passengers grew 9% in 2016. What's more, traffic to and from New Zealand is growing faster than passenger traffic globally. The International Air Transport Association (IATA) estimates total global traffic has grown at 5.5% a year over the past decade and increased 7% in 2016.

Cost curve

All this extra traffic comes down to one surprising factor – New Zealand is pretty much in the middle of nowhere. Its remoteness means that tickets from major markets are expensive, so – to borrow a mining term – Auckland Airport sits high on the ‘cost curve'.

As incomes rise, particularly in Asia, holidaymakers have more disposable income, which puts New Zealand within financial reach. Where once the scenic islands were reserved for rich western tourists, low-cost airlines and high-capacity aircraft have made long-haul travel cheap enough for Asia's rising middle class.

Nonetheless, we aren't banking on 9% international passenger growth over the long term. The airport's own long-term projection for growth of 3% a year as part of its 30-year masterplan seems more realistic.

Retail bonus

Passenger growth helped the airport achieve a 13% increase in revenue to NZ$574m for the year, but the benefits of international passenger growth don't stop at extra aeronautical fees. Retail sales get a kick too because international passengers have longer wait times for their flights and so tend to linger in the retail stores.

Sydney Airport's management has said that international passengers are around seven times more valuable to the airport than domestic passengers. We don't have a similar figure for Auckland airport, but this explains how a 9% increase in Auckland Airport's total passenger numbers led to a 19% increase in retail sales.

Unfortunately, being a tourist hotspot is a double-edged sword as it exposes the airport to volatile exchange rates, oil prices and tourism trends. If the world slipped into a recession, there's little doubt that Auckland Airport would have a rougher time compared to Sydney Airport.

Interest rates

As a vital piece of Auckland's infrastructure, with reliable, growing earnings, the airport can handle a lot of debt, which it uses to fund its capital expenditure needs, such as upgrading runways or terminals.

However, with more volatile earnings than Sydney Airport, Auckland Airport's management take a more conservative approach to borrowings. The company currently has NZ$1.9bn of net debt, which is roughly 4.4 times underlying earnings before interest, tax, depreciation and amortisation (EBITDA). The equivalent figure for Sydney Airport is 7.2.

What the airports have in common is that these debt piles have been a huge tailwind for earnings as interest rates have declined over the past few years.

Despite Auckland Airport's net debt almost doubling since 2008, interest expense has actually fallen slightly. Relative to 2008, the decline in funding costs saved the airport around $74m this year. Pre-tax profit has risen from NZ$160m to NZ$337m over that period, so, put another way, lower interest expense has contributed almost half the airport's pre-tax profit growth.

If interest rates stay low or fall further, Auckland Airport and other highly leveraged infrastructure assets will be among the biggest beneficiaries. But it's important to be mindful that every 1% rise in interest rates would now shave around 6% from net profit.

What's more, with a weighted average debt maturity of just 4 years – compared to 7 years for Sydney Airport – refinancing risk can't be ignored. Creditors may be clamouring to lend to Auckland Airport today, but plenty of airports and infrastructure assets had difficulty rolling over debt during the financial crisis, which led to a rush of desperate capital raisings. We don't expect trouble but this is one reason that, all things being equal, we still prefer Sydney Airport.

Highly valued

Of course, all things never are equal, and valuation is always the trump card. Here too Auckland Airport plays second fiddle with an enterprise value to EBITDA ratio of 26 (see The case for essential infrastructure for why we use this metric).

Make no mistake, an EV/EBITDA ratio of 26 is a hefty sum, even for a high-quality asset. Few airports are listed and they rarely change hands privately but we can get an idea of relative valuations by looking at two recent European transactions: Bristol and Toulouse airports were sold in 2014 and 2015, respectively, on EV/EBITDA ratios of 18.

Auckland Airport earns higher margins than both these airports thanks to its international exposure and undoubtedly has better growth prospects and less competition. It's a bit of an apples and oranges comparison, but it's still a sizeable gap.

Even Sydney Airport trades on an EV/EBITDA ratio of 22. Sydney Airport shareholders don't own the underlying land, though, which is held on a 99-year lease. Auckland Airport shareholders, on the other hand, have 443 hectares of freehold land available for development, which roughly matches the size of Auckland's CBD. As we've explained previously, Auckland Airport is a property developer's dream, and that option means a higher earnings multiple is probably justified.

Management expects underlying earnings per share growth of 8–13% in 2017. The board declared a final dividend of 9.0 NZ cents, with Australian shareholders receiving a supplementary 1.6 NZ cents in lieu of franking credits, for a yield of 2.1%.

We're a long way from buying, but Auckland Airport is still a high-quality, stable business with excellent growth prospects. We're raising the price guide and continue to recommend you HOLD.