Auckland Airport's rising tide

As far as businesses go, you don't get much simpler than Auckland International Airport. The company owns a long strip of concrete and a few adjacent buildings. It then charges airlines to land on the concrete and hawks whatever it can to their passengers as they scurry through the buildings, trying to get away.

What's more, unless you're a bird, the only way you're flying in or out of Auckland is via this strip of concrete – it's a monopoly.

We've been banging on about the beauty of airport assets for a good 13 years now, since we first recommended members subscribe to Sydney Airport's float – then known as Macquarie Airports – on 20 Mar 02 (Subscribe – $1.00). The stock is up 60% in the two years since we most recently upgraded it.

Steady growth

Auckland Airport has a stable, semi-regulated income stream of aeronautical charges and parking fees, and doubles as a shopping centre with captive customers and rents to reflect it.

But steady earners aren't too hard to find. What sets Auckland Airport apart from many other infrastructure and utility assets is its relentlessly growing earnings and traffic.

In 2000, the airport served just under 8 million passengers. Now it caters to more than 16 million – a 4.8% annual growth rate.

This is despite the 9/11 terrorist attacks, outbreaks of bird flu and SARS, and the Christchurch earthquake. In fact, the only year where passenger numbers didn't increase was 2009 thanks to the global financial crisis. But even then, the decline of 2% was nothing to lose sleep over. Two questions confront investors: why the steady growth, and will it continue?

Jet-setters

High growth in passenger numbers comes down to two main trends. Firstly, as the world's GDP per capita increases, holidaymakers have more disposable income. That's of particular benefit to Auckland Airport due to its remoteness from pretty much anywhere.

Tickets are expensive, so – in mining parlance – Auckland Airport sits high on the 'cost curve'. Rising incomes, particularly in Asia, have brought a deluge of new travellers within financial reach. 

Secondly, air travel has been getting cheaper in real terms, year in, year out, since Wilbur and Orville first hit the skies. With the rise of low-cost airlines and high capacity aircraft such as the A380, that seems set to continue.

International exposure

International passengers account for 55% of total passengers – well above the equivalent figure of 33% for Sydney Airport.

So far this has been working in Auckland Airport's favour. International passengers grew 6.9% over the past year, one of the strongest results on record and well above the 3.8% achieved at Sydney Airport.

But there's a flipside. A high reliance on international travellers makes the airport particularly exposed to volatile factors such as exchange rates and tourism trends.

A 15% increase in the value of the New Zealand dollar against the Australian dollar since 2012 has anchored growth in Australian arrivals.

A declining crude oil price, however, should soon have the opposite effect. The price of oil has fallen 65% since its July 2014 high. As airline ticket prices fall to reflect lower fuel costs, travel becomes more affordable and passenger numbers should pick up.

Furthermore, Auckland Airport's fastest growing markets – China, India and Southeast Asia – are among the largest net importers of oil. All things being equal (if only), those economies should get a boost from lower energy costs, further stimulating travel.

China impact

As you might expect, the growing wealth of China has had a major impact on Auckland Airport. The number of Chinese passengers that arrived in 2015 was a little over 320,000 compared to 243,000 in 2014. To put it in perspective, that one-year increase was more than the total arrivals from Japan – it's as if the airport found a whole new country to service.

China accounted for 27% of Auckland Airport's international passenger growth in 2015. However, the Chinese economy looks to be slowing. While this hasn't seemed to dampen any enthusiasm for international travel just yet, the repercussions could be large.

Any decline in Chinese travellers would hit the airport doubly hard. Chinese nationals account for 7.6% of international arrivals, but 15% of retail sales to international travellers. They're big spenders in the terminal, so any decline in passengers would have a disproportionate affect on retail sales and rent, in addition to the fall in landing fees.

Nonetheless, we expect passenger numbers to be resilient, with little reason to doubt the airport's own long-term projections for passenger growth of 3% a year or so. We're glad to see that management kept its cool when reflecting on the 4.8% growth rate achieved over the past 15 years and didn't just project that bumper number out to the horizon as part of its long-term masterplan.

Earnings

Persistent growth is one thing, but Auckland Airport has another wild card up its sleeve – operating leverage.

While total passenger numbers increased 5.0% in 2015, total aircraft movements actually fell 1.5% due to the increased use of larger aircraft. Many of the airport's costs are fixed, so, as revenue grows, a greater portion falls to the bottom line. Revenue has increased 19% over the past three years, whereas underlying net profit has increased 27%.

Adding it all up, its realistic to expect aeronautical fees and retail rents to grow a little faster than passenger numbers due to price increases, and – with the benefit of fixed costs – earnings per share should grow slightly faster still. We expect long-term earnings growth of 5–7%.

That's reasonable, but nothing stellar. However, given the quality of the asset and the stability of growth, we would still love to recommend purchasing Auckland Airport – if the price is right.

The price is wrong

With pitiful yields to be found elsewhere, infrastructure assets have become market darlings over the past three years. Transurban is up 68% over that time, Sydney Airport is up 82%, and Auckland Airport has risen 90%.

Remember that infrastructure assets are meant to be predictable and boring. In Auckland Airport's case, the business model and growth outlook hasn't changed since 2013, yet today you're paying 30% more per dollar of earnings.

An enterprise value to EBITDA ratio of 20 and unfranked dividend yield of 2.6% simply doesn't provide adequate compensation for the risks. Auckland Airport is a wonderful asset, but it's still, more or less, that one strip of concrete. A major earthquake or terrorist attack would be devastating, not to mention any disruption from the turbulent exchange rates and oil prices mentioned earlier. And we haven't even touched on the effect of rising interest rates (hint: it's not pretty).

The share price is up 28% since Auckland Airport downgraded to Sell from 27 Jan 15 (Sell – $4.25). We're increasing the price guide to reflect the growing business but the stock remains a SELL.

Note: The Intelligent Investor Growth and Income portfolios own shares in Sydney Airport. You can find out about investing directly in Intelligent Investor and InvestSMART portfolios by clicking here.