Sydney Airport cleared for upgrade

The annual results from Sydney Airport—the listed entity rather than the airport itself—were polluted by the important asset swap settled late last year. The actual airport’s results, in which an 85% stake is the listed entity’s sole investment, offers a clearer picture.

For the year ended 31 December, Sydney Airport registered a small 0.2% increase in total passenger numbers, on which it achieved 3.1% revenue growth. Earnings before interest, tax depreciation and amortisation grew a lesser 2.2% to $791m. It wasn’t a banner year for airport profit growth.

As with companies as diverse as Coca-Cola Amatil, JB Hi-Fi and Woolworths, as well as Tullamarine Airport, local consumers weren't keen to spend. But while domestic passenger numbers fell 1%, international passenger numbers rose 3%.

Key Points

It's impossible to know what 2012 may bring, or any year thereafter. But longer-term averages are likely to prove quite predictable. Growth in Sydney’s population, combined with the leveraged correlation between air passenger growth and real GDP growth—see MAp: A classic Long Term Buy (Long Term Buy – $2.99)—should result in at least 2-3% average annual passenger growth, well ahead of 2011’s 0.2%.

If Sydney Airport can achieve average annual growth in passenger numbers of a few percent, it will lead to more rapid growth in revenues, earnings and securityholder distributions due to the airport’s inherent operational leverage.

Let’s leave the airport now and return to the listed entity Sydney Airport, formerly known as MAp Group. The statutory results aren’t very useful in any particular year, and 2011 was messier than most.

As explained in several Ask the Experts responses last year, we lean on ‘Proportionate earnings per stapled security’ from the Management Information Report as a guide to economic progress, rather than the headline earnings per security (EPS) in the annual report. This is more volatile figure, influenced by depreciation charges that substantially overstate future maintenance capital expenditure requirements (meaning the group is significantly more profitable than the headline EPS suggests).

Using the preferred measure, proportionate EPS fell 9% to 21.8 cents. The fall is in part the result of last year’s asset swap. In early October, the group swapped its stake in the low growth European airports for an increased stake in the higher growth (but higher price tag) Sydney Airport. It means a step backwards in proportionate EPS today in exchange for the likelihood of more rapid future growth. In the long run, this should serve securityholders well.

Sydney Airport paid total ordinary distributions of 21 cents in 2011 and management reaffirmed guidance for 21 cents in 2012.

Hidden progress

Once a satellite of Macquarie Group, the group used to pay out more in distributions than it made in earnings. Following the financial crisis and 2009 management internalisation, directors came to their senses.

Ordinary distributions to securityholders were to remain flat until such time as they were fully funded by the distributions that the group received from its underlying investment in Sydney Airport, less the corporate costs of running the listed entity. Barring major shocks, management expects that 2012’s distributions will, for the first time, be fully funded under that definition.

So after years of flat distributions—despite strong average growth in airport profitability—securityholders can expect to see rising distributions recommence again from 2013.

While the details might be complicated, the case for Sydney Airport remains simple. It offers a high pre-tax yield of 8%, a figure that is likely to grow at a decent rate over the coming decade. The recent asset swap and airport reorganisation solidify the case for cautious enthusiasm.

Despite increasing chatter about a second airport for Sydney, we’re not overly concerned and intend to expand on that matter soon. The chief risks to the bullish case are massively higher oil prices, a sustained global economic meltdown, regulation to the currently unregulated parts of its business and black swans like a terrorist attack.

The airport also has a lot of debt at the asset level, about $6bn. And while we believe its debts are easily manageable given the airport’s significant and sturdy cash flow, one could never rule out a problem there.

Given the stock’s reliance on a single asset, please adhere to the suggested 5% portfolio weighting. Keeping that in mind, the stock is down 8% since MAp: Changing strokes of 6 Dec 11 (Hold – $2.83) and we’re once again upgrading to LONG TERM BUY.

To watch a video featuring Gareth updating Sydney Airport’s strategy, the simplification scheme and the airport reorganisation, click here.

Note: Both the Income and Growth portfolios own shares in Sydney Airport.