Sydney Airport: Interim result 2018

We've been banging on about the attractiveness of airport assets for a good 16 years now, since we first recommended members subscribe to Sydney Airport's float in 2002 at $1.00 per share.

One of their charms is that strips of bitumen – and the terminals that support them – become more efficient with each additional flight that touches down. Like toll roads or other large infrastructure projects, airports are expensive to build but, once they're up and running, the cash comes flooding through the doors.

Sydney Airport, itself, makes the point. Let's go back to this time last year: for the six months to June 2017, the company had $96.7m of operating expenses, excluding hotels and security. Over the past year, general inflation added $1.7m to those costs. Staff expenses added a further $1.7m, while product and activity costs added another $2.3m. So on the face of it, there was an extra $5.7m, or 6%, in operating expenses – except that the airport's continual efficiency and improvement programs knocked out around $3.3m, so operating expenses in fact only rose 2.5% to $99.1m.

This is despite a 3.3% rise in passengers to 21.6 million, with international passengers up 5.2%. Revenue rose 7.9% overall, but the improving operational efficiency meant that earnings before interest, tax, depreciation and amortisation (EBITDA) rose 8.1% to $623m. Maybe you're thinking 20 basis points here or there doesn't make a big difference, but the airport finds these efficiencies so consistently that the EBITDA margin has slowly risen from 74.6% in 2008 to 80.9% today. On the current level of revenue, that's $49m of annual savings returned to the pockets of shareholders.

Many more savings-oriented investments are in the works, including a boost to aeronautical capacity by increasing the size of parking bays, and the introduction of self-service check-in and bag drop areas for the international terminal. Access to the airport is also being improved with a new fly-over road into the international precinct to relieve congestion.

Better balance

Efficiency flows through to the balance sheet, too. With stable revenues, Sydney Airport – like most infrastructure assets – can handle a lot of debt, especially with today's low interest rates. The company currently has net debt of $8.2bn, up from $8.0bn six months ago.

The airport uses debt to fund its capital expenditure requirements, such as upgrading terminals and runways, so net debt rises year in, year out. Generally this condition is to analysts what bedtime is to 7-year-olds, but Sydney Airport is a special case.

The airport's operating leverage means that passenger numbers and earnings can grow faster than capital expenditure requirements. Whether it has six take-offs per hour or ten, the runways need roughly the same maintenance, for example. 

Counterintuitively, while the absolute level of net debt is rising, the company's balance sheet is improving at the same time: the interest coverage ratio improved from 2.9 to 3.1 this year – and is up from 2.3 in 2014 – while net debt as a multiple of EBITDA fell from 6.8 to 6.7. In other words, debt is less of an issue this year than last year, despite there being more of it. 

Retail, property, cars

Aeronautical revenue –  which accounts for 45% of the total – increased 8% for the six months to June due to the strong passenger growth mentioned above, combined with an increase in landing fees. Management singled out China and the USA as big contributors in terms of absolute market growth, while Taiwan managed a 49% increase in passenger numbers, albeit off a low base. 

Retail revenue rose 9% following the completion of lease renewals with more favourable terms, as well as good performance from the Duty Free stores. Property revenue was also a bright spot, rising 11% due to good performance from on-site hotels Mantra and Ibis. 

What let the result down was the increase of only 2% in revenue from the parking. As anyone who has driven to the airport will know, being a monopoly gives it significant pricing power at the car parks. Ultimately, though, it can only charge what its customers can afford – and Sydney Airport seems to have milked this cash cow a little too much over the past decade, so is pulling back on price increases. Average prices have actually been falling over the past few years once you factor in promotions offered for online and long-term bookings. Online bookings now contribute an impressive 45% of car park revenue.

Management expects 2018 distributions of 37.5 cents per share, a 9% increase on 2017. The stock is up 15% since our most recent upgrade in Sydney Airport: Result 2017 from 22 Feb 18 (Buy – $6.32). With formidable competitive advantages, decent growth prospects and an unfranked distribution yield of 5.1%, we're sticking with HOLD.

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

Disclosure: The author owns shares in Sydney Airport.