Why Airports make great investments

Monopoly infrastructure businesses such as airports are usually considered low growth, but investors may be surprised to learn that since GFC the number of air travel passengers has almost doubled.  With the growing number of airports around the world being privatised, investors can seek to profit from this growth.

Airports are now very much an essential component of infrastructure to most modern economies as they cater collectively to around 4 billion passengers annually, with future increases driven by a growth in middle class put together with a decline in the cost of air travel.

How an airport generates income is typically split into 3 core components.

  1. Aeronautical charges – fees paid by passengers for use of the airport
  2. Retail – rent received from shopping within the airport and also car parking
  3. Office / Industrial property – this can be from spare land owned by the airport that can be leased to companies wishing to be located near an airport, such as freight companies, hotels and airline businesses.

Usually airports generate around half of their revenue from aeronautical charges, which are linked to passenger numbers.

Passenger growth historically has been at the rate of approximately twice that of GDP. While risks such as terrorism and health scares such as SARS have put a short term dent in passenger numbers, over time these risks have been short term blips in a long term uptrend.  This can be seen in the chart below which provides annual total airline passenger numbers over the past 50 years.

Investors should have a high degree of confidence that passenger growth is likely to continue into the future due to structural demographic changes.  One only has to look at China which currently has 230 operating airports but by 2030 is forecast to be operating 430 airports.  This structural change is being caused by the large growth in the Chinese middle class who are forecast to double from around 300 million to 600 million in the next 5 years.  This, plus the fact that only around 8% of Chinese citizens have a current passport, sees a long runway for growth in passenger numbers.

Sydney Airport in its strategic planning for the next 20 years is forecasting a 51% increase in passenger numbers to 65.6m over the planning period.  International passengers will be the main driver of this growth and are forecast to represent 48% of total passengers by 2039 (source Sydney Airport Annual Report 2018).  This is important as it is generally considered that International passengers are worth around 5 times more to an airport than domestic passengers due to higher landing charges and higher retail spend from passengers.

Investors in Australia can gain exposure to airports through owning securities in Sydney Airports and Auckland International Airport which are both listed on the ASX.  Exposure can also be achieved through specialist infrastructure funds including but not limited to those offered by Magellan Financial Group and Lazard.

While the business case for airports is sound, investors should be mindful of the impact of long term interest rates on airport valuations.  Increases in long term interest rates are generally considered to be negative for airport valuations.

Other key risks investors should consider are those of regulatory nature.  There are generally two types of regulatory frameworks for airports around the world. One regulatory  model is where the entire airport is fully regulated, resulting in returns from the airport being in line with a fully regulated utility. This is known as single till.  The other model, which is commonly referred to as ‘dual till’ is where the aeronautical revenue is regulated, but the rest of the business (retail, car parking and property) is not.  The dual till model offers investors the prospect of higher returns, but at the same time investors are accepting higher risk. Most institutional investors prefer the dual till approach.

Growth in passenger numbers and consistency of revenue are two attributes that can generally be found in airport investments, which earns their right to have a place in a well structured investment portfolio.

 

This article was published in the Australian Financial Review during May 2019 and was written by Mark Draper.  Our thanks to Gerald Stack, Head of Infrastructure at Magellan Financial Group for his assistance in putting this article together.