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Morningstar | Beijing's Second Airport Will Most Likely Divert Traffic Away From BCIA, FVE Lowered to HKD 7.90. See Updated Analyst Note from 02 Sep 2018

Narrow-moat Beijing Capital International Airport, or BCIA, generated 6% higher passenger traffic during the first half of 2018, ahead of our forecast. While solid passenger numbers coupled with robust nonaeronautical revenue led to a notable 15% climb in revenue, profitability has not improved as we once expected. However, BCIA's miss on our bottom line estimate for the first half is the least of our concerns for the company. Instead, we are worried that BCIA will suffer material traffic diversion as Beijing's newly erected Daxing Airport is put into operation. Coupled with operating costs that are projected to outgrow revenue and high capital expenditure averaging 17% of sales over the next six years, we cut far value estimate on the airport operator to HKD 7.90 from HKD 10.80. Shares of BCIA appear overvalued, we suggest investors await a more attractive entry point.

The city of Beijing is on track to unveil its second airport in late 2019 to early 2020. While this is great for travelers, the same can hardly be said about shareholders of the once one-and-only BCIA. The new Daxing Airport is projected to have five runways, with an estimated passenger handling capacity of 72 million by 2025. Beijing Capital International Airport, at the same time, has three tracks and handled 96 million travelers in 2017. Even though our existing airport has been running on overcapacity for years, a new airport in the same city will certainly cannibalize traffic going in and out of BCIA. While we previously thought the listed entity might be able to obtain a stake in the second airport, management disclosed that such plan is no longer on the table, at least for the initial years of operation. Going forward, we assign a very low possibility to the group's parent (owner of both airports) selling portions of the new airport to BCIA at a large enough discount to have a material impact on BCIA's intrinsic value.

On the flip side, however, we do see an opportunity for BCIA to turn some of the previous domestic slots into higher-margin international routes. However, even after taking this into account, we still think the company will experience a total of a 4.2% decline in its aeronautical revenue between 2019 and 2022.

With the firm's top line staying stagnant over the next five years, the company's operating costs are expected to grow at 3.8% CAGR. Rising aviation safety and security guard costs, which have been growing at an average 8.2% over the past five years, will continue to outgrow top line as security protocol tightens. Management also guided noticeable growth in repair and maintenance expenses over the next two to three years to fix up worn-out equipment in the airport. Combined with expected increases in staff costs and environmental maintenance, we see BCIA's gross margin decline by roughly 300 basis points between 2019 and 2022. We do see some recovery in margins arriving post-2022, as rising costs are gradually being offset by a pickup in revenue growth. Our renewed midcycle forecast assumes revenue growth of 3%, in line with management's long-term guidance.

Lastly, we are intrigued by BCIA's decision to pay a lump sum of CNY 2.4 billion, plus a subsequent CNY 2.1 billion over the span of five years to acquire Ground Traffic Center from its parent company. While we assume the deal is value-neutral in the long run, it is worth noting that roughly CNY 225 million annual savings in lease expense will be realized. As a result of the CNY 4.5 billion acquisition, BCIA's capital expenditure will remain elevated until fiscal 2024.