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Morningstar | Auckland Airport Facing Slowing Passenger Growth, but Improved Retail Results; Shares Fairly Valued. See Updated Analyst Note from 21 Feb 2019

First-half results for wide-moat Auckland Airport were in line our full-year projections, with underlying NPAT up 3% to NZD 137 million. Traffic growth moderated but retail revenue climbed rapidly on the back of newly opened stores and restaurants in the airport. Profitability should expand markedly in the second half of fiscal 2019, and the company remains on track to hit unchanged full-year NPAT guidance of NZD 265 million to NZD 275 million. We forecast NZD 275 million, representing growth of 5% on the prior year. While some regulatory risk has crept into the outlook given the airport’s decision to cut aeronautical pricing following pushback from New Zealand’s Commerce Commission, or ComCom, we maintain our NZD 7.40 per share fair value estimate, while our ASX-listed share valuation lifts 3% to AUD 7.10 due to a stronger New Zealand dollar.

We expect the ComCom will remain supportive of a light-handed regulatory environment over the long term, and expect Auckland’s new investments to support continued passenger traffic growth and rising retail revenue. But near-term revenue will be slightly lower than we previously anticipated. Per our Nov. 1, 2018 note, the ComCom pushed back on Auckland’s planned per-passenger fees for the current five-year planning cycle, creating risk that the company may have to cut prices. Indeed, this eventuated, with Auckland Airport accepting a slightly lower rate of return and discounting pricing over the three-year period to fiscal 2022. While this decision in isolation has only a minor impact--an estimated NZD 30 million out of more than NZD 860 million in NPAT we previously estimated--it highlights regulatory risk. Auckland Airport could face pushback again entering its next price-setting period in fiscal 2023, particularly since planned capital spending will lead to an increased asset base and higher proposed pricing. However, we expect a fair outcome in our base case, and expect solid long-term returns on invested capital.

Passenger traffic in the first half grew 4.1%, as international and transit movements climbed 3.5%, while domestic traffic grew 4% versus the previous corresponding period, or pcp. These results are broadly in line with our full-year forecast for 3% domestic and 3.9% international gains, suggesting some moderation in domestic traffic in the second half, combined with less-pronounced declines in transit passengers, which fell 5.2% as new routes directly from Melbourne to San Francisco and Santiago are subsequently skipping Auckland as a layover location.

Similarly, we expect slowing revenue growth in the second half from the 11.5% rate posted in the first half. A major driver of this impressive result was a 25% increase in retail revenue following the recent opening of new retail floorspace, including several luxury stores in the international terminal. Retail sales per passenger leapt nearly 20%, but we see this slowing to 8% in the full year as the company laps openings in the second half. Nonetheless, we anticipate retail spending per passenger continuing to climb well ahead of inflation, averaging roughly 6% over the next five years as the airport benefits from rising international traffic, investments in e-commerce options for passengers, and generally strong performance of its retail sites.

Profitability expansion was minimal in the half, but we attribute this to timing of expenses rather than a sign of poor operating leverage. EBITDA margins slipped 40 basis points versus the pcp, versus our forecast for a slight improvement in fiscal 2019. Nonetheless, management maintained its outlook for costs to climb only by single digits in the full year, despite operating expenses increasing 14% over in the first half. This suggests second-half EBITDA margins should improve by more than a percentage point, keeping Auckland on-track to hit our projections. We continue to expect further profitability expansion over the long term as the airport leverages its fixed cost base, with EBITDA margins climbing to the high-70% range over the next 10 years.

Free cash flow will also be better than we previously expected for the year, although again this should be a timing issue rather than a structural step-change. Auckland now plans to spend NZD 280 million to NZD 330 million in capital expenditure for the year, down from a prior outlook between NZD 450 million and NZD 550 million, but this is driven by the delay of several construction projects into the following years. Management noted its cumulative capital spending plan through fiscal 2022 remains intact, and we have no changes to our long-term assumptions as a result.

We expect the firm’s balance sheet can comfortably meet these plans. The airport finished the period with net debt/EBITDA of 3.9 times, in line with fiscal year-end levels. While we expect this metric to climb back above 4.0 as the firm undergoes its capital spending initiatives, we believe risk remains low given EBITDA/interest cover of more than 5 times, on average, over the next five years. The company holds an A- credit rating from S&P-- a solid investment-grade profile.