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Morningstar | Rising Operating Costs Accompany Pacifico's Strong Passenger Growth, but Our Thesis Remains Intact

Wide-moat Grupo Aeroportuario Del Pacifico registered solid third-quarter results that featured 9% total passenger growth and operating margins slightly narrower than the second quarter last year. Our fair value estimate per ADR share is now $115 (from $116) after updating the spot rate in our model to reflect a weakening peso; however, our fair value estimate for the local shares is higher after we increased domestic traffic growth, subsequently raising revenue for Guadalajara for 2018. Our revised fair value estimate for local shares is now MXN 223 (from MXN 221). ADR shares trade in 4-star territory following our fair value estimate revision.

Pacifico turned in another quarter of robust revenue growth with aeronautical, or regulated, revenue expanding a little over 17% and nonaeronautical revenue improving almost 16%, year over year. Similar to last quarter, Pacifico pinned growing nonaeronautical top-line on VIP lounge volumes remaining firm and higher car parking revenue. The operator logged double-digit revenue growth in each of its airports, but Guadalajara made the greatest contribution to companywide passenger growth, comprising almost 34% of Pacifico’s total traffic. Our model includes total traffic for Guadalajara reaching above 14 million for 2018, with domestic traffic growing 12% over 2017. Combined with our forecasts for Pacifico’s remaining airports, we expect total passenger traffic will improve by 8.5% through 2018.

In the quarter, cost inflation accompanied growing traffic volume and offset many of Pacifico’s revenue increases over the year-ago period. The operator's cost of service rose 25%, with safety, security, and insurance; utilities; and lounge sales costs each leaping 30% higher. Operating margins were lower compared with the same period last year, but we believe the airport operator is still on track to reach our full-year operating margin of 55.5%.

Our attention now turns to the late October referendum, which will decide whether construction continues at Mexico City International Airport. If voters elect to discontinue the airport’s expansion, the referendum won’t immediately become policy, as Mexican law forbids a binding vote outside of an election, but we assume there is a chance that newly elected President Andrew Manuel Lopez Obrador will seek to enforce the vote. Anticipating higher uncertainty around the new Mexico City airport and a spillover for airport operators, we adjusted our outlook for 2021-22 midcycle years and lowered our stage II growth assumptions for Pacifico.