EUR 850.00 For Business Accounts Only

Morningstar | Sydney Airport Enjoys Improved Margins in 2018, but Traffic Growth Set to Slow; AUD 7.30 FVE Remains

Narrow-moat Sydney Airport’s full-year 2018 results were in line with our expectations and keep the firm on track for solid, albeit slowing, bottom-line growth going forward. As reported on Jan. 18, total passenger traffic increased 2.5% in the year, driven by 4.7% international and 1.2% domestic traffic growth. Alongside higher per-passenger rates and the positive mix shift of greater international traffic, regulated aeronautical revenue increased 7.6% versus 2017, while upgrades to retail facilities and higher leasing rates drove a 7.2% improvement in unregulated retail revenue. Total revenue climbed 6.8% to AUD 1.59 billion, nearly identical to our projection.

We’re encouraged by the airport’s good cost control in the period, which boosted EBITDA at a higher 7.2% rate, to AUD 1.28 billion, again on target with our estimate. However, we expect slowing growth in passenger traffic, revenue, and EBITDA in 2019. Management’s initial outlook for the year supports our view, with an expected distribution in 2019 of AUD 39 cents per security, or cps, up 4% on the prior year, versus the nearly 9% growth to AUD 37.5 cents in 2018. We maintain our AUD 7.30 fair value estimate. Shares screen as fairly valued.

We expect international traffic growth to decelerate to 3.6% in 2019, owing to a slowing of airline capacity growth, but forecast aeronautical revenue gains remaining north of 6% due to rising per-passenger charges. Similarly, we anticipate rising per-passenger retail spending. The metric climbed 4.6% in 2018, and we project 4% growth in 2019 and an average of 3.5% over the next four years as the airport benefits from rising international passenger mix, annual escalators on its leasing rates, and expanded retail offerings in domestic terminal 3, where the firm will gain control of commercial activity in July 2019. We also expect improving property revenue over the next several years given a planned additional hotel in 2021, following 7.5% top-line gains in 2019.

On top of solid revenue growth in 2018, Sydney Airport enjoyed operating leverage as costs grew at a slower pace than sales, in line with our forecast for rising EBITDA margins over the long term. Reported expenses increased 5.3% but, adjusting for increased hotel costs (two new hotels had a full year of operation, versus only six months in 2017) and passed-through security expenses, total costs increased by a commendably low 1.8%. We project costs to climb at about 4% annually, trailing inflation on a per-passenger basis. We see EBITDA margins climbing to the mid-80% over the next decade from about 81% in 2018, growing at about 6.5% per year.

However, we expect Sydney’s distributions to shareholders to grow at a much slimmer pace. Management noted it expects to begin paying cash taxes in 2022, following the usage of its tax loss benefits. This timing is slightly accelerated from our assumed 2023, but tracks our long-term expectations. As such, we see distributions growing at only a 3.4% annual rate through 2028. Cash available for distribution will likely increase at a slightly faster pace, though, as management plans to smooth the payout amount into 2022. We estimate the AUD 39 cps guidance for 2019 will represent about 94% of cash available this year, compared with a 98% payout ratio in 2018.

The regulatory environment for Sydney Airport remains favourable. A recent Australian Productivity Commission report recognised the airports have not abused their market power and recommended no changes to the commercial negotiation or monitoring framework. The final report will require another submission round and public hearings, and should be released later this year. But we don’t expect push back on Sydney’s likely per-passenger rate increases over our forecast period.

The Commission also recommended a public review of operating restrictions at the airport, including the current ban on take-offs and landings between 11pm and 6am. This curfew arguably can create more congestion and noise around peak times as aircraft circle the airport waiting to land, or in periods of poor weather. We’re not optimistic such a law would be overturned by the government, given the likely public backlash from residents near the airport, although such a move would probably help Sydney Airport better smooth its asset utilisation. But regardless, we’re encouraged management noted that a change to the curfew is necessary to meet its multidecade passenger plans, and that 35% of slots at the airport remain unutilised.

The major risk facing Sydney Airport remains its highly geared balance sheet, although metrics generally improved in 2018. Net debt/EBITDA decreased slightly to 6.6 from 6.7 in 2017, and the firm doesn’t face any maturities in 2019. Average maturity is roughly six years. We see servicing costs rising over time as interest rates move to a more-normalised level but expect Sydney Airport to cover its interest payments two to three times with EBITDA over the next 10 years.