Airports are considered high quality, low-risk monopoly infrastructure assets. Prior to the onset of Covid-19 the trailing EV/EBITDAC of 20x for Sydney Airport and 24x for Auckland Airport. (EBITDAC stands for EBITDA before Covid!). With the Covid-19 induced closure of international and state borders passenger volumes through the world’s airports have collapsed to near zero. Faced with the reality of no near-term revenues, airport stocks initially fell between 40-60%. Despite no recovery in passenger numbers over the last couple of months, prices have recovered about half of their descent. The share prices of some of the listed airports we track are presented in the chart below.
The monthly passenger statistics reported by Sydney Airport show passenger numbers are down 97% compared to the same period last year. The key question for investors is what does the path out look like?
History provides some confidence that passenger growth will return to long run averages. The largest shocks in Australian’s aviation history are the pilot strike in 1989 followed by the 2001 terrorist attacks. Passenger growth at Sydney airport turned mildly negative in the two years that followed 9/11 before returning to trend growth in 2003.
At Sydney Airport, the passenger breakdown is about 38% international and 62% domestic. However, the landing charges for international passengers are about five times that of domestic landing charges. This leads to aeronautical revenues being about 70% for international versus 30% domestic. Similarly, duty free revenues mean that international passengers generate disproportionately higher retail earnings.
Looking at the path out, we see three broad phases:
· domestic air travel is likely to significantly increase with the opening up of interstate borders over the next few months;
· travel with New Zealand is likely to follow (perhaps in the next 3-6 months); and
· broader international air travel is unlikely to restart in any scale until sometime in 2021.
New Zealand is Sydney Airport’s (and Australia’s more generally) largest international destination at 17% of international traffic. We would expect this route will rebound quite quickly given the high proportion of travel related to visiting friends and family (there are about 500-600k New Zealanders living in Australia) and business travel.
Beyond the Anzac Bubble, the next steps are more tricky. Singapore – with its strong track record of managing Covid-19 and position at no.2 on the list – is a natural candidate. However, many passengers coming to Australia via Singapore are actually just transiting through Singapore and originate somewhere else. A further complication is Covid-19 risks versus geopolitics. The former, would argue allowing Chinese passengers in (and excluding the US) but the geopolitics of Australia taking such a stance seems unrealistic. Rather, a full opening up might require developments on the medical side (testing, treatment or a vaccine) that would then allow a broader opening up of Australia’s borders.
When will be the likely restoration of trend passenger growth? Will there be a permanent reduction in travel?
Past episodes, such as 9/11 or the pilots strike, saw passenger numbers rebound to the prior trend over a couple of years. Whether this proves to be the case this time is difficult to forecast and will depend critically on the progress towards effective treatments or vaccines for Covid-19. Whilst ever mandatory 14-day quarantine periods for crossing international borders remain in place, this will discourage all but the most essential international travel. It is hard to imagine the attraction of a week in Bali if it also involves two weeks stuck in a hotel room to get back into the country!
The extended period of lockdown is also changing habits and it is impossible to know what the long‑term implications of these shifts might be. From an airport owner’s perspective, it is certainly a risk that the rise of video conferencing could undermine the rebound in business travel.
Irrespective, the weak economy is going to hurt discretionary leisure and business activity, and for this reason, we think the odds favour the rebound from Covid-19 being slower than historic episodes.
Valuation
Before reading further – a disclaimer – all readers should know that this newsletter is not intended as investment advice, and that every investor should undertake their own due diligence as to the appropriateness of any investment. Our analysis below reflects our approach to lending – we assess the enterprise value of all assets we lend to through a variety of scenarios to understand supportable levels of leverage.
We have updated our financial model of Sydney Airport to reflect the post Covid world. Our valuation is driven by passenger growth and forecasts 25 years of cashflows. We have assumed an unlevered terminal value of 15x EBITDA of final year cashflows, a WACC of 4.5% and 1.5% inflation. On passenger growth, we have bookended two scenarios – a bullish and bearish passenger growth forecast.
Under the bullish scenario passengers recover to their 2019 level by 2024 and grow at long run growth rates of 1.5%. Essentially this scenario sees Covid-19 as a temporary hit with underlying passenger numbers and profits returning to the original trend.
Under the bearish scenario passenger growth only recovers to 85% of the 2019 level before returned to trend growth of 1.5%. That is, the bearish scenario assumes at 15% permanent loss in passenger numbers compared to the pre-Covid trend.
We note that Sydney Airport has about $625 million in cash on the balance sheet and undrawn bank lines. It will probably not require an equity raise. The output from our model suggests the following valuation ranges under the bullish and bearish scenarios.
The current share price around $5.50 seems to approximate fair value based on the above analysis. However, if the pace of international borders re-opening disappoints, or there seems to a be a permanent hit to business travel from video conferencing, this would present clear downside risks from the current share price.
Conclusion
We valued Sydney Airport pre covid at $8.36 (actual trading price circa $9.50). The current valuation is probably somewhere between the bearish and bullish scenarios. That is, a $5.00 - $7.00 range. On this basis, the current market price at around $5.50 aligns with our analysis.
While the focus of our analysis is Sydney airport – this analysis is broadly applicable across all of Australia’s airports. It would of course be dependent on the starting valuation and whether it was more conservative than Sydney Airport, but assuming they were marked on a similar basis, we would be expecting unlisted airports to take a valuation hit of around 25‑50%. Where individual airports sit within this range will likely depend on two factors, one, the domestic/international split (with the more domestically focused airports proving a safe haven and starting valuation) and two, the more aggressive the pre-Covid valuation (eg Sydney airport), the bigger the fall.