Sydney Airport Holdings (SYD) posted a first half result that pleased brokers. Yield has expanded on the back of prior investment in the airport and international passenger growth is on the rise, supported by a number of new wide-body services which will commence operations in the second half.
Besides ramping up the potential for organic growth, the company has also announced an agreement with Qantas ((QAN)) to purchase Terminal 3 for $535m, which is expected to be earnings and cash flow accretive immediately. The transaction will be funded by a mix of debt and cash.
Aeronautical, retail and property revenue will be recognised initially by the airport, commencing after finalisation of the transaction, with advertising and valet revenue to be recognised from June 30, 2019. Strategically the acquisition will deliver control over all airport assets and provide the flexibility to move to a common user terminal after 2019, when Qantas’ existing lease runs out.
The purchase effectively brings forward a transaction that would have occurred when the lease ran out and until 2019 Macquarie suspects Sydney Airport has limited influence. Still, in 2019 it will be able to revamp and integrate the retail strategy for the whole airport. Sydney Airport has recently committed to increase its operating expenditure by $8m per annum as part of the new international aeronautical agreement to improve service quality.
Aeronautical revenue will be a higher proportion of T3 revenue compared with the existing airport composition, given the transaction does not involve car parking. Also, T3 is used for domestic and regional services so there is no duty free retail to boost earnings.
While not considered an inefficient terminal under exclusive Qantas control, brokers suspect capacity utilisation may be increased under common usage from 2019. Regardless, the accretive value of T3 and greater confidence in the international passenger outlook has driven a 2-3% upgrade to cash flow per share forecasts for UBS.
Deutsche Bank believes around 90% of the incremental revenue from T3 will flow to earnings and upgrades forecasts to reflect this outcome. The broker expects more opportunities to enhance revenue at T3 will be forthcoming, although there is likely to be some contraction in margins given integration costs associated with the purchase. Analysis suggests capacity into Sydney will increase in the second half of this year and the airport is positioning for a stronger 2016.
Meanwhile, the distribution was upgraded to 25.5c per security for the first half and is expected to be fully covered by net operating receipts. Morgans is hopeful there will be a further upgrade. Assuming the T3 acquisition is completed on schedule, and incremental earnings are realised as the company expects, then Morgans forecasts cash flow of 26c per security. A further 0.5c increase in the second half distribution may be possible, the broker contends, although this is not concreted into forecasts.
The main obstacle to an increase in distributions would be the capital contributions required for the second Sydney airport. On this point, the relative appeal of the stock, UBS asserts, is tempered by the uncertainty regarding the company’s involvement in the Badgery’s Creek airport development.
A notice regarding the second Sydney airport is expected from the government at the end of the year. This is a significant issue for Sydney Airport with the major uncertainty being the means of pre-funding the development before it opens in 2025. Morgans does not expect major capital investment from Sydney Airport until after 2020.
Macquarie believes confirmation of an ability to invest capital sensibly is what will ultimately drive value in the stock. The discipline and patience shown around the T3 opportunity demonstrates what can be done with the second airport and this should become clearer in the next nine months, Macquarie maintains. Revenue opportunities remain varied and range from new food areas, new yield management in car parking and hotel developments.
The stock looks fairly valued to Morgan Stanley, although yield and organic growth are attractive. This is reflected in the consensus target on FNArena’s database which, at $5.77, is close to the last share price and compares with $5.53 ahead of the results. There are three Buy ratings and four Hold on the database. The distribution yield is 4.5% on FY15 estimates and 4.9% on FY16.