Australia | Jul 01 2015
-Agreed price growth for 5 years
-Debt servicing costs to fall
-Capital returns?
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By Eva Brocklehurst
Sydney Airport Holdings ((SYD)) is expected to improve passenger experiences, with a brand new agreement on aeronautical pricing. The new agreement provides greater certainty as it is underpinned by a fixed pricing path and incorporates capital expenditure over the five-year period, enabling the airport to invest in its terminals and technology and improve services. This contrasts with previous agreements in which capital expenditure was agreed separately with airlines and charges re-set every couple of years.
The company has reached an agreement with the Board of Airline Representatives Australia. The price has not been re-negotiated since 2007 as negotiations were deferred in 2012 for three years to allow the company to establish a new vision for the airport. Macquarie observes that in interim fundamental inputs had materially fallen and many airlines considered the Sydney services were not as good as that of rival Melbourne.
This led to an increased requirement for operational and capital expenditure. Macquarie had built such expectations into earnings forecasts and so the negotiated outcome is a positive surprise, with an initial fee price decline of 0.75% and a price increase of 3.8% thereafter for the next four years.The agreement was reached with regard to a longer-term perspective on bond rates and funding costs. With debt spreads, too, a longer-term average was used in the fee calculation.
Passenger growth assumptions are more conservative than the 2007 negotiations, but Macquarie estimates they are still in the order of 3-4%. In return for generous pricing provisions, Sydney Airport has accepted performance measures to ensure base level services are delivered to airlines and passengers. Hence, Macquarie upgrades cash flow expectations by 7.0% for 2017 and 11.0% in 2018 and 2019.
Morgans is positive about the deal as it provides price certainty and the agreed price growth across the five years is ahead of its forecasts. The current pull-back in the share price is a buying opportunity, in the broker’s view. Sydney Airport is in advanced discussions with the airlines regarding their international agreements, which activity accounts for around 35% of the airport’s international passengers.
Sydney Airport should benefit from a number of tailwinds over coming years. Morgans observes international passenger growth, which drives 75% of earnings, will benefit from a tripling of bilateral air rights between Australia and China as well as an increase in capacity between Sydney and the US. The broker also expects servicing of debt will fall as out-of-the-money interest rate swaps expire and are replaced at lower rates. This should help drive cash flow and distribution growth.
Morgans expects distributions will lift to 28.9c in FY16. Guidance for FY15 is 25c a share. Moreover, this improved cash flow should improve credit metrics and create potential for shareholders to be rewarded with capital management initiatives. The broker estimates up to $800m could be distributed to fund a special distribution, buy-back, or capital return.
Credit Suisse is the fly in the ointment among brokers, reducing distribution estimates by 3.6% for 2016 and 4.8% for 2017. The broker now expects 2016 to provide 27c a share and 2017 to provide 29.5c. The broker also considers the risk of not achieving the 2015 distribution is now higher. The company’s policy is to pay out 100% of cash flow as a distribution but the broker notes cash flows, even for an infrastructure business, are not smooth and airport earnings could be more volatile than investors expect. Credit Suisse was not so struck by the agreement, having expected higher growth. The broker also expects higher operating costs for providing more services to airlines and passengers.
The steady revenue growth is attractive on a relative basis, in JP Morgan’s view. The price growth path is close to the broker’s base case assumption and the fear the negotiations would lead to a material downgrade to fees because of the lower interest rate environment appears to be unjustified.
FNArena’s database has four Buy ratings and three Hold for Sydney Airport. The consensus target is $5.37, suggesting 2.2% upside to the last share price. The dividend yield on FY15 and FY16 consensus forecasts is 4.8% and 5.2% respectively.
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