With the rise of air travel, airports have become essential to the functioning of societies. RARE Infrastructure makes the case for investing in listed companies that own airports.
Airports enable business interactions, tourism, visiting family and friends, and the movement of cargo and freight. All these activities are on the increase globally, fueled by rising incomes, growing populations and middle classes, falling air fares and higher air freight volumes.
So typically, inelastic demand combined with pricing power within a strong legal framework, mean cash flows are predictable. Airports generally face minimal competition too as most cities only have one major airport, while rail or road rarely offers a direct threat. As such, airports typically have strong pricing power given the lack of competition and high barriers to entry, namely regulation, safety and large capital investment.
Lastly, airports also have operating leverage in their favour. This means that revenues tend to increase with inflation and passenger numbers, whilst operating costs typically increase at a lower rate. This results in growing margins and cash flows to investors.
Airport operations and the services they provide can be best understood by considering their various revenue streams.
1. Aeronautical revenues: this is typically earned as a fee per passenger and aircraft size for the use of runways, terminals and associated infrastructure.
2. Commercial, non-aeronautical revenues: this is collected by the airport owing to their status as landlords across various activities such as shop rentals, car parking operations, building rentals, including car rental, cargo, office space and catering operations.
As airports have monopolistic characteristics, they tend to be subject to regulation to ensure prices for its aeronautical and commercial services are not excessive. The type of regulation an airport faces and the ability to predict how it will be applied is an important consideration for investors.
There are two styles of regulation around the world. The first is called ‘single till’ and it regulates both aeronautical and commercial activities. This limits the ability for the airport to earn excess returns or benefit significantly from strong passenger growth. Airport prices and the resulting returns are driven by the allowed return on capital set by the regulator and the size of the asset base. Single till is used to regulate UK airports, while in Europe there is hybrid version where some revenue streams such as car parking are included in the regulation, but other revenue streams are excluded.
‘Dual-till’ regulation is where one till is regulated (aeronautical) and the other till is non-regulated (commercial). This enables airports to earn higher return on the non-regulated portion of the business and to capture economic benefits of strong passenger growth. The downside of dual till operations is that these airports are more exposed to the risk of passenger shocks. Such a model is used in a light-handed way in Australia and New Zealand, where, notably, aeronautical prices are monitored but not controlled. In Asia, dual till regulation is used with quasi-government regulation.
Passenger shocks such as health epidemics (e.g. SARS), terrorism, volcanic ash clouds, airline bankruptcy and regulatory changes are typically the major risks that airports face.
The level of risk can depend on what proportion of passengers are starting or ending their journey at the airport and what proportion are merely transferring to another flight.
Some airports are predominantly used by transfer passengers and so are more exposed to the risk of an airline moving its hub operations to another airport. For example, approximately 60% of passengers at Frankfurt airport are transfer passengers, whereas virtually all Sydney Airport passengers are starting or finishing their air travel journey.
The characteristics of listed airport investments are similar those of the broader infrastructure asset class. They include long-term stable cash flows, lower correlation and beta to other asset classes and inflation protection while enjoying the added benefits of listed markets such as liquidity and lower fees.
The advantage of listed shares in airports over unlisted ownership is the opportunity to take advantage of market movements and to invest where we, as active managers, see value.