Airports have certainly borne the brunt of COVID-19 lockdowns, with border closures, movement restrictions and working from home orders leaving passenger numbers at rock bottom.
And after enduring the early part of the pandemic in 2020, it looked like airport investors could expect things to look better in 2021, but that false promise gave way to more of the same.
Now, however, it feels like things are genuinely looking up.
Finally, as the Australian economy reopens, the future for air travel looks positive.
Although the question remains what the recovery curve will look like, what the outlook for airports from an investment perspective may look like and how valuations may look across the sector?
At AMP Capital, we are confident of the recovery already underway for airports. There are a few reasons for this confidence.
The first is the experience of the industry in 2021 – and particularly the experience of Melbourne airport (AMP Capital manages funds that own a stake in the Australian Pacific Airports Corporation, which owns Melbourne and Launceston airports).
Melbourne was one the world’s most locked down city globally and, importantly, Victoria is the only mainland state without a significant intrastate air network. Once air travel to and from other states stops, air traffic in Victoria is very significantly affected.
So why do we have confidence in the outlook?
The reason is that when borders were open, the traffic recovery was very strong. In fact, when Melbourne opened for a month or two in the first quarter of this year, it hit more than 60 per cent of 2019 domestic volumes.1
We believe this demonstrates how much pent-up demand there is for air travel and how resilient the traffic is going to be once borders open and travellers have more certainty about being able to go somewhere and return.
The other change that bolsters our confidence in the outlook are the changes to the structure of the airline industry itself.
Prior to Virgin going into administration, it was financially weak and not well-capitalised to compete effectively with Qantas by deploying additional capacity or offering lower prices.
That meant we saw airfares continue to increase prior to the onset of COVID-19 because we effectively had a duopoly with only one player making money.
Now, Virgin has been recapitalised and it has a different cost base, which means it should be able to compete more effectively with Qantas.
That means lower airfares — and lower airfares means higher passenger volumes. Airports are a volume business, so higher volumes will mean a better economic outcome for the airport.
The third reason for our confidence is the vaccination outlook.
Australia is on track to be one of the most vaccinated jurisdictions globally. This is going to give people a lot of confidence to travel domestically because the likelihood of lockdowns and border closures is going to be reduced with such a high level of vaccination. Recent case numbers in Sydney are already seeing that play out.
This will allow the states with border closures to open up to Sydney and Melbourne – and importantly, allow Australia to open up to the rest of the world. International traffic is very important to airports as these passengers tend to have exposure to more of the airport’s commercial offer like duty free and restaurants.
So how exactly could the recovery play out? Airport traffic is benchmarked to 2019, because that is the last full year unaffected by the pandemic.
There are two key questions: when will traffic return to 2019 levels and, afterwards, when will it resume its old traffic growth curve and carry on as if the pandemic never happened?
Interestingly, the post-pandemic outlook is different for domestic and international travel.
For domestic traffic, we expect to be back at 2019 levels by early FY23, potentially as early as July or August next year2. A good indicator of what is going to happen is how airlines are scheduling capacity, bearing in mind that they can cancel this capacity, so it is not locked in. We see that airlines are scheduling a lot of capacity domestically in the first half of next year.
Looking ahead, by 2027, we expect that domestic air traffic is expected to catch up with pre-COVID forecasts. This forecast may come as a surprise to many who expect business travel to be permanently affected by working from home and video conferencing.
It is quite true that business travel is unlikely to regain its pre-COVID trajectory, but we don’t expect this to affect overall passenger numbers. This is because we expect airlines to adjust fares downwards in order to make pricing more accessible to leisure and more price-sensitive segments of the domestic market. It is our assumption that some of these segments had been previously priced out by high airfares.
There is some downside for the airlines, which may see yields fall, but we would expect them to remain profitable because Australian fares are high compared to other jurisdictions.
Internationally, it is a bit of a different story, and the forecasts are a little more conservative. This is due to several reasons including the fact that the international carriers have trimmed their fleets but we expect international traffic to regain 2019 levels by FY26.3
At that point, the relationship between economic growth and passenger traffic resumes, but we expect that it never recovers to the pre-COVID growth forecasts and always remains marginally behind where we thought it would have been from 2030.4
Of course, there is potential for this forecast to be on the conservative side and for international traffic to recover faster than anticipated.
Similarly, domestic traffic could be boosted by new domestic entrants.
There is also potential for downside risk.
Any recovery in Chinese traffic is unknown. In our view, before the pandemic, China was a key a growth market for Australian airports and Chinese passengers are among the biggest spenders on airport retail and duty free5.
The negotiation environment for airline charges is also proving difficult as the airlines seek to keep their costs down. Talent retention is also a key challenge for airports in this recovery phase.
Clearly, there is substantial investor interest in airports. The recent takeover offer for Sydney's airport has come in at a significant premium compared with what the airport was worth on or around 10 September 2021 and has been increased twice6. This implies upside for valuations of other airports although several approvals are still required before that transaction can be completed.
1. Melbourne Airport monthly traffic disclosures
2. Internal company forecasts, AMP Capital
3. Internal company forecasts, AMP Capital
4. Internal company forecasts, AMP Capital
5. Chinese and South Korean travellers remain Duty Free’s top spenders (Corporate Travel Community) available at https://corporatetravelcommunity.com/analysis/chinese-and-south-korean-travellers-remain-duty-frees-top-spenders-582848
6. Sydney Airport receives third takeover bid, valued at $23.6 billion (ABC News) available at https://www.abc.net.au/news/2021-09-13/sydney-airport-takeover-bid-infrastructure/100456642
Subscribe below to Institutional Edition to receive my latest articlesDavid Kenny, Managing Director Airports
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