Airports are back – why there’s plenty to like for investors

AMP Capital’s domestic airports team manages the largest investment (27.32%) in Australia Pacific Airports Corporation Limited (APAC), which is the parent entity of Melbourne Airport and Launceston Airport. AMP Capital also manages a 50% investment in Port Hedland International Airport.

While these airports operate in the same sector and have some common features such as a runway, terminal and landbank for development, all airports are not the same. Melbourne Airport services a major city, is part of one of the busiest domestic routes in the world (Melbourne-Sydney) and pre-COVID, had more than 37 million people passing through its terminals each year.

By contrast, Port Hedland International Airport (PHIA) in north-west Western Australia services the town that is home to the world’s largest bulk export port, which ships commodities like iron ore to overseas buyers. The airport moves around 450,000 passengers a year, most being fly-in, fly-out workers. It is a tiny airport compared to Melbourne Airport but due to its high exposure to the commodity sector it was not impacted as severely by COVID.

Despite the significant impact that COVID had on the aviation sector across the world, airports big and small can continue to form an important part of an investor’s overall investment strategy. Our airports are operated under long term leases, 99 years for APAC and 50 years for PHIA, and both are managed to realise long-term value for investors. Both airport groups have relatively small management teams that operate the facilities in conjunction with services from the airlines, government agencies and third-party providers like security companies, ground handling agents and retailers. Our airport investments are important, long-term enablers of employment and economic activity in the regions they serve and deliver an ongoing contribution in facilitating ‘connections that matter’ as APAC puts it.

As we navigate the post-COVID environment with our airports, we are confident that they are positioned well for 2023 – a year for ongoing recovery and growth. But we are also alive to the challenges that the sector faces as the world adjusts to a new ‘normal’.

Investment Outlook: 2023

There is little doubt that Australians love to travel domestically and internationally, and our airport infrastructure is ready to facilitate that. We are also ready to welcome back international visitors who travel to Australia to work, study, visit family and friends.

Airlines have struggled with resourcing post-COVID, including retraining of staff and finding enough people in a tight labour market. That has constrained their ability to shift to full capacity, and that has limited the short-term performance of airports – which are volume businesses first and foremost.

It is an interesting dynamic for investors and the airlines. From an earnings perspective, the airlines are doing very well because the short-term capacity constraints have helped to push airfares higher, pushing up revenue. That has given airlines the opportunity to consolidate balance sheets, after three very tough years.

But airfares need to come down to ensure there is a sustainable level of demand. Post COVID there’s been an initial rush from travel at any cost and people have been prepared and able to pay significantly higher airfares. That will not be sustainable in the long term.

The Qantas Group expects to be at 104% domestic capacity, compared to pre-COVID levels, by June 2023¹ which is positive. Its international capacity may take longer to fully return, in no small part due to the price of jet fuel which has a more significant impact on long haul flying. While prices are lower than the peak of 2022, they are still well above $US100 per barrel and significantly higher than pre-COVID levels².

The good news is that after three years, we expect conditions to normalise in 2023. PHIA has recovered with domestic volumes already above pre-COVID levels, while traffic at Launceston Airport has rebounded to approximately 90% of FY19 volumes. Domestic volumes at Melbourne Airport hovered around 85% of FY19 levels for much of 2022, with a further wave of capacity required to bridge the gap. This is likely to happen this financial year if current conditions continue.

In terms of international capacity, there have been some very positive developments to come out of COVID with growth in emerging travel markets such as India and Vietnam, the launch of services by new entrants such as Thai Air Asia X and Bamboo Airlines, and new routes to Dallas Fort-Worth and Jakarta to be launched by Qantas.

China is obviously a very important tourism, education and business market for Australia. Prior to the pandemic, Chinese visitor arrivals into Australia totalled almost 1.5 million³ per annum and that dried up overnight. The decision by Beijing to reopen its borders in January was welcomed, with the almost immediate return of the ‘big three’ of China Southern, China Eastern and Air China, complemented by services from Sichuan Airlines, Beijing Capital Airlines and Xiamen Airlines (Xiamen was the only Chinese carrier to operate to Melbourne throughout the pandemic). With further Chinese frequencies expected from the start of the new Northern Summer season, and growth in services to Hong Kong operated by Cathay Pacific and Qantas, flows between Melbourne and its growing network of Asian destinations should increase rapidly.

Investment Outlook: Beyond

The impact of the pandemic on the economy, and specifically airports, has been felt for the past three years. Despite this, the fundamentals of investing in airports have not changed, which still look attractive.

It is clear people still want to travel. We have seen that led by the leisure segment domestically, followed by international.

In the corporate sector, we are seeing a slow return to travel, with business flying interstate to visit colleagues or clients still to reach pre-pandemic levels.

While the airlines are achieving strong commercial conditions with limited supply and high demand, overall passenger movements, which is the primary driver of airport revenues, still have some way to go.

As investors increasingly look to ESG as a measure of performance, it is worth noting that airports have made great progress in managing their Scope 1 and Scope 2 emissions, with Melbourne Airport on track to be net carbon neutral by 2025. As organisations and investors turn their attention to Scope 3 emissions, airports will need to work constructively with airlines to manage the primary source of their indirect emissions.

Investing in airports in 2023 requires as much analytical rigour as ever, with an extra layer of risk assessment thrown in for good measure. Investors must continue to understand the type of airport they are investing in, the type of markets it serves and the composition of traffic using the facility. For APAC, we need to consider the drivers of corporate and leisure traffic as well as the ongoing reopening of international markets for airports. This is of most relevance to Melbourne Airport. Research house McCrindle has forecast that Melbourne will become the country’s largest city by 2030, thanks to net overseas migration, net internal migration and natural increase⁴. That in turn will boost traffic through Melbourne Airport. Activity at Melbourne Airport is focussed on a mix of medium and long-term growth enablers for the airport including a new third runway and ground access such as road and rail developments, which we support. It is a long term, stable asset with growth potential. These are good reasons to continue to invest in the asset.

For Launceston Airport, where one of the key drivers of passenger flows is tourism, it has been encouraging to see travellers embrace northern Tasmania and its diverse tourist attractions once again.

For PHIA, the long-term outlook for the resources economy is a key consideration. As we saw during the pandemic, having diverse drivers of demand can be good for investors where relative performance can vary.

We have strong conviction about airports as an asset class. If there is a silver lining to come out of COVID, it forced airports to look at all parts of the business including the cost base, and to accelerate change where possible to survive. Now the focus can turn again to how we thrive into the future delivering long-term value for investors.
 

¹ https://www.qantasnewsroom.com.au/media-releases/qantas-encourages-customers-to-use-travel-credits-with-double-points-offer/
² https://www.iata.org/en/publications/economics/fuel-monitor/
³ https://www.ttf.org.au/wp-content/uploads/2020/03/Economic-Impact-of-Coronavirus-TTF.pdf
⁴ https://mccrindle.com.au/article/topic/demographics/melbourne-set-to-become-australias-largest-city/