News Backgrounder
Analysts put “hold” on Mainland airport investment
China’s major listed airports are amongst the worlds’ busiest, but their value as short term investments is being questioned as e-commerce syphons off duty free spending and limited air space curtails expansion.
June 1st 2015
Low spare runway capacity, regulated airport charges and the negative impact of e-commerce on airport retail revenue is forecast to dampen revenue growth at China’s four biggest airports in the short to medium term, report global investment bankers, Jefferies. Read More »
Produced by the investment bank’s Hong Kong office, the report cautioned investors about Mainland airport stocks after it looked at prospects for return on investment at Beijing Capital International Airport, Guangzhou Baiyun International Airport, Shanghai International Airport and Shenzhen Airport.
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Jefferies rated Shanghai as a “Buy” because it has the highest earnings growth of the four airports in the study, is supported by “relatively large” spare capacity and expanding commercial space and will benefit from the opening of a Disney Park in the first quarter of 2016.
Shenzhen is a “Hold” while Beijing and Guangzhou at set at “Underperform” because of a dearth of spare capacity until 2019 that coincides with the beginning of a development investment cycle.
Jefferies said there is insufficient spare capacity to drive volume growth, with the four airports operating at 85%-98% of their runway capacity for peak hour take-off and landing slots.
The high utilization will limit the passenger throughput, which is an overwhelming earnings driver, Jefferies said.
Equity analysts, Boyong Liu, Johnson Leung and Violet Gu, predicted average earnings growth at the airports will drop to 8% for the next four years compared with 12% in the last three years (excluding Shenzhen, which is in ramp-up stage).
Adding to the pressure will be the next phase of airport expansion, planned to 2019, when surging construction costs are unlikely to be compensated by higher airport charges. The expansion will lead to up to six years of depressed earnings and deteriorating returns on investment before returning to previous profit highs.
It is estimated the cost of adding handling capacity for a single passenger will rise to above 100 yuan (US$16.12) by 2019, from 60 yuan in 2004-2008.
Additional runways or passenger terminals won’t solve the airport congestion if no airspace is added, said Jefferies. In China, 70%-80% of airspace is used for military purposes, particularly around major cities. It takes tough negotiations between the CAAC (Civil Aviation Administration of China), airports and airline managements and military air traffic controllers to add airspace to a newly opened airport, which means that expanding an airport may not lead to more capacity and better slot times.
Shenzhen has long been under-utilized because of insufficient airspace, the report said, and “we also do not expect Guangzhou to increase its peak hour air flights despite the opening of its third runway in earlier this year”.
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Another impediment to profitable airport investment is the impact of e-commerce on the airports’ earnings model. China’s airports, like their counterparts worldwide, rely on retail and duty free non-aeronautical revenue for a significant portion of their income. The Jefferies report said non-aeronautical revenue has been declining sharply since 2012 as online shopping flourishes in China.
“With booming emerging cross-border e-commerce, we expect this negative impact to quickly spread to duty-free shopping,” the report said. “This negative impact is not only irreversible, but likely to escalate, as online retailers benefit from continuing improvements in smartphone penetration, online payment systems and modern logistics services.
“Ineffective brand portfolios and a lack of consumer experience also make Chinese airports more vulnerable to e-commerce cannibalization than their regional peers, such as Hong Kong International Airport and Changi Airport in Singapore,” said Jefferies.
Until now, investors have viewed retail concession income at Beijing and Shanghai, with a smaller percentage in Guangzhou and Shenzhen, as less vulnerable to online competition because of the pricing of duty free products and the ever expanding foot traffic at Chinese airports.
However, the airports’ monopoly on duty-free products is being challenged by cross-border e-commerce companies such as Haitao, Amazon and eBay. Mainland consumers also are buying direct from overseas as well as shopping at the proliferation of new duty-free shops in China’s Free Trade Zones and offshore islands.
“We believe airport duty-free sales growth could face more downside risk, as cross-border e-commerce, as well as duty-free shops outside airports, are as yet low in penetration,” Jefferies said.
Airport valuations, are based on “bullish expectations” that China’s outbound tourist traffic will drive expanding non-aeronautical revenue growth and that a lack of near-term expansion will produce high dividends.
The sector presents fewer upside opportunities than toll roads and Hong Kong-listed seaports, which can raise tariffs and tolls and do not require the same level of capital investment as airports, the report said.
The analysts also argue there is little room to increase aeronautical charges in China. “Despite the recent deregulation of port tariffs and potential price reform for toll roads, we do not expect something similar to happen at airports in the near future.”
Jefferies forecast aeronautical charges will increase by two per cent a year if the aircraft and passenger mix is improved and fees for smaller ancillary services, such as security inspection fees, are increased.
“We do not see a significant rate hike for core aeronautical services such as take-off and landing fees and passenger service charges, said the analysts. “The government will continue to balance airports’ social value and profitability and expect airport operators to use non-aeronautical revenue to supplement earnings.
“The best mid-term scenario would be for the CAAC to set a narrow price range around a current guided price and let airports and airlines negotiate the charges. Airlines’ strong bargaining power should make it difficult to push aeronautical increases through. We expect strong resistance from carriers to any increase in airport charges, especially as airlines contribute to the CAAC’s Civil Aviation Development Fund for airport construction,” Jefferies said.
“Last but not least, airport aeronautical charges are regulated around the world, given an airport’s monopoly position in providing the service, which makes it difficult for airports to significantly raise prices.”
