The Australian Airport Sector: No short term concerns despite the pandemic

 

Like its global counterparts, the Australian airport sector has not been immune to the unprecedented decline in passenger volumes following the COVID-19 pandemic. Overall traffic is expected to be less than 2 million in Apr-Jun 2020, as against close to 40 million per quarter in the pre-COVID days – a fall of more than 95%. The Sydney airport, which is more reliant on international passengers than its Australian peers, witnessed an even sharper fall of 99%+ y-o-y in May 2020. ‘The Australian’ reports that fearing a protracted recovery, a major airport has consulted insolvency experts recently. The reduction in traffic is not very different from what is being witnessed the world over – traffic was down 95% at Heathrow and 96% at the Boston Logan airport (domestic airports of the US have recovered better) in Apr-May 2020. US airlines carried 96% fewer passengers in April 2020 y-o-y, according to preliminary data filed with the Bureau of Transportation Statistics (BTS).

Experts believe domestic passenger volumes will reach 2019 levels only by 2023. International volumes are likely to take longer, not only because stringent travel restrictions concerning foreign locations are more stringent, but also due to the rising geopolitical tensions with China.

Chinese travellers to Australia have doubled between 2013-2018 and accounted for the largest source of international travelers for the year ended June-2019 (1.4 million). As tensions between the two countries mount, the Chinese government took a spate of adverse decisions against Australia, such as a ban on Australian beef and a steep tariff being imposed on Australian barley. The Chinese Ministry of Culture and Tourism followed by recently issued a warning against travel to Australia. The Australian government, like many other nations, has also warned Australians traveling to China as citizens are at risk of arbitrary detention following the passage of the far-reaching security law.

Experience from other countries indicates that as lockdowns are lifted, almost entire travel is likely to be domestic. Even though that gives a false sense of security that airports with a high component of domestic travellers will be resilient, an ongoing reduction in inbound international tourism would also hurt domestic passenger volumes given that international passengers also travel domestically.

Aeronautical revenue constitutes almost half of major Australian airports’ total revenue, and international passengers tend to generate 3-4x more revenue than domestic ones on a per capita basis. The financial weakness of airlines could be another challenge in realising aeronautical revenue. Virgin Australia, the country’s second-largest airline, entered voluntary administration in April 2020 and has been sold to Bain Capital. Qantas Airways, which has a market share of two-thirds of the domestic market, is rated Baa2/Negative. In the US, many airports have offered airlines a deferral in rentals and other fees in the short term under the assumption that traffic levels will rebound.

Amidst all the bleak news, the Australian airports might find something to cheer. For one, Australia is heavily reliant on airlines to travel between its geographically distant cities, and fares are cost-efficient compared to railways. For instance, air travel from Sydney to Brisbane, or Melbourne, takes under two hours compared to an overnight journey by train but costs almost the same. The Sydney-Melbourne air route was the second busiest in the world by flight movements in the pre-COVID days. Even Sydney-Brisbane is comparable to North America's busiest domestic route, San Francisco-Los Angeles.

The impact of reduced traffic from China is also perhaps overstated, as even though China accounts for the largest share of foreign travellers at 1.4 million, the number is not significant compared to 82 million inbound international travellers in 2019.

The other silver lining could be domestic tourism. When the Gold Coast theme parks of Village Roadshow, Australia’s largest theme park operator, were closed in March, its Chief Executive, Clark Kirby, did not expect them to reopen by October or even January 2021. When the parks did open in end-June, they had visitors close to their capacity (albeit they opened up at 50% of actual capacity). The company’s hotel adjoining its Sea World park is close to being booked out for the September school holidays. Optimists in the tourism industry believe that as international travel remains restricted, Australians might shift to domestic locations instead of traditionally popular locales such as Fiji and Bali.

The optimism could however be unfounded given that 14.5% of the Australian workforce was estimated to unemployed in June 2020 by Roy Morgan, and another 10% estimated to be underemployed. Households might, therefore, decide to postpone their travel plans, and many are just not comfortable flying amidst the pandemic. A survey by Deloitte’s lead travel partner Adele Labine-Romain indicates that only 25% of people now feel confident taking a flight.

Another problem with domestic travel is that the busiest routes involve inter-state travel, which could be put on hold if there is another flare-up like the one witnessed in Melbourne.

Australian airports have strong liquidity positions, largely supported by undrawn bank facilities.

• The Melbourne airport, which is likely to be among the worst affected because of repeated lockdowns in the state of Victoria, has no debt maturities till FY22.
• The Adelaide airport has no maturities till FY23, and its low exposure to international travellers (~13% of total) might lead to a faster recovery of cash flows to normal.
• The Sydney airport, however, has sizeable maturities over the next five years, and RBC Capital Markets has indicated that the company, which has already cancelled its half-year dividend, might have to raise equity to survive the prolonged downturn. Sydney also has a meaningful exposure to international passengers (~38%) as against 27%-34% for other major Australian airports, leading to a protracted recovery.
• The Brisbane airport has large maturities in FY21 and FY22 but also has a large cash balance to counterbalance those, with no significant maturity till FY25. Cash is likely to be more valuable than undrawn bank facilities as the latter are subject to covenant compliance. Additionally, about half of Brisbane airport’s cash-based expenses are covered by its commercial property revenue (although a reduction in rentals is likely and some tenants might just be unable to pay).

In general, debt providers of undrawn facilities are likely to cooperate and waive covenants as long as the breaches are related only to the effects of COVID-19 rather than underlying business weakness.

While the aeronautical revenue is likely to decline sharply, rental income might be the least impacted. Globally, Australian airports have the lowest proportion of aeronautical revenues in their revenue mix, with only North America doing better. For major Australian airports except Melbourne, commercial property revenue covers 40-50% of cash costs, providing support in the medium term. However, passenger-dependent tenants, such as hotel operators and retailers at the airports, might find it difficult to pay rentals in a prolonged downturn. Food and service operators might face challenges due to social distancing, and retail shops could see lower spend on account of reduced purchasing power. Revenues from tenants, if based on a percentage of sales, could see a decline sharper than that from airlines.

Airports mostly have fixed cost structures, with operational, maintenance, utility, and personnel costs, usually comprising approximately one half of total cost. Personnel costs make up about one-third of the cost, which is why airports such as Dublin are resorting to layoffs and wage cuts (the proportion of personnel costs is, however, lower for Australian airports at 20%-25%). Utility costs to maintain air-conditioning and lighting are not easy to reduce, and the same holds true for maintenance to ensure safety. Nonetheless, airports have demonstrated operational flexibility by partially closing terminals and car parks, thereby saving on utility and security costs. Moody’s estimates that airports can reduce operational costs by 20%- 35%. For Sydney airport, an added concern is that interest on senior debt comprises 67% of total expenses, which might necessitate negotiating with lenders.

Moreover, of the total outlay, approximately 34% constitutes capital costs as per S&P estimates, which would be most likely deferred by airports. Moody’s expected over AUD2 billion of investment across the sector in 2020 and 2021 before the pandemic and expects a reduction of 50%-80% in this amount. Melbourne airport is an exception as it had commenced its capex program before the outbreak.

S&P believes that financially weakened airlines may have stronger negotiating power in the face of lower supply and may be unable or unwilling to pay higher aeronautical fees. That said, the regulatory framework in Australia is considered ‘light-handed’, which might prompt airports and airlines to come up with alternative revenue models. Under current agreements, airports take on the volume risk, which airports would be too glad to get rid of by offering lower aeronautical charges to airlines as a sweetener. The possibility of such arrangements could be monitored for Sydney and Adelaide, whose agreements are expiring in 2021.

To sum up, even though Australian airports are facing heat from passenger traffic declines like their global peers, most of them are shielded from near term challenges. Concerns about their creditworthiness are likely to arise only if the effects of the pandemic are felt beyond 2022. For now, liquidity, flexibility to defer costs, proactive countermeasures, potential support by domestic travel, and the airports’ key position in the country’s travel network are likely to help them sail through the crisis.

Sources:

1.      Australian Government: Department of Infrastructure, Transport, Regional Development and Communications

2.      United States Department of Transportation: Bureau of Transportation Statistics

3.      The Sydney Morning Herald

4.      Roy Morgan

5.      Bloomberg

6.      Standard and Poor’s

7.      Moody’s Investor Services