It’s widely recognised airport infrastructure and the airlines it serves play a vital role in facilitating economic growth and connecting communities around the world.
Less well understood is the significant role airports can play in relation to private citizens and SMSFs building a solid retirement portfolio.
The starting point for this discussion is that we are talking about an essential service. Imagine life without air travel.
As air travel has become more ubiquitous, airports have become essential to the functioning of societies – they facilitate business interactions, tourism, visiting family and friends and movement of cargo and freight, to name just a few key activities.
From an economic or commercial viewpoint, airport cash flows are predictable, typically as a result of inelastic demand characteristics associated with an essential service, combined with pricing power within a strong legal framework. Additionally, airports generally face minimal competition, either within their catchment area, as most cities only have one major airport, or from other modes of transport, such as travelling by rail or road.
Also, airports typically have strong pricing power, given the lack of competition and high barriers to entry, which include regulation, safety and large capital investment.
The totality is airports can be very good investments, and a great many are owned by stock market-listed companies around the world, and they are accessible to investors, most easily via a professionally managed fund.
The key issues relating to airports that any prospective investor should be aware of include typical risks, income models and the related regulation, and the main investment drivers.
Risks
Passenger shocks, such as health epidemics (for example, SARS), terrorism, environmental obstruction (for example, volcanic ash clouds), airline bankruptcy, regulatory changes and increased competition are typically the major risks airports face.
It’s important to note not all airports are equal, with a key consideration being what proportion of passengers are origin and destination versus transfer passengers. Some airports are predominantly used by transfer passengers and are more exposed to the risk of an airline moving its hub operations to another airport. For example, at Frankfurt airport around 60 per cent of its passengers are transfer passengers, whereas virtually all Sydney airport passengers are origin and destination.
A view of listed infrastructure airport assets
Regulation models
In general, economic regulation applies to either:
- Aeronautical and commercial activities: This is referred to as single-till regulation and limits the ability for the airport to earn excess returns or benefit significantly from strong passenger growth. In this case, 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, or
- Aeronautical activities only: This is referred to as dual till where one till is regulated (aeronautical) and the other till is non-regulated (commercial). This enables airports to earn a higher return on the non-regulated portion of the business and to capture economic benefits of strong passenger growth. Conversely, dual-till operations are also more exposed to the risk of passenger shocks.
Regulation models by region
Australia and New Zealand are dual till and light-handed. For instance, aeronautical prices are monitored but not controlled.
Asia is dual till with quasi-government regulation.
Europe is semi-dual till. For instance, some commercial revenue streams such as car parking are included in the regulation.
In the United Kingdom, Heathrow is single-till regulated. For instance, all activities are subject to economic regulation.
Favourable investment characteristics include growing passenger numbers supported by growing population, lower airfares and an increasing middle class.
Operating leverage: Revenues tend to increase with inflation and passenger numbers, while operating costs typically increase at a lower rate. This results in growing margins and cash flows to investors. Dual-till airports, in particular, can capture the benefits of operating leverage in their commercial operations.
Regulation: The type of regulation (single versus dual till) and its predictability are important considerations in airport investment.
How and where to invest
Listed infrastructure investors can enjoy the attractive characteristics of the infrastructure asset class, which 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.
Importantly, investing in listed markets provides the fund manager with the flexibility to take advantage of market movements and to invest where the managers see value.
RARE Infrastructure manages four listed infrastructure funds open to Australian investors, three of which hold investments in airports.
Chris Hillsdon is an investment analyst at RARE Infrastructure.