MEDIA RELEASE: It is very clear that infrastructure and global markets are currently behaving in an unprecedented manner. Whilst infrastructure assets typically behave more defensively in a downturn, this sudden sharp correction has not been driven by the macro but instead an infectious disease. The repercussions of society protecting itself from this contagion has ramifications for socialised assets that are used in all of our daily lives – especially airports and to a lesser extent toll roads.
These concession infrastructure assets have not fared well during the so-called COVID-19 crisis and are all under varying degrees of stress – both in terms of share prices and passenger volumes. Airlines – and by association, airports – are facing the biggest headwinds, who understandably have been subject to a significant reduction in volumes as much of the world moves into various stages of lockdown.
Transportation assets are typically, among other assets, hit hard in times of economic hardship. But this sharp drop in global travel is particularly troublesome for airports, where volumes in some places may soon approach zero. Whilst historically speaking, the impact of exogenous events on airports have typically proven to be short-lived (e.g. 9/11, SARS, Swine Flu, Global Financial Crisis, Eurozone Crisis) with a subsequent bounce back to trend growth, there is a growing risk that this time will be different.
Volume impacts observed
Not surprisingly in the face of restrictions of movement, we have observed extremely sharp declines in airport passengers globally, which became extremely pronounced in March and we expect will approach zero at some airports in April.
By 31 March, air traffic movements – the number of aircraft take-offs and landings – across European airspace was down 86%. The actual passenger volume decline is expected to be even greater – airline commentary suggests that load factors – the percentage of aircraft seats actually filled by passenger – have declined precipitously.
Total European Air Traffic % Change
(6 weeks to 31-Mar-2020)
Source: Eurocontrol; MBA GLI estimates as at 31 March 2020.
As long as lockdowns continue, it is expected that this type of traffic pattern will be sustained.
Virus impact on airports – why might this time be different?
The risk to the aviation industry is unprecedented – never in recent times has air travel been so limited, with so many countries in unison having all but grounded international and in some cases domestic flights. Even in the depths of the Global Financial Crisis, passengers still flew. Today that is barely the case. In our view, smaller airports will be the hardest hit – those without balance sheet capacity and those that aren’t major hubs for airlines to shelter in this crisis. We own a stake in Fraport, the operator of Frankfurt Airport, which is still open as the only cargo hub in Germany and still has very limited passenger volumes. Conversely, many other German airports have closed down. Other big hubs – Charles de Gaulle in Paris, Heathrow in London, Madrid in Spain, have all been scaling back operations and closing terminals down. In the UK, we note the Airport Operators Association has warned that some smaller airports will be out of business in the coming weeks.
The most obvious question that we have been doing a lot of analysis on has been when and how might traffic return, given the punitive impact the global shutdown will have on balance sheets. We do not believe it is being catastrophic to suggest that some airlines may cease to exist when we get through this crisis, particularly private operators that might have lesser prospect of explicit, or implicit, government support. At present, we believe that state aid is a necessity for even the largest of airlines, which face an unprecedented liquidity crunch that dwarfs that of 2008-2009. Some governments around the world have already stepped in, or indicated future support. However, it is not a guarantee – with other resisting such calls for taxpayers to foot potential bills, without shareholders investing fresh capital too.
The response from airports has been similar – cutting back operating expenses drastically, standing down workforces, slashing capex and cancelling or suspending dividends, particularly companies that will rely on state aid in the short term. There is no conviction around when volumes will return and so management teams are effectively placing their businesses into hibernation, or “life support”. The other big unknown for how long air travel takes to return is if, and if so, when, a vaccine may be developed and how long that would take to roll out.
Valuation metrics – how do airports look after the correction?
We note that airports, especially European airports, are now trading at or near cyclical lows on EV/EBITDA metrics, but caution this as providing valuation support due to (1) consensus EBITDA still appearing very overstated due to the uncertainty around the recovery profile in volumes; and (2) the long term growth outlook, as previously discussed, could be much lower than prior to the crisis.
Source: Sentieo; MBA GLI estimates as at 31 March 2020.
Despite the all-time low interest rate environment, valuation multiples are trading almost one standard deviation below the long run historical average over the last full market cycle, which captured the impact of the global financial crisis. This is the case for both European Airports (our portfolio has two investments here), as well as the aggregate of all Global Airports on our Focus List.
Beyond this crisis, the historical rule that “volumes return to trend” could possibly be broken. Based on industry conversations we’ve had, it’s possible it could take many years to recover to 2019 volume levels. This would be in stark contrast with the patterns observed during previous traffic shocks and virus outbreaks, where recoveries have typically been seen within 3-12 months. We also expect domestic and regional (short haul) traffic to recover much quicker; long haul international travel is expected to lag in the recovery.
Important for airports is that the airlines remain solvent so they can return passengers to the skies as we exit this crisis. We don’t think all will, or at least in their current form. Lesser competition amongst airlines post-bankruptcies or restructurings and changing consumer behaviours could put an end to that. On the latter, the global take-up of videoconference technology to facilitate working-from-home has been tremendous to observe. The efficiencies gained may potentially put a strain on the future level of business travel going forward. Similarly, in countries where it’s possible, the trend we have observed over recent years of an increasing normalisation of business and leisure travel by rail, not to mention the growing environmental benefits (or headwinds for air travel), is likely to gain faster traction the longer the crisis drags on. Thus we expect that “normalised” valuations will take a leg-down as long-term industry growth is expected to be lower than prior to the crisis.
Our Investment Approach
In terms of process, we have been stress-testing our assumptions with a strong focus on the liquidity of balance sheets of airports and more importantly their airline customers.
From a research perspective, over the last two months, we have had a significant number of meetings (via video conferencing) with global airport operators, airlines, duty free operators, consultants and industry groups (e.g. regulators), and of course analysts around the world. There are some relatively consistent messages that we have gleaned from these meetings, some obvious whilst others less so. Some of these include:
· Governments recognise the importance of “national” airlines to national economies, and will likely do whatever is in their control to support them through the crisis and into the recovery. We have already seen explicit support across many markets;
· Not all airlines will survive the crisis – those with strong balance sheets and liquidity will fare better, including some of the larger low-cost carriers, but expect consolidation;
· Airports are in cost-cutting mode, although some are already preparing for eventually traffic returning;
· Air traffic recovery profile will likely be slower than in previous crises, and it will differ by market and by airport;
· Even if the global economy and travel demand recovered sharply, a “v-shaped” recovery for air traffic is difficult to due logistical issues e.g. flight and ground crew rostering, capacity management, aircraft availability (many have been put in long-term storage). Crews will need to be retrained and importantly, pilots re-accredited, due to time out of the air;
· Behavioural patterns could be structurally changed – both in terms of passenger mix (business vs. leisure) and spending patterns. Retail spending at airports will be significantly impacted so long as long-haul/international traffic remains impaired.
In our view valuations appear to be at a level not seen in recent times – we can only consider the “pre-COVID-19” trading levels of airports given the wide range of scenarios that could play out for air travel – but it’s worth noting listed airports are currently trading at between 5-8x EV/EBITDA. For long-dated concessions, and especially those that are freehold, assets that can ride out the crisis from a balance sheet perspective are perhaps starting to look extremely appealing.