SINGAPORE (Oct 7): Investors looking for stable operating cash flow, low multiples, growth and a deep discount to book need look no further than relatively under-the-radar Chinese airport operator Regal International Airport Group. What’s the downside? Its association with the troubled HNA Group.

If the HNA name is too toxic, other airports that deliver decent yields and have sustainable cash flows and strong moats are Airports of Thailand (AOT) and Malaysia Airports Holdings (MAHB), despite its bad press.

Airports are usually busy places, and most investors in this region would have visited Phuket, Chiangmai, Bangkok, Penang and Kuala Lumpur.

Of course, there is no airport quite like Changi Airport, owned by Changi Airport Group (CAG). As a business model, Changi Airport is operated as an air hub, similar to Hartfield-Jackson Atlanta International Airport, the world’s busiest. An air hub is a central airport through which flights are routed, and spokes are the routes that planes take out of the hub airport. Most major airlines have multiple hubs. They claim that hubs allow them to offer more flights.

Changi Airport is a regional hub for airlines such as Australia’s Qantas Airways, Lufthansa (trading as Deutsche Lufthansa), Jetstar Asia Airways and, of course, Singapore Airlines. Singapore’s air hub is regulated by the Civil Aviation Authority of Singapore.

CAG for is always looking to strengthen its air hub status for sustainable long-term growth. It does this by expanding Changi Airport’s connectivity and getting more airlines to land here. As at July this year, Changi Airport served more than 100 airlines flying to 400 cities in over 100 countries. In FY2018, CAG notched up a 13% y-o-y growth in revenue to $2.6 billion and 28.3% y-o-y growth in net profit to $849 million. CAG distributed a dividend of $283.2 million to its shareholder, the Government of Singapore.

As demand for air travel continues to grow, CAG plans to increase Changi Airport’s handling capacity and secure its attractiveness as a transfer hub through new infrastructure developments and the upgrading of existing terminals.

Airports earn revenues from passenger- and aircraft-related charges, terminal rents and security charges. The more airplanes, people and cargo that move through the airport, the better. Revenue from duty-free shops, cosmetic outlets and other retail-related activities is an anchor to revenues.

At CAG, airport concessions and rental income contributed 50% to revenue, followed by airport services such as landing fees and taxes (32%), security services (10%) and others (8%). Rental income for concession space at Changi Airport is based on a portion of expected sales from liquor and tobacco or a minimum monthly guarantee per passenger of $4.15 based on total traffic movements for the month.

At the 2019 World Airport Awards, Changi Airport was voted by air travellers as the world’s best airport for the seventh consecutive year. CAG is not listed, however, so investors cannot benefit from its growth.

With the rise of low-cost carriers, the middle class in emerging Asia is travelling more. Revenue from airports is viewed as stable and growing. Global airline passenger movement is on a long-term uptrend (see Chart 1). In CY2018, there were 4.4 billion airline passengers, up 4% y-o-y. While the airline sector and various airlines are facing idiosyncratic challenges, airport revenue continues to grow.

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Of course, passenger air traffic can drop. This is what happened during the Gulf War, Severe Acute Respiratory Syndrome outbreak and the Asian and global financial crises, but the declines experienced were temporary (see Table 1).

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In addition, airports are regulated and have in-built moats that come from federal and state aviation policies that prohibit multiple airports from operating within the same vicinity, owing to environmental constraints, scarcity of land and potential overcrowding of flight pathways.

The International Air Transport Association (IATA) forecasts 8.2 billion air travellers in 2037, representing a compound annual growth rate of 3.5%. Specifically for regions, Asia-Pacific is expected to grow the fastest, at a CAGR of 4.8%. China is expected to displace the US as the world’s largest aviation market in terms of air traffic in the mid-2020s, and Thailand is seen to be among the top 10 aviation markets around 2030.

Along with Oxford Economics, IATA has projected growth in multiple scenarios, which range from 2.4% CAGR (worst-case) to 5.5% CAGR (best-case) from 2017 to 2037. According to Airports Council International, in 2017, airports located in emerging and developing economies saw 46% of global passenger traffic, and this market share is expected to reach 60% by 2040. These statistics show that growth will be driven mainly by the growing middle class in Asia and that the aeronautical revenue contribution from airports is likely to see stable growth over the long-term.

AOT to expand its airports

Stock Exchange of Thailand-listed AOT operates six airports in Thailand, of which two are in and around Bangkok: Suvarnabhumi Airport and Don Mueang International Airport. The other four are international airports in Chiangmai, Phuket, Hat Yai and Chiangrai. AOT is 70%-owned by the Thai Ministry of Finance and is the world’s largest public-listed airport operator, with a market capitalisation of US$34.7 billion ($48.09 billion).

AOT’s dividend policy is to have an annual payout of at least 25% of net profits after deduction of all specified reserves, subject to investment plans. This figure is rather conservative, as the payout ratio from 2012 to 2018 has increased from 39.7% to 59.7%. Still, AOT’s dividend yield is a paltry 1.4% (see Table 2).

For the first nine months of FY2019, departure passenger service charges (PSC) contributed 42.6% to total revenue, and concessions 27.9%. PSC is AOT’s growth driver, as it is based on the number of passengers travelling by air, while concessions represent stable income. Thailand is a popular tourist destination, and IATA has projected strong growth in international flights into and out of the country over the next 10 years.

AOT will be spending around THB200.6 billion ($9.07 billion) to expand all six airports over the next six years to accommodate growth in Thailand’s tourism numbers.

AOT’s passenger traffic growth increased 7.99% y-o-y in CY2018, up from a 7.73% y-o-y growth in CY2017.

AOT is negotiating a deal with Thailand’s Department of Airports to manage four regional airports: Buriram Airport, Tak Airport, Krabi Airport and Udon Thani Airport. This should ultimately boost AOT’s revenue.

MAHB reports growth despite headwinds

This year may not be Visit Malaysia Year, but the country’s domestic passenger traffic increased 7.7% y-o-y in 1H2019. The volume of international visitors grew 2%, resulting in an overall passenger growth of 4.7% for MAHB’s Malaysian operations. The company may face short-term industry headwinds, though. IATA in its June 2019 report forecasts lower passenger growth for CY2019 at 4.6% compared with CY2018’s 6.9%, owing to weak economic growth worldwide and fuel price increases. MAHB indicates that the outlook for airlines’ immediate future seat capacity remains optimistic, especially for the domestic sector.

In addition to operating the Kuala Lumpur International Airport (KLIA) and 38 other airports across Malaysia, MAHB also operates the Istanbul Sabiha Gokcen International Airport.

ISGIA, which recorded a 3.1% y-o-y rise in passenger traffic in 1HCY2019, contributes 26.2% of MAHB’s revenue.

The most recent announcement on PSC has caused a revision in the forecast for the stock’s short-term performance. From Oct 1, the PSC of international flights will be at a reduced rate of RM50 compared with RM73 previously. Only MAHB’s KLIA was exempted from the cut in PSC.

The Malaysian Aviation Commission (Mavcom) will introduce the Regulated Asset Base Framework to determine airport charges. Under the framework, PSC will depend on the size of the airports and their facilities and level of services. Mavcom says the new rates will be announced and gazetted for implementation effective from January 2020.

MAHB’s moat is considerably deep, given that it has obtained the approval of the Malaysian government to extend its agreement to operate the 39 airports in Malaysia for an additional 35 years, up to 2069. MAHB targets passenger growth of 4.3% and 4.9% respectively for its Malaysian and international operations for FY2019. Historically, the 10-year passenger CAGRs for MAHB’s Malaysian airports (ex-KLIA), KLIA and ISGIA are 7.5%, 7.9% and 23.9% respectively. MAHB’s targets may very well be attainable, given the “Visit Malaysia 2020” landmark initiative that was launched in July, the extension of the 15-day visa exemption for tourists from China and India, and the Turkish government’s initiatives to promote historical tourism.

Hong Kong-listed Regal was previously known as HNA Infrastructure Co, which led investors to give it a wide berth. It operates the Haikou Meilan International Airport in China’s Hainan province. Regal is a relatively small airport operator, with a market capitalisation of US$309 million, but its valuation multiples make the company stand out. Regal has a price-to-earnings ratio of 4.1 times, price-to-book value ratio of 0.4 times and EV/adjusted Ebitda of just 4.7 times. Compared with its global and regional peers, Regal is trading at a discount of more than 70% for its PER, P/BV ratio and EV/adjusted Ebitda, which makes the stock extremely attractive.

Regal’s capex for the next two years will be mainly for the second phase of its expansion of Meilan Airport. The project will integrate various modes of transport — aviation, railway and road — when it is completed. Meilan Airport should also benefit from the local government’s tourism initiatives such the Haikou International Duty-Free City project on the west coast of Haikou city, to be completed in 2023. The offshore tourist duty-free shopping policy is a special preferential policy granted by the state to Hainan. Regal ought to benefit from these initiatives, given that they will bring more passenger traffic to Hainan through the airport.

While the awards garnered by Meilan Airport pale in comparison with those of Changi Airport, they show that Meilan is recognised as an up-and-coming regional airport. Its 10-year CAGRs of aircraft, passenger and cargo traffic are 10.2%, 12.5% and 10% respectively (see Charts 2 to 4).

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Regal’s share price has halved since its peak in April 2018. We estimate HNA Group’s effective stake in Regal to be 11.52%; it is not Regal’s largest shareholder. The concerns may be overplayed, and Regal may very well be a significantly undervalued stock underpinned by its strong fundamentals (see Table 2).

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<h2>Hunting for an undervalued airport</h2>

The Edge Singapore shortlisted some of the largest public-listed airports globally, along with those that have attractive fundamentals and a market capitalisation of more than US$300 million ($415.8 million). From this list, we scored the airports based on four weighted metrics: historical performance (25%), yields and margins (30%), safety (30%) and analyst ratings (15%).

The historical performance metric evaluates the performance and consistency of the airports, based on net adjusted profits, operating cash flow (OCF), free cash flow (FCF) and dividend payments over the past 10 years. The yields and margins component looks at the airports’ attractiveness through earnings yield, OCF yield, FCF yield, operating margins and enterprise value/earnings before interest, taxes, depreciation and amortisation (EV/Ebitda) multiple. The safety metric assesses the company’s liquidity and solvency through the price-to-book value ratio, current ratio, net gearing, interest coverage ratio and retained earnings. The final component, the stock’s analyst ratings, comprises the consensus rating and potential upside based on the price target.

Based on the overall scores shown in the table, it appears that Airports of Thailand, Regal International Airport and Malaysia Airports Holdings are the most attractive.

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