Brian Gaynor: Airport playing high-risk game with revaluation

The sparks were flying between Auckland International Airport and Air New Zealand this week after the airport announced a huge asset revaluation.

Air NZ chief executive Rob Fyfe dubbed it the great New Zealand airport rip-off while chief financial officer Rob McDonald called for an immediate Government review of the airport regulatory framework. He said this was needed to protect the tourism industry and New Zealanders from the airport's greed and monopolistic price gouging.

The airline is upset because it is entering a fresh round of landing fee negotiations and these charges are based on the airport obtaining an adequate return on its aeronautical assets. In other words, the higher the value of these assets the higher the landing fees.

Meanwhile, Auckland airport chief executive Don Huse appeared on television looking remarkably relaxed, particularly for an executive who had just upset his largest customer.

Only chief executives with monopolistic or near-monopolistic market positions can afford to infuriate their biggest users.

The first point to note about airports and airlines is that the former are remarkably profitable whereas the latter face intense competition, escalating fuel prices and have low profit margins.

As the accompanying table shows, Auckland airport achieved earnings before interest, tax, depreciation and amortisation (ebitda) of $117.1 million for the six months to December last year on revenue of $149.3 million.

The group's ebitda margin has increased from 73.4 per cent in the June 2001 year to more than 78 per cent for each of the past three six-month periods. This compares with ebitda margins for the major Australasian airports such as:

* Sydney, 80 per cent.

* Melbourne, 71.2 per cent.

* Christchurch, 59.7 per cent.

* Wellington, which is 66 per cent owned by Infratil, 73.3 per cent.

By contrast, the two major airlines have had the following ebitda margins:

* Air NZ, 24.8 per cent for the six months ended December last year and 25.8 per cent for the June 2005 year.

* Qantas, 16.2 per cent for the six months to December last year and 17.6 per cent for the June 2005 year.

As airline executives usually blow their tops at any suggestion that airports are going to revalue their assets, the response to this week's announcement was predictable.

On Monday, the airport said it had revalued its property, plant and equipment and investment properties from $1.3 billion to $2.7 billion. The revaluation was unusual because of the timing and the extent of the increase. The announcement was made exactly one month before the group is due to release its results for the June year.

Why didn't the airport wait until August 24 to announce the asset revaluation as part of its June-year result? This would have reduced the media impact of the revaluation, as journalists and analysts would have been more interested in the result and the outlook for this year.

The airlines are furious because the huge asset revaluation was announced just before new landing fee negotiations were about to begin and the higher values indicate the airport will be seeking a substantial increase in charges (about one-third of the $1.4 billion asset revaluation will be included in the landing charges pricing review).

Landing fees were last increased by 7.5 per cent in September 2001 and 5 per cent in September 2002. Those negotiations were extremely acrimonious, with Air NZ threatening legal action before the airport agreed to reduce its fee increase by a third.

Analysts have been trying to forecast the next fee adjustment, which will be introduced in September next year. Many believe that landing fee increases of up to 30 per cent would be justified on the revalued assets. This would raise the group's annual airfield revenue from $67.4 million to more than $85 million.

But the most likely reason for the early announcement is to create the impression that Auckland airport is entitled to a huge increase in landing fees but will take account of the difficult conditions facing airlines and agree to a lower hike.

This is a high-risk approach, as airlines will not be fooled by this strategy and there is the threat that the Commerce Commission could introduce direct controls over the airport's aeronautical charges.

Auckland airport shareholders should not be too concerned by any commission intervention, as the bulk of the group's revenue is derived from other areas (see table).

The $25 departure fee goes to the airport, with the exception of the $2.78 GST content. Airports are able to include this fee in their statements of financial performance even though it is earmarked for development projects.

The airport's main source of revenue is its terminal retail assets, which were revalued to $710 million this week. This makes Auckland airport one of the country's biggest shopping malls.

The company has been tweaking its retail operations to ensure that these outlets achieve a high turnover, as it takes a percentage of the revenue. The duty-free walk-through for arriving passengers and the special immigration facilities for these shoppers has boosted turnover. Retailers should do particularly well this weekend because of the All Blacks test in Brisbane.

The other major sources of income are property rentals and car parking. Auckland airport has a huge freehold land bank with large development, sale and rental potential. This is one of the group's major attractions from an investment point of view.

Car parking is a lucrative income source for most airports and Auckland airport's charges are not out of line with other cities. The cheapest one-hour fee at Auckland airport is $6 compared with $4 at Wellington, $3 at Christchurch, A$9 ($11) at Melbourne and A$12 at Sydney.

The company is adding 850 spaces at the domestic terminal and 474 long-term slots at the international terminal.

Auckland airport is heavily reliant on passenger numbers and June-year figures released this week show that the recent growth in passenger numbers has slowed. In the June year, total international passenger numbers grew 1.3 per cent to 6.21 million, compared with a 24.5 per cent increase in the three years to June 2005. The Korean and Japanese inbound market has been particularly weak in the past 12 months.

The lower dollar should boost inbound passenger numbers, although 44.3 per cent of Auckland airport's international passengers are New Zealand residents and these travellers are under pressure from the lower dollar and higher airfares.

Domestic passenger numbers rose 2.8 per cent to 4.96 million in the June 2006 year, which was also below recent growth rates.

The general view is that Auckland airport is a strong takeover candidate, with excellent long-term prospects but a less exciting near-term outlook.

Analysts warn that investors should not anticipate any landing fee increases until a deal is struck with Air NZ and the other airlines. This is sound advice, given Fyfe and McDonald's heated response to this week's asset revaluation announcement.