The planes don't fly, so is SYD still a buy?
Sydney Airport and Transurban have been steady long-term performers and present opportunities for investors to add infrastructure exposure to portfolios.
Whilst explosive growth is not a characteristic associated with infrastructure stocks, the stable and predictable earnings from their strategic assets make them an attractive proposition, as the chart below illustrates.
Image: 10-year performance of SYD, TCL and ASX200 (Source: ASX)
However, these predictable earnings streams have been put to the test in the past 18 months, to put it mildly. Reading the ‘highlights’ of the Sydney Airport (ASX:SYD) Half Year Results release you’d be forgiven for thinking it was a parody. Just take your pick of the stats:
- 36.4% decline in passenger numbers
- 98% drop in receipts
- EBITDA collapsing 29.8%.
They all point to the bleak scenario unravelling at Australia’s busiest airport.
Whilst not immune to the impacts of Covid-related lockdowns, Transurban’s (ASX:TCL) more diverse asset base helped smooth over the hits to traffic, with levels roughly flat year on year. However, uncertainty persists with the on-again, off-again lockdowns playing havoc with traffic volumes.
As part of Livewire’s reporting season coverage, I spoke with Leon de Wet, Portfolio Manager at Elston Asset Management, to get his perspectives on the results and outlooks for these two companies. Leon says Elston takes a patient approach to investing, which makes him a perfect candidate to compare the prospects for these two businesses.
"Our time frames are generally three-plus years when we build those portfolios, so we’re prepared to look through some of the shorter-term weaknesses. That’s something we see as an opportunity that the market presents for patient investors."
In this interview, de Wet talks through the lessons from each of the results, discusses how they compared to expectations, and outlines why he prefers to own Sydney Airport over Transurban in Elston's portfolios.
You can watch the full interview by clicking on the video player below or read an edited transcript below.
What are the key lessons you drew from Sydney Airport’s result – and from that of Transurban?
Looking at Sydney Airport, it was able to withstand a cash burn – which management flagged at between $5million and $10 million a month – and we think it will hold up even if the lockdowns are extended to the end of the year. And, additionally, if the company doesn't refinance any of its debt of around $950 million, which matures by the end of 2022, we think it has ample liquidity to meet those obligations.
There is a combination of things that give us comfort: A strong balance sheet, half a billion of cash, and around $2.4 billion in undrawn debt.
We've clearly seen demand for travel rebound quickly when restrictions are lifted. That's important because if we look at the April to June period, before the lockdowns, this business was cash-flow positive. We think it will certainly return there reasonably quickly,
And finally, quite fortuitously, we’ve got the timing of the payment of around $200 million that Sydney Airport's going to receive related to that Sydney Gateway. Those are probably the key positives.
On the negative side, the key takeout is absolutely around air traffic, both domestic and international, which has basically come to a standstill.
The rate of travel is currently around 3% of the pre-COVID levels, and with lockdowns extended and measures seemingly tightened all the time, the recovery that we and probably most analysts expected has certainly been delayed until the second half, at best.
If we look at Transurban, and staying on the negative theme, it's really around those traffic numbers. We saw quite clearly the severe impacts on weekly traffic in terms of the data that they provided.
We think it's unlikely that we'll see any substantial improvement there until, and I’m guessing, October at the earliest. That's going to weigh on earnings, free cash flow and obviously on dividends. Essentially, the recovery has probably been pushed out into FY2023.
Another takeout from the Transurban result is in the West Gate Tunnel project. Management had previously cited contractual obligations that indicated they were probably going to have a limited contribution.
Certainly, our take on the commentary now is that the pain from this will probably be shared and it's potentially quite a big hit. Referring to the costs overrun, management has said it’s around $3.3 billion – so, we think they’re on the hook for a substantial payment.
Transurban is incentivised to get this project completed as quickly as possible. If we think about the West Gate Tunnel, they do have tolls there that are escalating at 4.25% until 29 June. But those reduced to quarterly CPI thereafter. My understanding is there's no extension of that 2029 date and so I think they want to get that done pretty quickly.
The knock-on of that, unfortunately, is you're probably going to have a partial offset in terms of those capital releases that we think are going to happen over the next four odd years, as they must fund their contribution there.
How did the results compare to market expectations?
With both stocks, we can see monthly traffic numbers. So, from that perspective, there wasn't a significant surprise. Sydney Airport's first-off revenue was probably a little bit better than both consensus and our expectations. But again, for context, that was still 57% below pre-COVID levels – these are difficult conditions.
We were probably a little more pessimistic than consensus regarding the costs. In EBITDA terms, that was a miss of about 9% versus consensus. And in distributions, I don’t think anybody was surprised they’re still suspended and will likely remain so for the foreseeable future.
On Transurban, our expectations were broadly in line with consensus. And we were a little bit too optimistic on the revenue, so that was a 4% to 5% miss. But on the upside, Transurban showed exceptionally good cost control. If we strip out its strategic initiatives and the new assets the company brought online, the underlying costs are $10 million lower than last year.
At an EBITDA level rate, Transurban was broadly in line with consensus. Again, distributions were already announced so there were no surprises there. For us, if there was a positive surprise, it was around free cash flow. Unfortunately, that was because of the capital releases.
What's your view on the outlook for these two businesses?
As I said earlier, we are Sydney Airport shareholders currently, so it’s probably no surprise we're reasonably positive on the outlook.
But experience has shown that both here and abroad, travellers do return reasonably quickly once those restrictions are lifted - and we think that will certainly happen.
If I look at my colleagues and circle of friends, there's a desire to travel. As you mentioned, Sydney Airport is iconic, it’s a central hub and was Australia's busiest airport pre-COVID. It's exceptionally well-positioned to benefit.
But that said, it is a very tough environment. The rules are constantly changing, so patience will be required for that full recovery, particularly in international passengers. Vaccinations, especially among emerging countries, are clearly just one wildcard.
But over the medium term, yes, we're optimistic.
For example, the growth in Asian passenger volumes, as that region's middle class expands, is a big plus. And we know that international passengers are around three times more valuable to the airport than domestic passengers, in terms of the revenue they generate.
And on Transurban, looking at the earnings and dividend outlook over the medium term, the current lockdowns do push the recovery out. But like air traffic, it bounces back. Airport traffic bounces back quickly and we see no reason why that won't be the case for motorway traffic.
Another positive for Transurban versus Sydney Airport, is that it relies only on domestic traffic.
As the vaccinations increasingly roll out, we don't see any reason why restrictions should be an issue for Transurban after the first half of next year. By 2023, we think traffic will be back above pre-COVID levels. Dividends are coming back strongly, probably about 60 cents a share and maybe even a little higher, depending on the kicker that we get from capital releases that are still expected over the next couple of years.
But the other thing I’d highlight for Transurban is the growth option in the New South Wales Government’s WestConnex project, in which it holds a 49% stake. That's an asset Transurban understands very well, having operated it since 2018, and we think it will be successful in bidding on at least one of the two tranches.
What’s your take on the board rejecting the takeover bid?
We certainly do have a view. We understand why the board is trying to maximise the value for shareholders and agree on some of its reasons for that rejection. And I refer here to the strategic and irreplaceable nature of the airport, the earnings diversity, the land bank and all the development opportunities that exist there.
But at the revised offer of $8.45, to us, that's probably a point at which we think it incentivises management to engage with a consortium.
Along with the largest shareholder, we're certainly advocating for those discussions to take place, given the current bid.
What are some of the reasons for and against owning Sydney Airport and Transurban as an infrastructure allocation?
On Sydney Airport, it is probably endorsed by the consortium's bid. For us, there's long-term value in Australia's busiest airport, as a critical hub with global connections, particularly as international travel returns.
And we believe that will happen. Yes, the timing is uncertain, and it may still be a few years away, but passenger numbers will exceed pre-COVID levels.
But one risk I’d highlight is the uncertainty around the outcome of negotiations on those longer-term aeronautical agreements. Those are critical because they set the landing charges with the airlines.
Despite the diversified revenue base, in ordinary times, those aeronautical fees are still the single biggest contributor to revenue, so we need a resolution on that. It's been pushed out again for another year because of COVID disruptions. That's something we’re mindful of, as those negotiations continue.
And on Transurban, for people looking at it, the city of Sydney is key, given that’s where it generated about half of its financial year 2021 revenue. Of course, Melbourne is in there too, but Transurban has stakes in almost every toll road in Sydney.
With very long duration concessions across its portfolio, including in Sydney, Transurban is exceptionally well positioned to benefit from further expansion in Australia's most populous city over time. These are 30 to 40-year concessions, or even longer, with many years to run.
From an infrastructure investor's perspective, another consideration is that Transurban provides real purchasing power and decent protection against the impacts of inflation. Most of its revenue sources have embedded escalations of CPI or greater, including concessions like the M4 or M8 motorways and others, with escalations CPI or 4% annually. There’s a good underpin there in terms of providing real protection of purchasing power.
Elston Asset Management's investment solutions range from a core Australian Equities Large Cap model through to full risk-based multi-asset class models. To find out more, visit their website.
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