AIRPORT has signed new operating and land lease agreements with the government that extend the airport operator’s concession to manage 39 airports in the country to 11 Feb 2069. The new terms for the operating agreements (OA) mildly lighten AIRPORT’s capex burden but have no material impact on its earnings. We maintain our forecasts, TP of RM9.00 and MARKET PERFORM call.

The new material terms for the OA between the government and AIRPORT to operate, manage, maintain and develop 39 airports and Short Take Off and Landing (STOL) airports until 2069 (New OA) are as follows:

1. the government and AIRPORT have the flexibility to fund airport developments using either government allocations through development expenditure (DE) or AIRPORT through any suitable investment recovery model mechanism or any other bankable financing model agreed between both parties with the weighted average cost of capital (WACC) to be determined only at project implementation;

2. the establishment of the Airport Development Fund (ADF) to receive contributions from airport users, the public and also airlines to fund future airport capex;

3. 50% of the Passenger Service Charge (PSC) component that is considered in the calculation of the User Fee will be channelled to the ADF trust account. AIRPORT and the government will review the user fee percentage on a three-year cycle;

For illustration purposes, a RM1b airport revenue will translate to a RM24m contribution to the ADF. This is based on PSC revenue making up 40% of total airport revenue and a user fee rate of 12%. Only user fees on PSC revenue will be subject to contribution to the ADF and the proposal entails half of these to go into the fund (RM1b x 40% x 12% x 50% = RM24m); and

4. in anticipation that AIRPORT is expected to incur losses following the slow recovery for air travel post pandemic, the OA allows AIRPORT to recover its losses in RP1 via a loss capitalisation mechanism (LCM) starting from Regulatory Period 2 (RP2), The LCM will be applicable to allow MAHB and the operators to recover a proportion of regulatory losses in RP1 (Jun 2024 – 31 Dec 2026) over ten years, beginning 2027. The loss refers to the difference between: (a) an estimate of the revenue that AIRPORT would require over RP1 to cover its prudent and efficient costs (the allowed revenue); and (b) the revenue that AIRPORT will actually earn over RP1 from the imposition of aviation service charges (the actual revenue).

For illustration purposes, assuming that over RP1, AIRPORT’s reveal that it incurred operating costs of RM200m and depreciation of RM500m, suppose the regulator estimates that AIRPORT should be allowed a return of a further RM500m (to reflect a reasonable rate of return on the unrecovered cost of invested capital). In this case, AIRPORT’s allowed revenue for RP1 would be RM1.2b, which is the sum of its operating costs, depreciation, and allowed return on capital. At the start of RP2, the regulator would compare this total allowed revenue for RP1 with AIRPORT’s actual revenue for RP1.

Assuming AIRPORT actually earns RM1.3b over RP1, which it earned RM100m more that it required to cover its costs. In this case, AIRPORT would be entitled to retain 10% of the gain (i.e. RM10m) but would be required to return 90% of the gain (i.e., RM90m) to customers via proportionately lower charges over the ‘payback’ period. Conversely, assuming AIRPORT actually earns RM1b over RP1, which is RM200m less than it required to cover its costs. In this case, AIRPORT would be required to bear 10% of this loss (i.e., RM20m) but would be entitled to recover 90% of the loss (i.e., RM180m) from customers through proportionately higher charges over the ‘payback’ period.

5. All Marginal Cost Support Sums (MARCS) mechanisms are retained. Under the New OAs, the MARCS Passenger Service Charges mechanism has now been replaced by the enhanced Passenger Service Charges Compensation mechanism. Generally, MARCS is a compensation mechanism under the Operating Agreement (OA) where the government is obliged to pay AIRPORT for any difference between what is permitted to be collected (i.e. benchmark PSC) and what is actually collected (i.e. actual PSC – paid by departing passengers). For example, benchmark PSC rate for international travel is RM80 per pax vs RM73 per pax for actual PSC. AIRPORT can claim the difference of RM3 per pax under MARCS. Note that benchmark PSC rate is subjected to increase every five years pegged to CPI.

6. The new OAs offer AIRPORT “flexibility” to pursue strategic investments needed, including partnering with any external parties to improve capacity, facilities and infrastructure of the airports or any of the facilities subject to mutual agreement with AIRPORT.

Forecasts. Maintained as we believe the lightened capex burden will not have material impact on its earnings.

Valuations. We also maintain our TP of RM9.00 based on 22x FY25F EPS at a 40% discount to its closest peer Airport of Thailand due to its smaller market capitalisation. Note that Thailand’s tourism revenue is 3x larger than Malaysia’s. There is no adjustment to TP based on ESG given a 3-star rating as appraised by us (see Page 4).

Outlook. We expect business and leisure air travel to continue to recover throughout FY24. According to our in-house projection, tourist arrivals in Malaysia are expected to jump 35% to 27m (consistent with Tourism Malaysia’s projection to return to pre- pandemic levels) in FY24 from an estimated 20m a year ago (see Exhibit 2). A key driver is Chinese tourists that had historically contributed to an estimated 12% of total tourist arrivals in Malaysia. Furthermore, tourist arrivals is expected to be boosted by the 30-day visa-free regime for Chinese and Indian visitors to Malaysia starting from Dec 2023 and China, allowing Malaysian inbound visitors 15 visa-free days between 1 Dec 2023 and 30 Nov 2024.

This should underpin growth in AIRPORT’s passenger throughput demand in 2024. We expect traffic trajectory to grow in subsequent months as airlines continue to re-activate more aircrafts to match increasing demand. Amplifying traffic growth trajectory is aircraft movements that are pointing towards increased medium and long-haul flights to Perth, Sydney and Auckland, Southeast Asia and South Asia destinations. KL International Airport saw the return of Kuwait Airways after a seven-year hiatus, while two other foreign carriers i.e. KLM Royal Dutch Airlines and All Nippon Airways, will resume non-stop flight operations to Amsterdam and Tokyo, respectively, after temporarily ceasing operations due to the COVID-19 pandemic. In addition, Malaysia Airlines has increased its flight frequency to Tokyo from November 2022, meeting the surge in travel demand after Japan reopened its borders to international travellers. AirAsia Group meanwhile is focusing on its medium-haul operations and had increased its Malaysia AirAsia X flights to 44 times weekly across 10 routes from Nov 2022.

Investment case. We like AIRPORT for: (i) it being the dominant airport operator in Malaysia and one of the largest in Türkiye, (ii) being a good proxy to the recovery of air travel and tourism locally, regionally and globally, and (iii) its strong shareholders who have demonstrated unwavering support through thick and thin (including during the pandemic and a massive cash call in 2014).

The recently announced tariff revision is positive to its earnings but may not be sufficient for it to fund more aggressive capex plans. Maintain MARKET PERFORM.

Risks to our call include: (i) endemic and pandemic occurrences, deterring air travel, (ii) unfavourable terms for airport operations, and (iii) risks associated with overseas operations.

Source: Kenanga Research - 19 Mar 2024