A defensive ASX share to own forever

Simonelle Mody | Morningstar

In a recent podcast episode, Morningstar’s Mark LaMonica and James Gruber discussed ASX shares to buy and hold forever. Auckland International Airport received a mention as travel ramps up in a post-covid world and amid the announcement of a significant expansion project. 

Auckland International Airport (AIA)

• Moat Rating: Wide
• Share Price on 30/9/24: $6.84
• Fair Value: $7.30
• Price to Fair Value: 0.9 (Undervalued) 
• Uncertainty Rating: Low

Auckland Airport is New Zealand’s largest airport and one of the country’s largest listed companies. With over 1,500 hectares of land, the airport sees ~75% of the country’s international arrivals and departures. The company also profits from commercial services such as retail and duty free, car parking, hotels, warehouses and offices. 

Our Auckland Airport analyst Angus Hewitt expects to see Auckland Airport profiting from rising rate of air travel to the island nation, with capacity to increase to 27 million passenger movements (up from 21 million in 2019) by 2033.  

Economic moat

Thanks to its near-monopoly position in a stable regulatory environment, the company has carved a wide economic moat with no considerable competitor emerging in the rearview.  

The next largest contenders are Christchurch and Wellington Airports, with a 2019 figure of 7 and 6 million passengers respectively. Auckland’s dominant position is further entrenched by expectations that population growth in the region will match or outpace other cities. 

Returns on invested capital are expected to lag with sizeable capital projects underway, however, Hewitt expects returns to exceed the weighted average cost of capital by the end of the next decade. 

Regulation 

Auckland Airport’s aeronautical and nonaeronautical operations each contribute approximately half of the firm’s revenue, with profitability generally higher in the nonaeronautical segment. 

The aeronautical business is regulated but the company is free to set fees with airlines for passenger movements, aircraft landings, parking and more. This allows the airport to earn a suitable return on its regulated asset base, which includes prior capital expenditure and some revaluations. 

Landing charges are set with airlines every five years and independently reviewed to ensure there isn’t abuse of monopolistic power. Passenger fees are also set five years ahead, which represents near-term earnings risk as lower-than-expected traffic could weigh on returns. The unregulated nonaeronautical business has higher profitability but is still driven by passenger traffic, primarily the number of international passengers frequenting the firm’s retail operations. 

Risk and uncertainty

Morningstar assigns Auckland Airport an Uncertainty Rating of Low with no looming competitors in the New Zealand landscape. Despite the company’s large capital expenditure plan, there is relative earnings confidence with the regulated side of the business to reap a suitable return on investment. 

Early this year the country’s largest airline, Air New Zealand, expressed concern over the development project and the additional fees passed onto passengers. Despite the complaints we do not see tighter regulatory measures given landing charges are only a small portion of ticket prices (~5%). 

Latest equity raise

Auckland Airport has recently begun a colossal NZD 7 billion capital expenditure plan that will constrain the firm’s free cash flow over the next five years. 

Hewitt expects this to put temporary pressure on the balance sheet, however, following the NZD 1.4 billion equity raise in fiscal 2025 the balance of capital expenditure may be funded by additional debt facilities and earnings. 

The equity raise is slightly dilutive to shareholders and additional upgrades will naturally depress cashflows but there are some positives for the long-term investor. The facility’s expansion and increased pricing power with airlines leaves significant room for growth. 

Should you own it forever?

Despite a weak balance sheet, debt metrics have remained at comfortable levels and the company is able to cover the 70% dividend payout ratio entirely with free cash flow. 

Airports are generally exceptional defensive assets due to monopolies that embed long term pricing power. With a growing population and increasing levels of air travel, there are significant growth opportunities that will likely be caught by the NZD 7 billion expansion plan. 

Bulls say

• Auckland Airport provides exposure to rising incomes in the region, and population growth in New Zealand.
• Auckland Airport has a wide range of attractive development projects on the horizon, with undeveloped land providing optionality.
• Auckland Airport should enjoy a meaningful increase in regulated passenger fees, to compensate the firm for its likely sizable capital spending over the next decade.

Bears say

• A slowdown in the global economy, a deterioration in international relations, or climate challenges could affect tourist inflow to New Zealand, limiting passenger fees and retail spending at the airport.
• A more onerous regulatory environment could curtail Auckland Airport's ability to generate economic profit from its aeronautical business.
• The firm's bottom line and expansion plans are sensitive to interest rates, which have increased substantially from their all-time lows during the pandemic.
   

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Terms used in this article

Fair Value: Morningstar’s Fair Value estimate results from a detailed projection of a company's future cash flows, resulting from our analysts' independent primary research. Price To Fair Value measures the current market price against estimated Fair Value. If a company’s stock trades at $100 and our analysts believe it is worth $200, the price to fair value ratio would be 0.5. A Price to Fair Value over 1 suggests the share is overvalued.

Uncertainty Rating: Morningstar’s Uncertainty Rating is designed to capture the range of potential outcomes for a company. An investor can think of this as the underlying risk of the business. For higher risk businesses with wider ranges of potential outcomes an investor should consider a larger margin of safety or difference between the estimate of what a share is worth and how much an investor pays. This rating is used to assign the margin of safety required before investing, which in turn explicitly drives our stock star rating system. The Uncertainty Rating is aimed at identifying the confidence we should have in assigning a fair value estimate for a stock. Read more about business risk and margin of safety here.

Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn about finding different sources of moat, read this article by Mark LaMonica.

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