In a recent announcement Sydney Airport Holdings Ltd. (ASX: SYD) CEO and Managing Director Kerrie Mather said, "Sydney Airport reached a record of over 4.5 million international passengers year to date, a growth rate of 2.9% on the prior corresponding period (pcp). Domestic growth was also a very solid 1.7% over the same period."
As well as increasing passenger numbers, there has also been lots of discussion about the second airport at Badgery's Creek. In particular, investors are concerned with Sydney Airport's first right of refusal over the second airport, and whether it will likely end up developing and owning it.
Even though this appears to be good news for Sydney Airport, this is why I think it is the right time to sell.
Net profit has fallen sharply
Sydney Airport's revenues are derived from aeronautical and non-aeronautical operations. Aeronautical fees contribute close to half of its revenues, and are mostly charged on a per-passenger basis, with base charges set every five years in negotiation with airlines. Retail is the most significant non-aeronautical business, contributing about a quarter of its revenue. Sydney Airport has attractive long-term potential from rising rents and incremental expansion as passenger numbers grow. Rent is based on a percentage of retail stores' sales turnover, providing direct upside from spending growth.
In spite of this and its obvious monopoly, since 2005, Sydney Airport's revenues have decreased by 2.19% per year, from $1.4 billion in 2005 to $1.1 billion in 2014. More importantly, its net profits have decreased by 23.7% per year from $670 million to just $59 million.
Debt has increased by over 200%
Not only have profits dropped by over 90% since 2005, but Sydney Airport's debt has increased by over 200% from $2.2 billion to around $6.7 billion, and its debt-to-equity ratio has increased to a staggering 477% in 2014. Return on equity (ROE) has consistently averaged 8.67%, and in 2014 Sydney Airport generated an ROE of just 3.44%.
Funding gap
While the company has very healthy cash flows after investing $8.8 billion, since 2005 its dividend payouts ($3.5 billion), other financing cash flows ($6.8 billion), and foreign exchange effects ($121 million) have left Sydney Airport with a major funding gap of around $1.4 billion. To offset this gap, Sydney Airport has had to increase its borrowings by over $1 billion and raise equity of over $1 billion to cover the shortfall. As of 2014, Sydney Airport has $451 million in cash compared to its $7 billion of debt.
Monopoly advantage
Sydney Airport has an obvious monopoly advantage that comes from its exclusive concession to operate Sydney Airport until 2097. It is currently the only regular passenger transport airport in Australia's largest city, and is also the gateway for the majority of international flights to and from Australia.
However, airports are highly capital intensive, and as we can see from the analysis above, use substantial debt funding. While defensive revenue streams can support high financial leverage, Sydney Airport is more highly geared than many global airports and other Australian infrastructure assets.
Dividends and retained earnings
There has also been lots of discussion about Sydney Airport's high dividend yields, and this may appear to be great news from an income investing point of view. The question is, how long can the company sustain these payouts with its mounting debt and decreasing profits given its continual failure to convert $1 of its retained earnings into at least $1 of book value for its shareholders? Since 2005 Sydney Airport has lost $2.22 in book value per share.
Price performance and valuation
In the past 12 months, the share price of Sydney Airport is up nearly 20%, which has outperformed the S&P/ASX 200 (Index: ^AXJO)(ASX: XJO), up just 2% in the same time. From my viewpoint, at its current price of around $5 and a P/E of around 200, I think Sydney Airport is one of the most overvalued shares on the ASX. That is why I think now is the right time to sell.
