Rating Action Overview

• We believe the recovery in domestic passenger traffic at Melbourne Airport, the major asset of Australia Pacific Airports Corp. Ltd. (APAC), will remain strong. International traffic should also pick up rapidly over the next several months.
• Rising passengers should increase the earnings and cash flow of the Australian airport operator, supporting the recovery in its credit metrics.
• On July 28, 2022, S&P Global Ratings revised the outlook on the rating to stable from negative. At the same time, we affirmed our 'BBB+' long-term issuer credit rating on APAC and the issue ratings on the airport's rated debt.
• The stable outlook reflects our expectations of a strong recovery in passenger traffic at Melbourne Airport over the next 12 months, such that APAC's ratio of funds from operations (FFO) to debt rises to about 8.5%-8.9% in fiscal 2023 (ending June) and above 9% thereafter.

Rating Action Rationale

The stable outlook reflects our expectation that domestic traffic through the airport will remain strong, while international traffic will continue to grow over the next six to 12 months. Based on observed trends at the airport in the past six months, total passenger traffic and EBITDA could improve to 80%-90% of pre-COVID levels in fiscal 2023, from about 35% in fiscal 2022. We believe pent-up demand for air travel following a relaxation of pandemic restrictions that began in 2020 will largely drive this growth.

The steady rise in passenger traffic should strengthen APAC's earnings and cash flow. This should lead to a recovery in the airport operator's financial metrics from fiscal 2023. In our view, its FFO-to-debt ratio will improve to about 8.5%-8.9% in fiscal 2023 and about 9.4%-9.7% by fiscal 2024.

APAC's traffic could return to pre-COVID levels sometime in 2024, albeit with a potential change in the passenger mix between international and domestic. We continue to believe that air travel remains critical for Melbourne. This is given the city's location, economic importance, size, and a lack of meaningful alternative modes of transport between capital cities. With no restrictions on domestic travel, domestic passenger traffic could potentially reach pre-COVID levels in fiscal 2024.

While there are no restrictions and quarantine requirements for international travel, the recovery in international traffic will lag the domestic recovery, in our view. This is because some Asian countries such as China (including Hong Kong), South Korea, and to some extent, Japan continue to apply some restrictions. In addition, the capacity of some airlines is lower than pre-COVID levels.

Incremental relaxation of restrictions as well as capacity additions by airlines should ultimately benefit international traffic. Growth is likely to gather pace in fiscal 2023 and well into fiscal 2024, ultimately reaching pre-COVID levels sometime in calendar 2024.

Rising traffic and passengers are likely to support higher earnings in all segments.  Melbourne Airport is well progressed in negotiating a three-year tariff agreement with respect to landing changes. Overall, we forecast improving aeronautical cash flow over the next few years, which we believe could reach pre-pandemic levels sometime in fiscal 2024, slightly before passenger levels return to pre-COVID levels.

Retail revenue will also likely rise steeply in fiscal 2023, in line with international traffic and a return to minimum guaranteed rents. Similar to other airports in the country, Melbourne Airport is enjoying high demand for ground transportation, with a mode shift toward car parking, which is mostly tied to domestic passengers.

We believe the airport will continue to benefit from high demand for car parking. This is likely to exceed pre-COVID levels as the traffic recovery continues. In addition, property revenue remains strong and should grow in line with the airport's additional spending on property development during fiscal 2022 and beyond.

Likewise, underlying operating expenditure (opex) may climb significantly in fiscal 2023 directly relating to increased passenger traffic levels. This follows a 30% spike in underlying opex in fiscal 2022 due to increased activity. However, the increase should be more than compensated by higher revenue. This would help operating margins inch toward pre-COVID levels.

Capital expenditure (capex) is large, but should be manageable with policies continuing to support current ratings.  APAC expects to spend A$350 million-A$450 million on capex in fiscal 2023 and similar levels in fiscal 2024. A large portion of the budget will be used for aeronautical spending, with remaining spending on property and retail development. There is a reasonable likelihood that APAC will spend its budget, unless the traffic recovery is slower than our forecasts.

After incorporating the above capex forecasts, APAC's FFO-to-debt ratio is likely to come in at about 8.5%-8.9% in fiscal 2023. This is comfortably above our downside threshold of 8%. That said, our base case assumes a strong recovery in international passengers, who generally contribute much higher to earnings through higher aeronautical and retail revenue. Should passenger traffic be lower than this, we expect management to exercise discretion on capex and dividends.

APAC has not made any dividend payments in recent years and in our view, will continue to monitor operating conditions and key target metrics before committing to further distributions. Based on our base case assumptions, we believe that APAC will not resume payouts until late fiscal 2023 or in fiscal 2024. The operator aims for a minimum FFO-to-debt ratio of 8% on a forward-looking basis before it recommences with shareholder distributions. We view this as supportive of current ratings.

As the third runway is some time away, it is currently excluded from our forecasts. Management expects the physical construction of the third runway to be several years away, with planning phases currently underway. Reflecting this, we continue to exclude this project from our analysis. APAC will review funding for the project sometime in the future.

Outlook

The stable outlook reflects our expectations of a strong recovery in passenger traffic at APAC over the next six to 12 months. As a result, we expect cash flow to improve, such that the operator's FFO-to-debt ratio will rise to about 8.5%-8.9% in fiscal 2023 and above 9% by fiscal 2024.

Downside scenario

We could lower the ratings by one notch if the FFO-to-debt ratio remains below 8% on a sustained basis. Such a scenario could occur if:

• The recovery in traffic is materially slower than our expectations, resulting in continued weak financial metrics; or
• Capex is materially higher than our forecasts or dividends to shareholders are inconsistent with the company's policies, both of which can result in higher leverage.

Upside scenario

An upgrade is highly unlikely. This is because of the trend in APAC's financial metrics, which are mainly driven by the traffic recovery at its airports as well as the company's large, but manageable capex plan. That said, we could raise the rating by one notch if the FFO-to-debt ratio remained above 10%, supported by company policies that can sustain a higher rating.

Company Description

Headquartered in Melbourne, APAC owns and operates Melbourne Airport and Launceston Airport in Tasmania. Both are under 50-year leases from the Australian government, with options to extend for a further 49 years at the airports' discretion.

Curfew-free Melbourne Airport is Australia's second-largest airport and APAC's principal asset. It sits on 2,457 hectares (ha) of land with an undeveloped land bank of more than 300 ha. Melbourne Airport handled 37.4 million passengers in fiscal 2019 (before the pandemic) and contributed about 98% to APAC's EBITDA and cash flow.

APAC holds a 90% stake in Launceston Airport. This is a small domestic-only facility that services the northern part of Tasmania. The airport handled 1.4 million passengers in 2019.

APAC is owned by infrastructure funds, with no shareholder having majority control: AMP Capital (27%), the state of New South Wales government--The Treasury (19%), Utilities of Australia (managed by HRL Morrison & Co Ltd., 9%), IFM Investors Pty Ltd. (25%), and Future Fund (Australia's sovereign fund, 20%).

Our Base-Case Scenario

Assumptions

• Passenger growth will not correlate with the GDP growth of Australia or passengers' countries of origin over the next several years as travel rebounds from record-low levels;
• A continued domestic-led recovery in passenger traffic, with the international passenger recovery slightly lagging;
• Aeronautical revenue based on passenger volumes. Domestic passengers' contributions to such revenue are disproportionately lower than the passenger mix in general;
• Aeronautical landing charges in line with current three-year commercial negotiations;
• Retail revenue linked to passengers. This will increase from fiscal 2023, when international traffic ramps up;
• Car-park and ground transportation revenue in excess of overall passenger growth, with expectation of a progressive move to pre-Covid mode share;
• Property income includes new additions;
• Step increases in underlying opex in fiscal 2023, primarily reflecting increased airport activity and higher inflation; and
• An all-in effective cash interest rate of about 5%.

Key metrics

Table 1

Liquidity

We assess APAC's liquidity as strong. We expect sources less uses of funds to be more than 1.5x over the next 12 months and above 1x over the following 12 months if EBITDA were to decline by 30%.

APAC has solid liquidity. The operator has about A$1.8 billion of undrawn committed bank lines. This should adequately cover capex for the next few years and debt maturing over fiscal 2023. We expect APAC to manage its debt facilities in accordance with traffic trends and the need for capex at its airports.

APAC had debt covenant waivers in place until December 2021. Covenant testing should have commenced for the six months to June 30, 2022. We believe the operator can comfortably meet its covenants, given the recovery in its passenger traffic in the past six months. We expect APAC to remain in compliance with the covenants.

Principal liquidity sources:

• Cash and undrawn bank lines of about A$1.85 billion as of June 30, 2022.
• Cash from operations of about A$435 million over the next 12 months.

Principal liquidity uses:

• Debt maturity of A$375 million due between September and November 2022;
• Capex of about A$400 million over the next 12 months; and
• Possibility of no distributions to shareholders in fiscal 2023.

Environmental, Social, And Governance

ESG credit indicators: To E-2, S-3, G2; From E-2, S-4, G-2

Social factors are a moderately negative consideration in our credit rating analysis of APAC and its main asset, Melbourne Airport. Health and safety issues due to COVID-19 have had a negative impact on the company's financial performance because of a drop in traffic at its airports. This had resulted in pressure on its cash flow.

However, both domestic and international traffic is now recovering, at run rates of about 90% and 50% respectively compared with pre-COVID levels. While a repeat of extreme disruptions is unlikely, uncertainties remain. A resurgence of the pandemic could hurt business at Melbourne Airport as well as the other airports.

Issue Ratings - Subordination Risk Analysis

Capital structure

As of June 30, 2021, the group's consolidated capital structure consisted of A$4.6 billion of senior secured debt (total hedged value of the debt). The bulk of APAC's rated debt was issued by its 100%-owned subsidiary, Australia Pacific Airport (Melbourne) Pty Ltd. (APAM) and is guaranteed by APAC.

Analytical conclusions

We rate APAM's senior secured debt 'BBB+', in line with the long-term issuer credit rating on APAC because the debt is secured. APAL's debt is unrated.

Ratings Score Snapshot

Issuer Credit Rating: BBB+/Stable/--

Business risk: Excellent

• Country risk: Very low
• Industry risk: Low
• Competitive position: Excellent

Financial risk: Significant

• Cash flow/Leverage: Significant

Anchor: a-

Modifiers

• Diversification/Portfolio effect: Neutral (no impact)
• Capital structure: Neutral (no impact)
• Financial policy: Neutral (no impact)
• Liquidity: Strong (no impact)
• Management and governance: Satisfactory (no impact)
• Comparable rating analysis: Negative (-1 notch)

Stand-alone credit profile: bbb+

Environmental, social, and governance (ESG) credit factors for this change in credit rating/outlook and/or CreditWatch status: 

• Health and safety

Related Criteria

• General Criteria: Environmental, Social, And Governance Principles In Credit Ratings, Oct. 10, 2021
• General Criteria: Group Rating Methodology, July 1, 2019
• Criteria | Corporates | General: Corporate Methodology: Ratios And Adjustments, April 1, 2019
• Criteria | Corporates | General: Reflecting Subordination Risk In Corporate Issue Ratings, March 28, 2018
• Criteria | Corporates | General: Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Dec. 16, 2014
• Criteria | Corporates | General: Corporate Methodology, Nov. 19, 2013
• General Criteria: Country Risk Assessment Methodology And Assumptions, Nov. 19, 2013
• General Criteria: Methodology: Industry Risk, Nov. 19, 2013
• General Criteria: Methodology: Management And Governance Credit Factors For Corporate Entities, Nov. 13, 2012
• General Criteria: Principles Of Credit Ratings, Feb. 16, 2011

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