Down but not out
Passenger traffic dynamics have been distinct to different airline segments: the traditional airlines and ?no frills? carriers. Owing to higher exposure to North Atlantic and Middle East routes, the Association of European Airlines (AEA) carriers' traffic fell by 12% in the 12 months following the attacks. As an annual 6% increase in traffic would be expected under normal conditions, passenger traffic for these carriers has effectively lost three years of growth. In contrast, no frills airlines, which are not members of AEA and carry only intra-European traffic, enjoyed growth of more than 30% over the same period. The strong activity of no frills carriers has somewhat offset the traffic declines experienced by flag carriers and other traditional airlines and airports with higher exposure to the no frills airlines have benefited from these developments.
Ratings stability has been maintained
Although no frills carriers' growth is one factor that contributes to rating stability, the airports' ability to maintain their credit profile is also a result of the following factors:
? Most airport ratings are supported by their average or above-average business profile;
? A Gulf War scenario was assumed under a stress test and incorporated in the ratings;
? Conservative budgeting techniques, which provide some headroom for traffic declines;
? Sufficient financial liquidity to overcome one to two years of financial stress;
? Much of the projected capital expenditure (capex) requirements over the next three years could be deferred; and
? Tariff increases and cost containments partly offset the effects of traffic declines.
Over the past year, seven of the eight European airports rated by Standard & Poor's maintained their ratings. The ratings on Schiphol were lowered to ?AA-/Stable' from ?AAA/Negative' to reflect the airport's stand-alone credit quality rather than that of its majority owner, the Kingdom of the Netherlands (AAA/Stable/A-1+). This approach is in line with Standard & Poor's policy of rating state-owned entities and the rating action was not related to the effects of the terrorist attacks.
In addition, Aer Rianta's outlook was revised to negative to reflect expectations of a deterioration in the company's financial profile with the implementation of airport charges for the 2002-2006 period in accordance with regulatory determination.
Expectations
Standard & Poor's expects the operating environment to remain challenging in the short to medium term. Airport operators must cope with increased traffic uncertainty, which affects capex and financial profile forecasts. Besides the lower base traffic volumes, additional uncertainty arises from the threat of a war with Iraq, which could create a ?double dip' scenario. In this instance, passenger traffic could decline before returning to pre Sept. 11, levels and the recovery horizon would be prolonged. Nevertheless, because transatlantic routes were the ones most affected during the Gulf War, the impact would probably be less severe than that experienced during ?Desert Storm', since these routes are still experiencing the sharpest volume decline. Middle Eastern routes only provide for small volumes at airports like Schiphol, Heathrow, and the Paris airports. Overall, it is difficult to assess the extent of a war's impact on the European airport sector's financial health; however, some immediate negative impact seems likely. In addition, the impact varies from airport to airport. A key issue will be whether intra-European traffic, which has recovered somewhat from Sept. 11, will stand firm. In a non-war scenario, however, European airports are expected to maintain adequate liquidity to withstand temporary balance-sheet pressures due to cash flow stability, capital spending flexibility, sizeable unused banking lines, and good access to the financial markets. Despite the impact of Sept. 11 on passenger traffic, several airports were able to issue debt on favorable terms thereafter.
Nevertheless, other issues could have a negative effect on the airports' financial profile:
? Further exogenous events could erode passenger confidence, which had been slowly improving;
? The financial health of the airline sector, both the flag carriers and the fast-growing low-cost segment, which has been an important engine for traffic recovery over the past year;
? The outcome of pending regulatory issues, which will be key for BAA PLC and Aer Rianta, and the ability to increase charges;
? European and national transportation policies;
? Global and regional economic dynamics; and
? Sizeable investment programs, which can significantly reduce financial flexibility when the ability to reprofile or cut committed capex is limited.
Decline in air traffic: Gulf War compared with Sept. 11
Standard & Poor's has evaluated the effect of both the Gulf War (January 1991) and Sept. 11 on airport traffic in the 12 months immediately following each event. The results indicate that the Sept. 11 recovery is taking longer than that following the Gulf War; most airports had reported traffic growth six to 10 months after the start of the Gulf War, while in the 12 months following the Sept. 11 events, most airports were still experiencing lower traffic volumes.
Among Standard & Poor's rated airports, Aeroporti di Roma SpA (AdR; A-/Stable/A-2) and Aeroports de Paris (AdP; AAA/Stable/?) have been most affected, given their high exposure to transatlantic traffic. AdP has also felt the effects of high-speed rail substitution. Nevertheless, in August 2002, AdP showed positive traffic growth supported by domestic routes.
Reflecting its dependence on business travel, London City Airport's (City Aviation Finance Ltd. (LCY); issue rating; BBB/Stable/?) average passenger traffic decline of 7.3% primarily reflects the slowdown in the European economy; summer public holidays, which resulted in lower business traffic; and diversions to Stansted due to the poor weather in August 2002. As expected, LCY reported a 22% passenger increase in September 2002 on September 2001, when the airport was closed for two days after the terrorist attacks.
Birmingham International Airport Ltd. (BIA; A-/Stable/A-2) and Newcastle International Airport Ltd.'s (NIA; BBB+/Stable/?) lower exposure to long-haul traffic limited passenger volume decreases to 2.5% and 5.6% on average over the 12 months following Sept. 11, respectively. Amsterdam Schiphol's relatively low exposure to North Atlantic routes (5% of total ATMs) and the strong growth of no frills airlines limited the average traffic decline to 2.6%. The Dutch airport also benefited from the demise of SwissAir and Sabena S.A. (Sabena). However, Schiphol's traffic decline was still above that following the Gulf War.
Despite its high exposure to the North Atlantic traffic at Heathrow, BAA PLC's (AA-/Negative/A-1+) overall traffic decline was mitigated as it is the owner of a large number of UK airports, which showed diverse results. The negative impact on Heathrow and London Gatwick was offset by the expansion of the no frills airlines at London Stansted, where passenger numbers saw double-digit increases. Ongoing growth at the Scottish airports was a positive factor. In addition, in the first five months of the 2001/2002 fiscal year (April to August 2001), passenger numbers had only grown by 1.4%, reflecting the effects of the ?foot and mouth' outbreak and the US economic slowdown. Lower growth prior to the Sept. 11 attacks also partly mitigated traffic declines and supported stronger performance than during the Gulf War.
Aer Rianta remained an exception among the rated airports, recording an average traffic increase of 3.5% from September 2001 through August 2002. In contrast with the period after the start of the Gulf War, when passenger traffic at Aer Rianta airports experienced a 4.6% decline, the events of Sept. 11 only slowed overall passenger growth. This solid performance has principally derived from the strength of the Irish economy, as well as sound European traffic, driven by the growth in a range of services including charter operations at Dublin and Cork airports, and the rapid expansion of the Irish low-cost airline Ryanair Holdings PLC (Ryanair; not rated).
Of the unrated airports reviewed by Standard & Poor's?Copenhagen (CPH) Airport, Vienna Airport, Zurich Airport (Unique), and Fraport?Copenhagen, on average, showed the least decline after Sept. 11 compared with traffic during the Gulf War. The airport also recorded traffic growth in both April and June 2002, and, as expected, in September 2002. Unique was badly affected by the demise of SwissAir and recorded an average traffic decline of about 24.0% in the 12 months following Sept. 11. Nevertheless, the operator of Zurich airport slowly decreased the rate of decline on a monthly basis, reducing it to 18.1% in August 2002. Vienna Airport reported its first traffic increase in June 2002, but showed volume declines in July and August, primarily due to a fall in tourism-related charters and the disastrous floods in central Austria. The bigger German hub in Frankfurt reported negative volumes of 6.2% between September 2001 and August 2002, but the monthly rates of decline reduced to 2.7% in August 2002.
?No frills? carriers: will growth last?
Flag Carriers: Strategies and Financial Health Regulation is Still Evolving A key driver of many airports has been the success of no frills airlines, which have been growing at more than 30% per year and have helped to mitigate the slow pace of traffic recovery since Sept. 11. Some airports, like Bristol and London Stansted, have seen a surge in traffic since these carriers started operations at these airports. Schiphol and AdR, particularly at Ciampino, have also benefited from the expansion of easyJet PLC (not rated) and Ryanair, respectively. At Schiphol, no frills airlines now represent about 7% of total passengers compared with 5% in 2001. Ryanair has increased its market share in Aer Rianta's Dublin airport to 30% from 25% in 1999 and early 2002 results indicate that it is continuing to take market share from its rivals.
As more and more no frills airlines start operations they also seek an airport as their base. This has started to benefit many regional airports. Recently, MyTravel Group PLC (not rated) announced the planned development of a new low-cost carrier service at Birmingham Airport.
Although the current popularity of no frills airlines has played an important role in the recovery of passenger traffic at most European airports, Standard & Poor's remains cautious of the increased exposure of airports to this airline segment. The question is whether these airlines can maintain the surge in passenger volumes in the longer term. The signs are positive if one looks at the US-based Southwest Airlines (A/Negative/?). Nevertheless, the low-cost model remains relatively new in Europe and the high growth rate is a concern. The ongoing ?price wars?, aggressive marketing strategies, and the purchase of a large fleet of new aircraft for Ryanair and easyJet could weaken the no frills carriers' financial standing, from their current strong financial profile. Furthermore, while much of this growth is supply-driven, coming from passengers that would not fly in the absence of a low fare, some ?cannibalization? of existing full-service flights also exists. Although no frills airlines provide increased passenger volumes and passenger fees, they often negotiate discounts on landing fees and pay for minimal airport infrastructure, which means that they are not necessarily a good deal for airports. Results vary on retail spending per low-cost carrier passenger. In the UK, commercial revenues from this passenger group are generally higher, while in countries such as Italy, they seem to be lower than for full-service passengers.
Flag carriers: strategies and financial health
The ability of key national carriers to survive poses a potential threat to airport credit quality. The demise of the flag carriers SwissAir and Sabena compounded the negative effects of the terrorist attacks on the non-rated airports Unique, in Zurich, and Brussels International. Both of the airports recorded sharp passenger declines following the demise of these carriers, mainly due to the loss of transfer passengers. Following Sept. 11, however, there was some general substitution of smaller airlines and routes, as demonstrated at Newcastle and Gatwick, where cancelled routes were quickly taken up by other airlines. These examples show that while smaller airlines could be easily replaced at various airports due to the origin-destination nature of their traffic, transfer passengers from national carriers are not easily replaced. Although the credit rating of an airport is not directly related to the quality of the dominant airline, its financial standing and strategy are important factors. Potential consolidation among European airlines and the effect of this on airport strategies could also become a key factor for some airport operators. Similarly, the increasing importance of international airline alliances and the development of multiple hubs in some main carriers' home markets creates uncertainty for the airports. Debate continues over whether KLM will join the Skyteam alliance, which includes Air France, Alitalia SpA, and Delta Airlines Inc. This could have an impact on the operations of the related airports in France, Italy, and the Netherlands.
To maintain credit quality, it is imperative that airports recoup their short-term operating costs and longterm capital costs. Several regulatory reviews of airport charges are in progress. In the UK, a key fiveyear review of BAA's airport charges begins April 2003, after postponement following Sept. 11. The Civil Aviation Authority (CAA) is considering whether to allow BAA ?dual till? regulation (i.e. the separation of aeronautical revenues from commercial revenues) or to retain the current ?single till? policy. Under the latter, commercial revenues subsidize the aeronautical charges. Although there is no indication that the final resolution of the regulatory price review will be detrimental, a conclusion has not yet been reached, and this, therefore, remains an ongoing risk. A decision is likely to be made by January 2003.
In August 2001, only six months after it was created, the Irish Commission for Aviation Regulation determined the maximum levels of airport charges to be levied by Aer Rianta at its three airports for 2001-2006. The prices are based on a single-till methodology. The airlines and interested parties appealed against the determination and a revised determination was subsequently issued in February 2002. Aer Rianta applied for a judicial review of the revised determination, which is still pending. Although the outcome of the judicial review will probably not be known until early 2003, Aer Rianta has adopted charges that comply with the revised determination. Conflicting views on Aer Rianta's investment needs are at the center of the judicial review proceedings.
The regulatory regime in Italy seems to be more favorable than in Ireland. AdR has agreed with the Italian Civil Aviation Authority (ENAC) on a revised concession agreement, which provides a more favorable regime in case of revocation in the public interest. In addition, the framework for AdR's airport charges is supportive, as it allows for charge increases equal to the European average, although the timing for this has not yet been determined.
Government-owned airports such as AdP and Schiphol face stricter regulation on environmental issues, which could limit capacity. On the other hand, tariffs have increased at a faster pace than those of other regulated airports, despite airline protests. After the expected privatization of Schiphol, the future tariff regime will allow the company to continue to set its tariffs in conjunction with airport users, which will be able to appeal to the Dutch competition authority. The tariff base for Schiphol will likely be a dual till approach post privatization.
Overall, there appears to be a trend toward dual-till price regulation, which focuses on the investments in and quality of an airport's infrastructure. In the Irish case, it seems that the Commission regards the dual till as a superior regulatory approach. The choice of a single till methodology was more due to time constraints and lack of information on detailed cost allocation. Another pitfall of the revised determination is that it does not adjust assumptions of the charge calculation for the effects of the Sept. 11 attacks on traffic growth. These drawbacks could be addressed in an interim review, which could take place in 2003.
Transportation policies
The UK government's consultation proposals for the development of additional airport runway capacity are likely to have a long-term impact on the credit quality of UK rated airports. These proposals, combined with the publication of the aviation white paper in 2002, will shape the development of airport capacity in the UK, as it responds to the expected doubling of UK air passengers to 400 million per year by 2020. As the owner of London Heathrow, Gatwick, and London Stansted airports, BAA would be most affected by the proposed additional runways and associated infrastructure at these sites. This increased capacity would allow BAA to meet the demand for increased passenger growth and reaffirm the company's strong competitive position as owner of the main international hub airport for Europe (Heathrow). The impact of a significant new capex program on the company's financial profile would, however, be a key credit issue.
For Aer Rianta, the competitive landscape could change in the long term in light of the recent invitation by the Irish Minister for Transport to submit proposals for construction of an independent airport terminal at Dublin. The announcement is preliminary in that the invitation is designed to allow the Irish government to assess interest in the project and enable progress toward the formal public tendering process. Since there are no details as to where the terminal will be constructed or which airlines it will serve, the potential impact on Aer Rianta cannot be assessed at this stage. Ryanair, which accounts for a large proportion of Aer Rianta's traffic at Dublin, has been pressing publicly for an independent terminal. Bond spreads have widened significantly since this announcement, and have converged with those of Newcastle. Recent comments on ownership or management structure changes at Shannon and Cork airports, both of which are owned and operated by Aer Rianta, could also have affected spreads.
Global and regional economic dynamics
Airports with a large share of intercontinental or international traffic are vulnerable to global economic cycles. The slowing economy had already affected the pace of growth in several major European hubs even prior to Sept. 11. The slow growth reported by BAA in the first half of its fiscal year ending March 2002 was partly related to declines in US economic activity. Similarly, airports with exposure to regional downturns related to specific sectors of the economy, for example, high technology, cargo operations, or the financial services industry are more vulnerable. LCY has been most affected by the depressed business activity in the banking sector, as the European economy slows down.
Need for capacity leads to high investment requirements
Despite passenger traffic declines, capacity constraints remain an issue, which could affect the airports' business position in the long term. In Europe, delays have almost become a normal part of air travel. Insufficient airport capacity is not entirely to blame; air traffic control, environmental concerns, and permitting issues also play a part.
Innovative structures and financial methodologies, such as off-balance-sheet financing, could play a growing role in funding airport capacity increases.
The airports' investment programs place a strain on operations and often result in lower traveler perceptions of quality, while pressuring an airport's financial profile before the investment benefits can be seen. Consequently, Standard & Poor's often considers a large capex program to be a negative rating factor, although it recognizes that it is necessary to provide future quality capacity and maintain the airports' business position in the long term.
In the past year, some airports deferred capex as passenger traffic declines, but investments are expected to resume in 2003. BAA, however, continued its extensive capex program, spending more than £630 million in 2001-2002 on new and improved airport facilities. The company's ambitious existing capital plans forecast an investment in excess of £8.1 billion over the next 11 years subject to the appropriate regulatory pricing review. About £3.7 billion will go to the T5 project, which is designed to increase capacity at Heathrow by 30 million passengers. This will ensure that the airport's international competitive position is maintained. In contrast with previous years, the large scale of the capital projects is likely to reduce BAA's flexibility to reprofile projects in times of financial stress. The program will be funded through debt and cash flow and will, undoubtedly, present a significant challenge to the company's existing financial strength.
AdP had embarked on substantial capacity-addition works, which can only be marginally deferred. AdP's planned investment outlays will result in significantly higher leverage, but sovereign support will continue to underpin the rating for the foreseeable future.
Schiphol's fifth runway is expected to be operational in early 2003 and should fulfill capacity needs for the next 10 years. Although a heavy investment program still lies ahead in the next five years, the nature of the investments would allow Schiphol to significantly reduce capex if needed.
The court's decision on the revised determination will be crucial in determining ultimate capital expenditure levels for Aer Rianta.
Analyst e-mail addresses
maria_lemos@standardandpoors.com
jan_plantagie@standardandpoors.com
infrastrutureeurope@standardandpoors.com
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