The aviation industry can be a tough gig. High cost of capital, high rates of depreciation, fierce competition, thin profit margins and low return on incremental capital are just some of the challenges facing the industry. In this article, we weigh up the advantages and potential risks of investing in the aviation sector.
Aviation is broader than airlines
The aviation sector extends beyond pure airlines as we traditionally think of them. Frequent-flyer programs, aircraft manufacturing and infrastructure are all examples of related sectors which are often quite profitable and are not so bound by external factors such as oil prices, which can heavily influence airline profitability.
In fact, aviation-related infrastructure - such as airports, runways, terminals, hangars, and ground transport systems can present a compelling opportunity for investors. Generally speaking, aviation-related infrastructure has similarities to other forms of civilian infrastructure in that it can provide an ongoing cash stream that gradually rises with inflation.
Other advantages of infrastructure as it relates to the aviation industry include:
- Monopolistic characteristics. Unlike roads, airports tend to have limited competition from alternative airports. Once they are established, potential competitors would have few reasons to attempt to open a ‘better one next door’. These days, competition is more likely to come from alternative modes of transport such as high-speed rail, which is particularly popular across Asia.
- High barriers to entry: A substantially high initial investment is required to build the necessary infrastructure for airports and other services related to infrastructure. There are also various regulatory and government restrictions such as noise limits and the realities of airport-based airlines which favour concentration of operations in a few ports.
- Ancillary income streams. Additional cash flow can stem from non-aviation sources such as car parks, shops and ground transport systems. These sources of income, along with the aeronautical revenues received from the airlines for the use of runway and terminal infrastructure can also provide a valuable hedge against inflation.
- Shelter against a nation’s economic cycle. When an economy is in good shape, and its currency tends to be high, outbound international travel generally becomes more popular. Conversely, in a weak economy, a net inflow of international tourists is often seen, as foreign citizens take advantage of their greater purchasing power.
What are the considerations?
Like all potential infrastructure investments, any prospective investor considering the aviation sector should carefully assess risks. Competition from other hubs may be an important factor though this is generally more relevant overseas than in Australia. Investors should also consider competition from other travel destinations, which is particularly relevant for airports where traffic is majority inbound tourism.
Some other questions that may be worth exploring include:
- Is the airport dependent on one or few airlines?
- Is there a good mix of domestic and international traffic?
- What’s the balance between aeronautical and commercial revenues?
- What potential competing transport modes could emerge?
- What regulatory risks exist?
These are all questions that investors should consider before allocating any capital. Positive financial indicators of a ‘good’ airport investment should include a favourable regulatory framework that doesn’t cap returns, high operating margins, strong aeronautical asset base with spare capacity, moderate level of gearing and an ability to expand.
With the appropriate research, the potential exists to provide an ongoing, inflation-sheltered income stream that should rise in value meaningfully over time.
Important note: While every care has been taken in the preparation of this information, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) makes no representation or warranty as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This information has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. Certain information in this website has been obtained from sources that we consider to be reliable and is based on present circumstances, market conditions and beliefs. We have not independently verified this information and cannot assure you that it is accurate or complete.