Fraport FRA GY
November 10, 2009 - 9:40am EST by
2009 2010
Price: 32.79 EPS $1.50 $1.85
Shares Out. (in M): 91,859 P/E 21.9x 17.7x
Market Cap (in $M): 4,521 P/FCF 8.0x 6.7x
Net Debt (in $M): 1,917 EBIT 288 348
TEV ($): 6,438 TEV/EBIT 22.4x 18.5x

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1. Unique asset

  • Airports are vey attractive infrastructure assets due to asset ownership and unregulated segments
    • Unlike toll roads (for example), most airports own the land and thus have an "infinite" concession
    • Dual till airports like Fraport have regulated aviation services, but unregulated retail and property activities (where most of the value lies), which is a huge positive over airports like Paris, London, and Rom
  • Location and scale: Frankfurt is a major European hub, which has scarcity value
    • Fraport has the largest catchment area in Europe with 38mm people within 200km  
      • The catchment area includes 50% of the German population and 70% of GDP
      • Frankfurt will have the most capacity in Europe once the new runway opens in late 201 
    • The major EU hubs have proven to be resilient, with airlines reducing capacity from secondary airports first
      • Negotiating leverage: although Fraport has high exposure to transfer traffic and Lufthansa, its high density network is unmatched and therefore Lufthansa's most profitable routes will continue to be there
      • Lufthansa was adding capacity to secondary airports recently due to Fraport's supply constraints, but in downturn has cut capacity from Munich/Zurich instead of Frankfurt, validating Fraport's claims
      • The 09/10 winter schedules recently published by airlines support this view, with Munich -5% and Frankfurt -1.5 
    • Fraport is also Europe's #2 cargo airport
    • There are only two listed EU major hub airports and one port (illiquid), giving Fraport scarcity value
  • Fraport has the highest utilization of any major EU airport, being notoriously supply constrained in the last few years
    • This was a disadvantage in the boom years as investors wanted to pay for growth. Now it provides a cushion (in the medium term)
      • Many airlines (e.g. Air India, Middle Eastern airlines) wanted a bigger presence there, but couldn't get the desired scale due to supply constraints. Fraport estimated there was >20% excess slot demand (pre-Lehman)
      • The 80/20 rule states that airlines must use 80% of their capacity to keep their slots, which allows airports to replace unprofitable airline slots with fast growing / healthy airlines that have few slots
      • This rule has been temporarily suspended and could be renewed for winter, but in the medium term, market forces will work for Fraport's benefit-in other words, #s are currently understated
    • As the new runway comes online, this cushion ensures there will be significant demand for the new capacity, which is usually the main risk for such large expansion projects
    • Frankfurt is the only major EU hub opening a new runway in at least the next decade (Heathrow has talked about a potential plan), so it should take share in the EU long haul transfer traffic marke 
  • Hub airports are usually dependent on the national champion airline for most of their traffic--Fraport is fortunate to be the home of Europe's strongest network airline, Lufthansa
    • Fraport estimates that 2/3 of Lufthansa's (normalized) profits are made in Frankfurt routes
  • Retail and Property represented 61% of Fraport's 2008 EBITDA, making it the bulk of Fraport's value
    • Fraport will continue to structurally increase retail spend per passenger in the next few years
      • Retail space is also growing aggressively, from 15,000m2 in '06 to 20,000m2 by end '09 and 30,000m2 by 2012
      • As such, 1H09 retail spend passenger of €2.90 grew 4.3% YoY despite recession, reflecting the structural nature of the improvement; conservative target is €4 by 2012
      • This is the highest return business for dual till airports like Fraport 
    • Real estate free option
      • Fraport owns all the land on which the airport is based, totaling >20 sq km
      • This used to be the core of the bull case in 2006-2007, that they would spinoff some land, create REITs, etc.
      • Bull case then was that the real estate alone could be worth >€6bn (on 7% yield), or more than the current EV
      • I conservatively estimate €2.1bn value for real estate, meaning there's theoretically considerable upside. But this is an issue analysts and management currently barely discuss, so it's basically a free option
  • Operating leverage
    • ~90% of aviation costs are fixed, so in a recovery #s will go up significantly
    • Increased passenger traffic is also the main driver for its other businesses (retail, parking, etc)
    • Fraport will have a slide on this topic in the Sept 10th Investor Day, management believes not factored in
    • A380 introduction in 2010 (Lufthansa ordered 15 of 200): the 525 seater doesn't increase the cost for Fraport, but provides a huge benefit for aviation and non-aviation revenues (also increases the importance of hub airports)
  • External airports: this is a growth area and will represent ~25% of 2010 EBITDA
    • Owns stakes in Antalya (Istanbul, 50%), Lima (70%), two Bulgarian airports (60%)-the first two are still growing in 2009, which is quite a feat
    • Has management contracts with airports in Saudi Arabia, Egypt, China, and Senegal
    • Just won the contract to develop and operate the new St Petersburg airport (35.5% stake in JV), the 2nd largest in Russia. No value attributed to this yet as details will emerge once deal is closed by the end of the year.

2. Misunderstood story

A. Capex

  • A major pillar of the bear case is the ongoing €7bn capex program 2007-2015 (greater than company's EV), which will result in highly negative free cash flow, and increased leverage (epitomized by GS Conviction Sell view)
    • As a result, the stock screens badly on net debt / EBITDA (used to be the least leveraged infrastructure stock but with this capex program it peaks at ~4.5-6x depending on estimates in the next couple of years 
  • This is completely the wrong way to look at an infrastructure business and presents a unique opportunity to buy a great asset at a significant discount to its intrinsic value
    • An infrastructure project almost by definition is based on investments in the early years that result in highly negative cash flows, followed by decades of increasing profitability such that over time one earns a decent return
    • The charts below show that over time Fraport's leverage and valuation are reasonable, and since infrastructure assets are by definition long life businesses, it makes no sense to take a snapshot view of these metrics
  • An alternative way to think about this issue is to split up the company into two different entities, one being the current business and the second being the new runway and terminals, which will only start yielding a return in 2012-2017
    • Out of the €7bn capex, €2.5bn will have been spent by year-end and €1.5bn will only see a return in late 2011 and beyond. Therefore, one can adjust the 2010 EV by €1.5bn (by 26%!), adjust the net debt / EBITDA, and exclude interest pertinent to this extra debt from the FCF calculation.
    • This results in an adjusted unlevered FCF yield of 11% for the current business (12% levered), which is extraordinarily high for this type of business
      • This compares to levered FCF yields of 6.5% for Aeroports de Paris, 6% for the contractors, and 11% for the highly levered toll roads, all also adjusted for maintenance capex. On an unlevered basis it's even more attractive since it's adjusted 2010 net debt / EBITDA of 1.6x is significantly below peers (see comps)
      • Alternatively, the core business is on a 6.3x EV/EBITDA, way below the rule of thumb 10x
    • Therefore, the stock is implicitly pricing in significant value destruction from this capex, even though as discussed earlier, this is a capacity constrained airport with excess demand (that is investing at arguably the bottom of the aviation cycle), and the terminal investments will drastically improve its retail spend / passenger
    • This is discussed further in the valuation section, but below is the detailed capex and what I'm excluding

B. Aviation business

  • In the last few years, this has been a major source of disappointment, with Fraport not increasing tariffs last year and only increasing them by 2.3% this year, despite the theoretical ability to make large increases, a bull market, and double digit % increases by its peers
    • This led to investors derating the stock in the belief that Fraport was not seeking to maximize shareholder value or that Lufthansa had too much power in this discussion
    • Another view was that Fraport's costs were too high relative to other Lufthansa airports, so it could not increase fees due to a fear of losing business
    • Naturally expectations were that in a recession it would be even harder to raise fees
  • The proposed 8.4% fee increase should go through and relieve a lot of these fears
    • Fraport didn't get larger fee increases in the past because it didn't ask for them, but from a regulatory perspective they were allowed to do that. Therefore, the odds of the fee being approved are high
    • To put this into perspective, Heathrow increased fees by 23.5% in '08, 15.1% in '09, and expects ~10% in 2011-2012. Unlike Fraport, it is not building a new runway with huge capex needs. Furthermore, other airports have now brought fees in line with Fraport, such that Frankfurt is now the cheapest of the big 3 hubs
    • Out of the 8.4% fee increase, most of it will be an increase of €1.4 charged directly to the passengers. Only 20% of the increase will be an increased charge for airlines.
    • Fraport has indicated that it will seek 5-7% fee increases for the next 3 years as it needs to get paid on the capex. The market is not convinced it will be able to pass these through.
    • Fraport's expansion plan will benefit Lufthansa in many ways, providing it with the best terminal, preferential slots, etc, such that there are things Lufthansa will need from them in the future
  • On a sum of the parts basis, I estimate we are getting Fraport's aviation business for free (more later)
    • Since there is nothing inherently wrong with the regulatory framework, it is reasonable for Fraport's aviation business to be valued in line with peers, which would provide considerable upside (up to €16 / share)

3. Attractive real yield uncommon in current environment

  • Hard to get real yield today and likely in foreseeable future
    • Real bond yields are the key variable for determining infrastructure stock valuations (because inflation hedged).
      • In other words, if nominal interest rates increase in response to inflation this has no impact on the company's valuation.  If interest rates increase by less than inflation, it's a net positive for Fraport.  If they increase by more than inflation it's because German GDP is recovering, therefore a win-win in any scenario 
      • German/US real yield curves are pricing in that real yields will stay below '06-'07 levels for the next 10 years
    • Fraport's double digit unlevered free cash flow yield is unique. The stock also pays a 3.5% dividend yield
    • Another way to see this is through a lower WACC. When the equity risk premium was increasing in 4Q08/1Q09 (Germany was 8.5% in March according to JP Morgan), WACC's were still high despite a sharply lower risk free rate, but now I'd argue sell-side's WACC's are too high (more in valuation section)

4. Valuation

  • Multiples based valuation leads to a target for the stock of €60
    • Stripping out the growth capex that will only yield results in 2012 and beyond, the stock has an unlevered FCF yield of 10.7% now. At a 7% yield, the stock would be €59.5
    • With the same adjustments, the stock is trading at 6.3x adjusted 2010 EV/EBITDA. At 10x adjusted EV/EBITDA, the stock would be €62.3
  • DCF valuation yields a target of €55
    • This is based on a conservative WACC, but inputs suggest the WACC could be lower
      • I assume a beta of 1, but technically the beta calculation gets one to 0.9. I assume a risk free rate of 3.8% even though the German 10yr bond is at 3.27%. I assume a debt/capital ratio of 35%, even though it will be 50% over the next 5 years. I also assume a 6.3% pre-tax cost of debt even though their current average cost of debt is 4%.
      • As such, the 7.3% WACC could easily be <6%, which would increase my target up to >€80
      • Each 10bps move in the WACC has a ~€1.8 impact on the taget, making it one of the most sensitive stocks in my coverage universe
  • SOTP (DCF based) valuation yields a target of €56; as a check RAB suggests this is reasonable
    • A good benchmark for regulated assets is the regulated asset base (RAB), which is similar to book value
      • Even at its SOTP target, Fraport's aviation business would still be at a 4% discount to RAB
      • I estimate we are currently getting Fraport's aviation business for free (CS estimates a 63% discount to RAB)
      • CS estimates that ADP is trading at RAB, Heathrow implicitly is at 8% premium / RAB, UK water companies are trading at around RAB. Historically, airports and UK water have traded at a ~10% premium / RAB


1. Airport fee decision should come in next few weeks

2. Monthly traffic will continue to lead sell-side estimates higher, with positive yoy #s coming in Dec or Jan

3. Due to the low base in 1H09, traffic growth estimates for 2010 are still too low.  Most analysts and guidance are at 0-2% traffic growth, but recently IATA predicted 4% traffic growth for 2010.  I get to 3-4% even if I assume 0-1% growth from 4Q09 to 4Q10 just due to easy comps in 1H09.

4. External airports: continue to surprise on upside, sell-side hasn't fully accounted for their Turkish airports recent performance, and give no value for the recent St Petersburg win.  Although no data has been given on St Petersburg, management believes this concession (Russia's #4 airport) will prove to be more valuable than Turkey's Antalya (which on a SOTP analysts estimate is 10-15% of Fraport's value).

5. Positioning: high short interest, at 15 days of volume, or 10% of free float (excluding strategic shareholders)

6. Rerating of infrastructure stocks as investors reach for real yield in a prolonged low interest rate world

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