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Connectivity and growth 2017 edition
November 2017 Introduction 1 Aviation growth in a changing world 2 Economic growth and air traffic: developments in Australia and Britain 6 Air connectivity: Why it matters and how to support growth 14 Aeronautical charges and air traffic demand risk: what is within our control? 22 Are European airport valuations taking off? 28
Contents | PwC | Connectivity and growth Introduction
This has been a year of record In this, our fifth annual prices and valuations for airport compendium we again open with assets – yet the perfect storm of Andrew Sentence’s observations low interest rates, low oil prices on the potential of the aviation and increasing airline yields market, and the issues that may seems to be drawing to a close. impact growth. We have updated With airline failures, such as our analysis for the key themes Monarch and Air Berlin, and of traffic, connectivity and expectations of tightening airline valuations – core considerations margins from overcapacity and for airport investment. higher oil prices – can the good times last? I hope you find this year’s new and updated articles a source of Yet, passenger demand and growth interest and debate, and I look remain strong, and both airports forward to discussing these issues and airlines continue to innovate with you over the coming year. to improve efficiency and provide new services and revenue streams. With these market headwinds, and the potential turmoil of Brexit yet to impact, signs of any Best Regards, reduction in investor appetite for airports will be closely assessed.
Michael Burns Partner, PwC UK
Introduction | 1 and both sides seem to have different objectives and strategies. The EU is Aviation growth in a seeking to secure its financial position and the rights of EU citizens. The UK is changing world more concerned with a post-Brexit trade deal and securing a reasonable transition to a new relationship with Dr Andrew Sentance, PwC UK the EU.
Talk from senior UK government figures We live in a world of political uncertainty, What do these developments mean for of “No Deal” with the EU is worrying yet the global economy is looking the world of aviation? Aviation has been to many business executives. As long relatively strong. The latest forecasts a major beneficiary of the globalisation as this “cliff-edge” scenario is avoided, published by the International Monetary of the world economy which has been it will not be until the 2020s that a Fund (IMF) in October point to the underway since the 1990s. The opening Brexit agreement will be properly strongest global growth in 2017 and up of major emerging markets like China implemented with more fundamental 2018 since 2010/11. All the three main and India to the global economy, the changes to the relationship between engines of world economic growth – development of the Single European the UK and its European neighbours. North America, Europe and Asia – are Market and other regional trade blocs, firing together for the first time in the and the strong growth of trade and Meanwhile, across the Atlantic in the post-crisis recovery. We can see the investment worldwide, have all United States, the Trump administration impact of this in terms of strong growth benefited the growth of the aviation is still clarifying its policy agenda and of demand in the airline industry. industry in the past three decades. has yet to establish a good working In August 2017, global passenger travel relationship with the Houses of was up over 7% on a year ago and air In the short-term, the aviation industry Congress. The immediate threat of cargo was up over 12% – according is benefitting from the upswing in the new protectionist measures has not to IATA. global economy. But there is still a been realised. But it has not totally possibility of disruption to established gone away either. The tax reforms The political events of 2016 in the patterns of trade and investment over promised by Trump and his team UK and US created a sense of upheaval. the longer term, with the UK set to have yet to attract the necessary The UK referendum vote for “Brexit” and leave the European Union (EU) and a support in the Senate and the House of the election of Donald Trump as the 45th growing threat of protectionism if Representatives. Meanwhile, global US President sent shockwaves through President Trump’s more extreme tensions on the Korean peninsula have the political systems on both sides of proposals were carried through. If this been rising following a series of missile the Atlantic. They have also raised a protectionist threat materialises, the tests by North Korea. Global security new set of economic uncertainties – world of aviation and its future growth concerns are generally bad for air travel particularly relating to the stability and would be very significantly affected. and aviation more generally, though future direction of the world trading they do not seem to be having much system. In 2017, political developments It will take time for it to become clear impact yet on the strong growth in the major western economies have how seriously the aviation industry recorded by the airline industry. been more reassuring – with France should take these protectionist worries. electing the reform-minded President The Brexit negotiations are proceeding Macron and Angela Merkel returned slowly. They were disrupted by the to power in Germany. General Election in the UK in June 2017,
2 | PwC | Connectivity and growth Though these political developments Atlantic, the US economy is forecast to projections1 suggest that the Asia- are creating an air of heightened grow by over 2% this year and next, Pacific economies will account for a uncertainty, the world economy with Canada expected to record a larger share of world GDP than Europe continues to grow well (see Figure 1). similar growth rate. Despite the lack of and North America combined. Also by 2017-18 looks set to see the strongest clarity surrounding the policy agenda this date, China will have overtaken period of global growth since 2010-11 of the Trump Presidency, consumers the United States as the world’s largest when the world economy bounced and businesses have remained confident economy, a position that the US has back from the depths of the Global and the US economy has continued to held for around 150 years. Against this Financial Crisis. The main exception grow steadily. The modest interest rate backdrop, it is perhaps not surprising to this global upswing is the UK, where rises implemented by the US Federal that US politicians are particularly economic growth has slowed from Reserve have not seriously disrupted sensitive about the rise of China and the around 2.5% in the three years 2014 economic growth. role it is playing in the world economy. to 2016 to a projected 1.5% in 2017 and a PwC forecast of 1.4% in 2018. Asia also continues to power ahead, led by the large population economies – Elsewhere within Europe, there has China, India and Indonesia. Chinese been a turnaround in growth in a growth is expected to be over 6% in number of economies over the past 2018 with India growing by over 7%. few years. Spain is the most striking The Asia-Pacific region is already example, where growth of around 3% substantially larger than the other is expected this year, followed by major regions in the world economy – 2.3% in 2018. France and Italy are accounting for around one-third of also reporting better growth prospects, global GDP, compared with the EU’s while most countries in Northern and share of just over 20% and North Eastern Europe continue to report America’s contribution of around a strong growth. Meanwhile, across the quarter. By 2030, PwC’s “World in 2050”
Figure 1: Outlook for global economy in 2017
Russia Canada 1.4 UK 1.4 1.9 Germany 1.7 Ireland 3.4
France 1.7 1.6 Greece 2.2 US Japan
Spain Italy 0.7 China Mexico 2.3 1.1 1.9 6.2
India
7.4 Australia Key Brazil South Africa 2.8 1.7 X.X = GDP growth in 2017 1.2
Source: PwC Oct/Nov 2017 Forecasts Note: Weather icons are for indicative/descriptive purposes only
1. https://www.pwc.com/gx/en/issues/economy/the-world-in-2050.html
Aviation growth in a changing world | 3 Looking ahead to the 2020s, it is How should airlines and airports central scenario – but if such a world possible to envisage two scenarios for respond to these developments in their did emerge, it would be much less the global economy as the current business planning and investment? favourable for the aviation industry. period of political uncertainty plays The most immediate consequence of the So it makes sense for businesses and itself out. The first – and most likely – recent change in the political climate regulators to consider how robust scenario is that the present highly is a rise in risk and uncertainty. That plans and forecasts are to a more globalised economy remains broadly points to the need to consider a wider serious disruption to world trade and intact and countries in the western range of scenarios for growth in the investment and a less positive outcome world adapt to the rise of China and current environment. A continuation from both Brexit and the Trump other large Asian economies. This of recent healthy growth of air traffic presidency in the US. scenario might be characterised as demand should be considered the “adjustment and acceptance”: an most likely scenario for the short-term The fundamentals of planning for acceptance of the changing world outlook (see Figure 2). However, sustainable growth remain the same, economic order and an adjustment of looking ahead, it makes sense to be however. For airlines, the watchwords economic policies to adapt to the new cautious about the medium-term should be profitable growth, cost control world order. outlook for a number of reasons. and connectivity. Growth opportunities need to be profitable. Chasing volume A more worrying and negative scenario First, the world economic recovery growth supported by declining yields is that a new form of economic rivalry which began in mid-2009 is now into has brought financial ruin and disaster develops between the major economic its ninth year. Periods of growth can to many airlines and their investors. powers – as the US and Europe adopt a only continue for so long before an So airlines need to undertake a careful protectionist stance to the rise of China economic shock or some series of evaluation of growth opportunities, and other emerging economies. unforeseen events come along to both in terms of new routes and At present this seems the less likely disrupt it. Periods of sustained global additional frequency of service. scenario, but the upheaval of Brexit economic growth lasting longer than They should not be seduced by the and the protectionist rhetoric from ten years are relatively unusual. Second, optimistic forecasts presented to them President Trump, means it cannot be a lapse into a more protectionist and by aircraft manufacturers, which ruled out. This more protectionist defensive world in the 2020s would be rarely mention the profitability of scenario would be associated with associated with much weaker economic growth opportunities. To achieve much slower economic growth and growth and a much less co-operative profitable growth, airlines need to more volatility than the more benign approach to trade, investment and the control costs and develop their “adjustment and acceptance” scenario. movement of people. That is not the networks by improving connectivity.
4 | PwC | Connectivity and growth expansion of the industry. These The fundamentals of planning for sustainable environmental challenges arise both growth remain the same, however. For airlines, at the local level – where the main issues are noise, air quality and the watchwords should be profitable growth, surface access – and globally, where the main challenge is the impact of the cost control and connectivity. industry on climate change. It is encouraging that the global aviation Connectivity is at the heart of what In developing and emerging markets, industry has recently agreed an approach makes airlines successful – finding new airport expansion appears easier – to limiting its contribution to climate routes, either directly or via an efficient and is often supported strongly by the change – though much of the detail hub-and-spoke network operation. regulating authorities as a means of remains to be worked out. On the providing strategic support to economic other hand, this is another area where Airports face a different set of growth growth in a region or nation. But that a change of direction following the US issues. Unlike airlines, which can expand carries a different risk – of over-ambitious presidential election could create capacity quite quickly by ordering a few expansion – akin to the problems that disruption and additional uncertainty. more planes and finding new runway the airline industry has experienced slots to operate, airport capacity by over-investing in capacity in the past. The aviation industry worldwide has expansion is more lumpy, requiring Also, alongside airports, airspace been remarkably resilient in the longer lead times, as well as much more capacity needs to be developed. aftermath of the global financial crisis. intensive stakeholder discussion and In Europe and North America, there is The industry coped much better than dialogue. This is most noticeable in the a high degree of capability in airspace after 9/11, which created more financial major Western economies. In the UK, management which can be deployed distress and business failures. But there we have had 15 years of discussion in Asia, the Middle East and Africa as is now growing political uncertainty about new runway options at the major these regions start to experience following the UK’s referendum London airports, and still no firm airspace congestion around major decision to leave the EU and the US decision has been made – let alone any cities and airport hubs. presidential election. concrete or tarmac laid. The UK may be an extreme example, but similar issues The final issue bearing on the aviation The short-term economic outlook is exist in many other advanced economies growth agenda – which affects aircraft/ favourable – but there are growing where there is great sensitivity about engine manufacturers, airlines, airports risks to longer-term economic prospects the local and environmental impacts and airspace managers alike – is the which need to recognised. The current of aviation expansion. environmental challenges facing the economic upswing is becoming more mature. And there is a danger of a lapse into a more protectionist world in which Figure 2: Global growth is a key driver of air travel globalisation moves into reverse. Air traffic (RPKs) and World GDP – % per annum change While that is not the central scenario, a more protectionist and defensive 15% global economic and political climate in the 2020s would not be a good 8% business environment for the aviation 12% industry. The risks of a less positive 6% economic outlook in the next decade 9% therefore need to be taken into account in planning and investment decisions. 4% 6%
2% 3% About the author: Andrew Sentance is a
0% 0% Senior Economic Adviser at PwC UK and is a former Chief Economist at British Airways (1998–2006) and a former member of the -2% -3% Bank of England Monetary Policy Committee (2006–2011). He is based in London.
GDP (LH scale) RPKs (RH scale) E: [email protected] T: +44 (0) 20 7213 2068 Source: IMF and ICAO/IATA
Aviation growth in a changing world | 5 Passenger numbers at Sydney and Melbourne, meanwhile, are Economic growth and air responsive to Australian GDP to a similar extent. traffic: developments in • Brexit: As a consequence of revised economic outlook made by the Office Australia and Britain of Budget Responsibility (OBR) after the referendum last year, our forecast trajectory for UK passenger number Edmond Lee and Shivangi Jain has been adjusted downward accordingly, and the difference between two trajectories would each 4.6 million in 2020.. Global air traffic has grown a We first explain the methodology we substantial 78%1 in the past decade. have used, what it reveals with regards Innovations in the aviation market, such to the GDP-passenger demand The GDP-air passenger as deeper aviation market liberalisation relationship in the UK and Australia, demand relationship: A tale in developed economies and the rising and the latest developments in the of two aviation markets prominence of low-cost carriers in intra- two markets. Then we look into how We start our analysis with a case study regional routes have helped spur this volatility in passenger numbers vary of the link between national income growth. However, propensity to fly has from airport to airport, and potential and air travel in the UK and Australia. also been associated with global reasons behind it. Finally, we apply our We obtained passenger number data economic growth, both in emerging model to forecast passenger demand from the Civil Aviation Authority (CAA) and developed markets. There is little as a result of revised economic outlook of the UK and Bureau of Infrastructure, consensus on the question of causality that follows the Brexit vote in the UK. Transport, and Regional Economics in the relationship between passenger Our key findings are: (BITRE) of Australia, and official GDP numbers and GDP. Some think GDP • On the country level, in both figures from the Office of National drives air passenger demand; others Britain and Australia, the relationship Statistics (ONS of the UK) and the think that better air travel infrastructure remains strong and significant. Reserve Bank of Australia (RBA) leads to GDP growth; whilst still others But while we observed that the respectively. suggest there is a two-way-causality. 2008 Financial Crisis is correlated Mukkala and Tervo (2013)2, Ishutkina to a downward level shift in air and Hansman (2009)3, and Green passenger demand in the UK, (2007)4 all reach different conclusions we did not find a similar association on the issue. However, for the purposes in Australia. of this report, the issue of causality is less important as only the correlation • On the airport level, we find is needed to forecast air traffic demand. that passenger numbers at London Heathrow are least responsive to In this article, we will look into the GDP among the UK’s four busiest relationship between air traffic demand airports. This is followed by and GDP in two countries: Britain and London Gatwick and Manchester. Australia, employing our econometric London Stansted has the most and forecasting techniques as well as volatile passenger level: demand at industry expertise. London Stansted is found to be around four times as responsive to UK’s GDP as demand at Heathrow.
1. Sourced from the World Bank’s World Development Index database. 2. Mukkala, K and Tervo, H. (2013), ‘Air transportation and regional growth: which way does the causality run?’ Environment and Planning A, 45:1508-1520 3. Ishutkina, Marya and Hansman, R. John (2009), ‘Analysis of the interaction between air transportation and economic activity: a worldwide perspective’, MIT International Center for Air Transportation Report No. ICAT-2009-2 4. Green, R. (2007), ‘Airports and economic development’, Real Estate Economics, 35:91-112.
6 | PwC | Connectivity and growth Figure 1: UK air passenger traffic before and after seasonal adjustment,
90
80 Millions 70
60
50
40
30
20
10
0
Before seasonal adjustment After seasonal adjustment
Source: CAA, PwC analysis
Both GDP and air passenger traffic We then examine the relationship are known to be seasonal; for example, between demand for air travel and air traffic is significantly busier in the GDP by applying an Error Correction summer months due to increased Model (ECM) to the adjusted time demand from leisure travellers, whilst series. The ECM approach allows us to construction GDP typically dips in disentangle two distinct relationships winter months. In order to focus on from the data: on one hand, it estimates the long-term relationship between the long-run relationship between GDP and air passenger traffic, we first GDP and air traffic; on the other hand, remove seasonal effects from the air it describes the short-term dynamics passenger series with the X-12-ARIMA such as deviations from the long-term package developed by the US Census trend, and estimates how quickly Bureau. In Figure 1, we present the these deviations would be ‘corrected’ time series of air traffic in UK airports or revert to the mean. The ECM forms before and after seasonal adjustment. the basis of many aviation forecasting model, such as the National Air Passenger Demand Model that has been maintained by the UK Department for Transport (DfT).
Economic growth and air traffic: developments in Australia and Britain | 7 Our ECM model shows a continuing We find that between 2010 and 2016, above-trend growth in passenger relationship between GDP and the actual passenger level through UK numbers at UK airports. Indeed, in passenger demand in both the UK and airports has been persistently below de-seasonalised terms, the number of Australia. In the UK, we also find a the forecasts by around 4–5 million passengers who used UK airports in significant one-off downward level people per quarter based on coefficients Q2 2017 has approached the pre-crisis shift in the wake of the 2008 global estimated only with pre-crisis data. trend line. financial crisis. Figure 2 shows the In contrast, actual passenger levels central case of the forecasts we would broadly follows forecasts made using There are various reasons why a level have obtained if we had applied the coefficients estimated with both pre- shift in the GDP-passenger relationship same methodology at the beginning of and post-crisis data. This suggests that, might have occurred. For example, it is a certain year. For example, to obtain between 2008 and 2010, the relationship plausible that the post-2008 economic the 2007 ‘in sample’ forecast, we applied between GDP growth and demand for recovery has been driven by growth our methodology on data up to the end air passenger traffic in Britain might around London, where air capacity is of 2006 and, using the resulting have experienced a level shift. more constrained. parameters, made projections for As we show in Figure 3, we find that passenger levels based on the level of It is worthy to note that over the last while London accounted for more than GDP that actually materialised. four quarters, we observe a strong two thirds of all passenger growth between the calendar years of 2010 Figure 2: Backtesting the model: do past relationships predict current passenger and 2015, the rest of the UK accounted numbers in the UK? for 55.3% of the growth in the last
) four quarters. This could be driven by 80 a delayed economic recovery outside
illions the capital, combined with inward M 70 tourism growth as the sterling became
60 weaker after the referendum. Given the data available, it is difficult 50 to establish whether this above-trend adjusted (actual and forecast and (actual adjusted growth in passenger demand will be 40 sustained in the medium term. In the
30 interest of prudence, in this publication we continue to use the econometric
20 model with a crisis adjustment, and
derive forecasts based on the assumption per quarter, seasonally seasonally quarter, per 10 that passenger numbers would slowly return to the lower trend that has been
- prevailing over the last decade. Passenger Passenger
Actual Forecast (2007) Forecast (2008) Forecast (2013) Forecast (2014) Forecast (2015) Forecast (2016)
Source: CAA, PwC analysis Note: The thick burgundy line rrepresents the actual quarterly passenger level, seasonally adjusted. The thinner lines represent the central scenario of different forecasts we would have obtained if we had carried out the analysis at the beginning of each year between 2007, 2008 and every year between 2013 and 2016
8 | PwC | Connectivity and growth Figure 3: Drivers of passenger volume growth in the UK 0% 10%20% 30%40% 50%60% 70%80% 90%100%
2010 to 2015 22.4% 21.9% 9.7% 14.7% 13.2% 18.1%
London: 68.6% Rest of UK: 31.4%
YE Jun 2016 to YE Jun 2017 9.1% 17.1% 7.1% 11.5% 14.2% 41.1%
London: 44.7% Rest of UK: 55.3%
Heathrow Gatwick Stansted Other London Airports Manchester Other non-London airports
Source: CAA, PwC analysis
On the contrary, we do not observe a same growth trend without any reflected in the fact that Australia similar structural break in the long- statistically significant break in the never fell into a recession throughout term relationship between GDP and wake of the financial crisis. the period. Australia has also benefited passenger numbers in Australia from a fast recovery in its trading throughout the 2007–2017 period. This highlights some interesting partners, especially China, and the As shown in Figure 3, we find the differences between the UK and fiscal and monetary response of financial crisis to have had relatively Australian aviation markets. Australian institutions. Finally, little effect on the degree of association Australian airports have not faced Firstly, the 2008 financial crisis had a between Australian GDP and the similar restrictions to growth as have smaller impact on the Australian number of passengers going through the UK’s largest airports, and it is economy, which relies less on financial Australian airports. Our Australian plausible that this has allowed the services (which was heavily affected) forecasts lie only slightly below the strong relationship between the two and more on commodities and mining actual passenger numbers between variables to continue. (which were less affected). This is 2008 and 2017, and they share the
Economic growth and air traffic: developments in Australia and Britain | 9 Secondly, to verify our findings, we Figure 4: Using Australian GDP figures to forecast passenger numbers passing also conduct a Supremum Wald test on through Australian airports the UK and Australian data to test whether there had been a structural ) 45 break in the relationship between GDP and passenger numbers. In the UK recast 40 Millions dataset, we find a statistically
and fo 35 significant structural break in 2009, straight after the financial crisis. In 30 contrast, the Wald test does not find (actual 25 any structural break in the Australian
dataset since 2000. The hypothesis adjusted 20 that a structural break exists in 2009 ly 15 is rejected at 5% significance level.
seasonal 10 A closer look: aviation demand at the airport level 5 quarter, -
To understand our findings in more per depth, using data from the CAA and BITRE we also analyse the GDP- Actual Forecast (2007) Forecast (2008) Forecast (2012)
passenger level responsiveness at the Passenger level of individual airports. Figure 5 Forecast (2013) Forecast (2014) Forecast (2015) 5 presents the elasticity of air Source: BITRE, PwC analysis passenger levels in six major airports Note: The thick burgundy line represents the actual quarterly passenger level, seasonally adjusted. The thinner in UK and Australia to a change in lines represent the central scenario of different forecasts we would have obtained if we had carried out the GDP growth at the national level over analysis at the beginning of each year between 2007, 2008 and every year between 2012 and 2016 the long term. For example, an resilient to fluctuations to GDP; our There are two plausible explanations elasticity coefficient of 1.5 for an estimated elasticity for Heathrow of 0.7 for why passenger numbers in Stansted airport can be interpreted as an implies that a 1% change in the UK’s are most responsive to changes in GDP. estimate that on average and in the real GDP is on average only associated long run every percentage point in with a 0.7% change in the number of GDP growth in the host country is passengers travelling through the associated with 1.5 percentage points airport. Conversely, Stansted, the of growth in passenger numbers. third largest London airport, which For the UK, while passenger numbers caters mainly for low-cost flights to at all four airports we studied exhibited Europe, has a significantly higher a positive relationship with GDP, our elasticity coefficient of 2.2. London results suggest large variations in the Gatwick, the second busiest airport in long run elasticity of passenger numbers the UK, and Manchester airport, across the airports. Heathrow, London’s Britain’s busiest airport outside of the principal international airport where London area, have estimated long- most long-haul flights are based, and term air passenger elasticities of 1.2 the UK’s busiest airport in terms of and 1.6 respectively. passenger numbers, has been most
5. In economics, this is defined as the ratio between the percentage change in passenger numbers and the associated percentage change in GDP of the host country
10 | PwC | Connectivity and growth Looking next at the two largest Figure 5: Estimated relationship between growth rates of passenger numbers and GDP airports in Australia, Melbourne and Sydney, our analysis suggests less variation in the elasticity of passenger 3.0 numbers to changes in GDP compared to that observed in the UK. With
2.5 estimated long-run elasticities of 1.7 s and 1.6 in Melbourne and Sydney ent ci
fi respectively, we find that passenger
oef 2.0 demand at Sydney and Melbourne c airports is significantly more responsive to real GDP than Heathrow and elasticity 1.5 Gatwick, and about as responsive as
term passenger numbers in Manchester. These findings might be attributed to Long 1.0 two factors.
Firstly, Sydney and Melbourne 0.5 airports are not close substitutes for each other; they are around nine hours apart in terms of car journey 0.0 times, and their catchment areas London Heathrow London GatwickLondon Stansted Manchester MelbourneSydney rarely overlap. As a consequence, the Source: PwC analysis order-of-preference effect that may Note: We present our point estimate in solid dots, with the 95% margin of error (confidence interval) in a paler have been in play in the London area shade around it. is unlikely to be significant between Sydney and Melbourne, and it is Firstly, Stansted is dominated by that a stronger economy brings, and is therefore not surprising to find that low-cost carriers such as Ryanair and also the most negatively affected by an their elasticities are similar to that of easyJet. These airlines have a higher economic downturn. Manchester Airport in the UK. proportion of leisure passengers, who Secondly, the two Australian airports do are more sensitive to fluctuations in The case of Manchester airport also not face the same capacity constraints the business cycle. helps puts this into context. Manchester is the busiest British that have been rife for London airports, Secondly, the effect of an economic airport outside of the London area, particularly Heathrow and Gatwick: downturn may differ across airports and has a more balanced mix between new flights are more likely to be as the airline industry may choose to long-haul and European flights as well scheduled in response to economic absorb the decrease in demand by as between business and leisure growth in Sydney and Melbourne than cutting capacity in a less preferred customers. While the London airports in Heathrow and Gatwick. This also airport; for example, the full-service are substitutes for each other, supports the finding that GDP has carriers may scale back their Gatwick Manchester is a catch-all airport that been a better predictor of passenger operations, which started as Heathrow serves the North of England with few numbers in Australia than it has been overspill. The available capacity at close alternatives. It is not surprising in the UK, while other factors, such as Gatwick could then be filled by budget that Manchester has an elasticity capacity constraints, are less influential. airlines as they move some operations coefficient that lies between the three from Stansted into the more preferred London airports, despite its passenger Gatwick. As a result, it is perhaps not levels being comparable to that of surprising that Stansted benefits most Stansted in the last decade. from the additional passenger flow
Economic growth and air traffic: developments in Australia and Britain | 11 Brexit in the Air Figure 6: The impact of Brexit on air passenger forecasts Using the long-term and short-term relationships between GDP and 80 ecast ) passenger numbers that we estimated 75 for the UK as a whole, we can estimate Millions how the UK’s vote to leave the European 70 Union may affect passenger demand 65 in the medium term. We have forecast passenger numbers under potential 60 growth scenarios (see Figure 6). 55 As our core scenario, we use the growth 50 assumptions published by the Office for Budget Responsibility (OBR) in 45 March 20176. In addition, before the , seasonally adjusted (actual and for referendum, PwC had worked with the 40 Confederation of British Industry (CBI) 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 to produce an assessment of economic n n n n n n n n n n n n n n n n n n n n n Ja impacts that a vote to leave would entail7 Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja under two scenarios: (i) the UK reaches Actual OBR forecast (Mar 2017) OBR forecast (Mar 2016) PwC/CBI WTO Scenario a trade agreement with the rest of the Passenger per quarter EU similar to that with Canada (the Source: OBR, CAA, PwC analysis ‘FTA scenario’) and (ii) the UK does Note: Our core scenario is based on the OBR’s latest forecast made in March 2017, represented by the brown not reach any trade agreement with line. The yellow dashed line represents the pre-referendum view with the UK’s continued membership in the the rest of the EU, and trade between EU being assumed, while the pink dashed line represents the air passenger forecast under PwC/CBI WTO the two entities revert to World Trade scenario, under which Brexit would take a more disruptive from to current trade patterns. Organisation rules (the ‘WTO scenario based on the OBR’s March The way ahead scenario’). We also derive forecasts for 2017 growth estimates and 6.1% passenger flows through UK airports lower in the WTO scenario. In annual Overall, our analysis provides some under the WTO scenario, which we terms, compared with our median interesting and relevant insights into assume to be the ‘worst case’ scenario. estimate of the counterfactual the relationship between GDP and air ‘Remain’ case, under which there traffic demand. In both the UK and To assess the potential impact of would be 293.3 million passengers in Australia, we find a strong relationship Brexit on passenger demand, we the year 2020, there would be 4.6 between the two variables. Our compare our findings under our core million fewer passengers across UK investigation of the impact external scenario using the OBR’s (March airports in the same year under our shocks on passenger levels found that 2017) assumptions and our WTO core scenario, and 15.7 million fewer the 2008 financial crisis resulted in a scenario with the counterfactual that passengers under the PwC/CBI WTO level shift downwards in air passenger the UK had voted to remain in the UK. scenario. In terms of growth, our demand in the UK, but also observed The counterfactual is based on the analysis suggests that air passenger signs that passenger demand growth OBR’s outlook for the UK economy levels would increase year on year by outside London may be bringing the before the referendum, published in 1.7%–2.6%, instead of 3.0% under British aviation market back to the March 2016, under the assumption pre-Brexit forecasts. pre-crisis trend. On the other hand, that the UK would remain in the EU8. given the relatively more muted It is important to note that there is impact of the crisis on the Australian Our findings show that on a quarterly increasing uncertainty around our economy as a whole, the 2008 crisis and seasonally adjusted basis, by the forecasts as we move deeper into the did not have such marked effect on end of 2020 and compared with the future. To reflect this, we also present passenger volume in Australia. counterfactual that the UK had voted the margins of error around our central to remain in the EU, the level of estimates under the core scenario in passenger demand at UK airports different shades in Figure 7. would be 1.7% lower in the core
6. The OBR’s Economic and Fiscal Outlook (March 2017), sets out its latest estimates for real GDP growth 7. The full PwC/CBI report, Leaving the EU: Implications for the UK economy, can be found at http://pwc.to/1WxjlXc 8. In its Economic and Fiscal Outlook (March 2016), the OBR explicitly set out that it has “made no assessment of the long-term impact of the potential long-term impact of ‘Brexit’ on the economy” (para. 1.27)
12 | PwC | Connectivity and growth Figure 7: Uncertainty around our forecast Geographical features of a country also play a key role in air traffic demand. ) 90 Countries which are isolated, such as Actual Forecasts islands, or where land transport is 80 limited as the infrastructure for Millions transport like high-speed rail could 70 be more challenging or costly to implement, are likely to observe a 60 higher propensity to fly. As a result, 50 passenger levels are likely to be more
adjusted (actual and forecast resilient to fluctuations in GDP. As an 40 island country, the UK’s air traffic demand could therefore be driven by 30 the lack of alternative transport options; for travellers to the European continent, 20 for example, with the exception of the channel tunnel and ferries for Western per quarter, seasonally 10 Europe, there are few comparable
0 alternatives to air travel. A final consideration is that of the hub Passenger 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 status of an airport. Hubs such as
Source: OBR, CAA, PwC analysis Heathrow, Singapore and Dubai offer Note: The central estimate and the fan around it is calculated with OBR’s latest forecasts on GDP growth in the air connectivity far out of proportion near and medium term published in March 2017. to their size, owing to the availability of air services and geographical location. For the UK, Heathrow continues to We have also assessed the responsiveness However, our analysis should not be act as a hub but still faces competition, of passenger numbers at individual considered exhaustive. While we have particularly from the Middle East airports to GDP growth, from which modelled the impact of GDP on air (e.g. Dubai). intuitive results have emerged: traffic demand, there could be other airports that have a relatively higher important factors that also affect air In conclusion, our study of the share of leisure travel and which are traffic and which should be taken into dynamics of aviation growth in the less preferred in the same catchment account. For example, it could be argued UK and Australia demonstrates a area have air traffic demand which is that at least part of the growth in air strong correlation between GDP more responsive to changes in GDP, traffic in the past two decades has been growth and air passenger traffic. compared to large hubs which face driven by the rise of low-cost carriers However, we recognise that air traffic less direct competition. and the decrease in air fares associated is affected by a number of factors with them. Indeed, the DfT observed including demography, competition Finally, we have applied our models ‘there is typically a downwards trend and geography. More research into to assess the impact of Brexit on air in air fares’. Changes in air fares over these factors will provide valuable passenger numbers. Our findings time could significantly impact on insight into the drivers of demand for suggest that, compared to the passenger numbers, and would be a air travel globally. counterfactual that the UK had voted useful extension to our model. to remain in the EU, passenger numbers through UK airports could be between 4.6-15.7 million lower under About the authors: Edmond Lee and Shivangi different growth assumptions. Jain are economists in PwC UK’s Economics team in London, which applies robust and state-of-the-art economic analysis to business and policy questions for both public and private sector clients around the world. Contacts: Edmond Lee: E: [email protected] T: +44 (0) 7802 660 423) and Shivangi Jain: E: [email protected] T: +44 (0) 7802 661 353)
Economic growth and air traffic: developments in Australia and Britain | 13 Air connectivity: Why it matters and how to support growth
Claudia Bottini, PwC UK and Hayley Morphet, PwC Australia
Global air travel has changed By understanding how air connectivity considerably over the past decade. is measured, how it has changed, how Thanks to major improvements in it relates to economic growth, and technology, air travel is more efficient, what drives it, key aviation stakeholders making distances between countries (i.e. States, airports and airlines), can seem shorter than ever. Meanwhile, the make strategic decisions on how to continued growth of low cost carriers enable and unlock the air connectivity (LCCs) and their increased penetration potential of a country. into emerging markets has made air travel more accessible, while the rapid How is air connectivity expansion of Middle East hub carriers measured? has changed intercontinental travel patterns. As a result, air connectivity We can use a variety of measures, at has also changed. various levels of granularity, to measure air connectivity. These measures – But what is air connectivity exactly? The including total passenger movements, International Civil Aviation Organisation air fares, the number of direct (ICAO) defines it as an indicator of a destinations and travel time – can network’s concentration and its ability serve as standalone proxies or may be to move passengers from their origin combined to create a measure to their destination seamlessly1. capturing different features of the air-transport market. (See Figure 1.) Air connectivity is key to unlocking a country’s economic growth potential, Travellers have different priorities, in part because it enables the country depending on the purpose of their to attract business investment and journey. That means we can use human capital. An increase in air different measures to assess air connectivity also spurs tourism, connectivity for each passenger which is vital to many countries’ segment. For instance: economic prosperity.
1. ICAO (2013), Worldwide Air Transport Conference (ATConf/6-WP/20)
14 | PwC | Connectivity and growth Figure 1: Air connectivity measures
Business Leisure
• Direct seat capacity • Passenger movements • Air fares • Availability of direct flights • Average seats per movement • Availability of seats • Direct destinations • Indirect one-stop destinations • Choice of destination • Average daily frequency/route • Country GDP/GDP per capita • Convenience of schedule • Route network concentration • Distance to city centre • Airline concentration • Access to flexible fares • Route stability • Travel time • Access to sales channels
Source: PwC analysis Note: VFR is a subset of leisure travel. However, this segment differs from leisure in that passengers don’t have a choice of destinations and appear to be less sensitive to price. (Price, however, may determine how frequently they travel).
• Business travellers tend to be • Travellers visiting friends How has air connectivity time sensitive and relatively and relatives fly primarily to see changed? indifferent to fare levels. Frequent loved ones. In some markets, this and flexible service that enables category of travel is substantial. Over the past decade, the aviation passengers to quickly change flights Passengers travelling for this purpose industry has experienced the effects of to a more convenient time, coupled tend to consider fares a major factor various shocks (such as terrorist attacks, with easy surface accessibility, in determining how frequently natural disasters and pandemics), matter most to this segment. they travel. However, unlike leisure a weak economy and rising fuel prices. Thus air connectivity for them could passengers, they don’t have the The industry has shown its resilience be measured by frequency of service, option of changing their travel by adapting itself to satisfy the needs convenience of schedule, travel time, destinations if fares are too high. of an ever-evolving market. number of direct routes available The importance of air connectivity has If we consider the number of direct and proximity to the city centre. led to the development of a number of international routes as a proxy to • Leisure travellers care more indices in aviation economics literature measure connectivity at a regional about fares, with cost-effectiveness (See Table 1.) Each measure aims to level, we can see that a significant often the most important factor in capture a range of factors influencing increase was observed in the Middle decisions about whether to travel connectivity. At the same time, aviation East and Asia, with Europe’s routes and where, especially for short stakeholders looking to understand increasing by 107% since 2003 as a breaks. An unacceptably high fare the integration of country (or city) result of the increased penetration of could cause them to change their within the global air network can tailor low-cost carriers and the subsequent mind about their destination. their choice of air connectivity indices increase in point-to-point services. Measurements of air connectivity to suit their needs by identifying the (See Figure 2.) for this segment should therefore criteria most important to the country include fares. (or city) they’re interested in and by developing an integrated index which takes multiple variables into account.
Air connectivity: Why it matters and how to support growth | 15 Table 1: Air connectivity indices in aviation economics literature
Measure Description
York Aviation Business Captures the economic importance of destinations and measures value of Connectivity Index connectivity to businesses
Netscan Connectivity Index Captures seat capacity, accounts for direct and indirect connections and for transfer time as well as potential delay time when connecting
IATA Connectivity Index Captures the importance of destinations based on the size of the final destination airport
World Bank Air Connectivity Weights value of a route based on the number of onward connections available Index reflecting benefits of hubs
World Economic Forum Presents data on scheduled available seat kilometres per week in 2012 for a Connectivity Index sample of 144 countries
Source: York Aviation, Netscan, IATA, World Bank, World Economic Forum
Figure 2: Number of international routes by region: 2003 vs 2016
12000
+107%
10000
8000
of Routes 6000
Number 4000 +76% +183% 58% +61% 58% 2000 58%
0 Africa Asia Pacific Central AmericaEuropeMiddle East North America South America
2003 2016
Source: Milanamos PlanetOptim Future, PwC analysis Note: the chart only looks at international routes excluding domestic in-country traffic
16 | PwC | Connectivity and growth Figure 3: Direct and connecting passenger traffic, 2003 and 2016
Growth in Connecting Pax
Growth in Direct Pax +32%
+130% North America Europe +39% 150 400 ) ) M M 100 ( (
200 x
x +183% a a 50 P P 0 0 2003 2016 2003 2016
Middle East +189%
150
) +353% +130% M 100
( Asia Pacific
x
a 50
P 300 +92% 0 ) +268%
M 200 (
2003 2016 Latin America x a 100
+200% P 100 +143% 0 ) Africa 2003 2016 M ( 50 x a 60 177% P 0 ) M 40 (
2003 2016 x
a 20 P 0 2003 2016
Source: Milanamos PlanetOptim Future, PwC analysis Note:the chart shows the pattern of travel of passengers originating from each region. It excludes domestic traffic. Latin America is defined as South America, Central America and Caribbean
Assessing direct and connecting How are air connectivity and Obviously, it benefits travellers by passengers further highlights the economic growth linked? giving them access to a wider network aggressive expansion of the Middle as well as more frequent and better Eastern hubs, which experienced Aviation generates significant benefits connected services. But it also can larger growth in passenger demand for the global economy. In 2014, strengthen a country’s economy over than any other region around the world. it contributed US$2.7 trillion to the the long haul, boosting productivity (See Figure 3.) At the same time, global GDP (3.5%). Direct benefits through its positive impact on Europe and the Asia-Pacific region (i.e. employment and economic activity businesses. For example: generated by the air transport industry) saw strong growth in the number of • Increased connectivity reduces air are estimated at about US$664.4 billion; direct passengers, driven mainly by travel times, giving businesses indirect benefits (generated by the significant penetration of LCCs in access to a wider marketplace. that market and a subsequent increase employment and economic activity of in the number of point-to-point services. suppliers of the air transport industry) • Increased connectivity makes it Latin America and Africa have also US$761.4 billion2 3. Aviation also plays a easier for managers and executives shown considerable growth, as key role in enabling the economic growth to oversee far-flung operations, opposed to the more mature North of countries which rely on major hubs which infuses efficiency into American market, which has seen a such as Singapore and Dubai. In Dubai, those operations. moderate increase in the number of for instance, aviation generates about • Better transport linkages enable 4 passenger movements. 27% of the city’s GDP . investment and human capital to Therefore, we can see how improved flow more freely across borders, air connectivity plays a large role in improving returns on investment creating such economic value. for some projects.
2. Air Transport Action Group (2016), Aviation Benefits Beyond Borders 3. Note: Other benefits generated by aviation include induced and tourism catalytic benefits, which in 2014 made up for the remaining US$1,247.4 billion 4. Quantifying the Economic Impact of Aviation in Dubai’, Oxford Economics, 2014
Air connectivity: Why it matters and how to support growth | 17 With such insights in mind, PwC conducted an econometric study for the UK Airports Commission. The study used seat capacity as a proxy for air connectivity to estimate the impact of improved connectivity on the UK’s economy. The study revealed that a 10% increase in seat capacity could improve5:
• Short-term GDP by 1%. • Tourism by 4% within the UK and 3% among UK tourists travelling abroad. • Trade by 1.7% in terms of UK product imports and 3.3% in terms of UK product exports. UK service imports and exports would also improve by 6.6% and 2.5% respectively. • FDI by 4.7% in terms of increased UK FDI inflows and by 1.9% in terms of increased UK FDI outflows.
What drives air connectivity? Examples include Singapore; Hong • Asia – Asian hubs such as Kong; Seoul; the Middle Eastern hubs Singapore and Hong Kong have Four main factors enable air of Dubai, Abu Dhabi, and Doha; traditionally enjoyed advantages connectivity: geography, airport as well as the emerging Turkish hub of with respect to traffic routes infrastructure, airline models, and a Istanbul – all of which have exploited between Europe and Australasia, country’s regulatory and economic their favourable position in the global and with respect to other points in frameworks. These enablers all play air-travel network to build strong hubs Asia where traffic to and from an important role in ensuring that a with far-reaching spokes. Europe is less developed (such as country can cement or expand its global Indonesia and Vietnam). air network to enhance air connectivity. If we look at Europe, Asia and the Middle East, we can see how each of • Middle East – Within a four-hour Geography these regions has capitalised on its radius of Middle Eastern locations geographical location by capturing lie the eastern parts of Europe and Air connectivity is especially important intra-and inter-regional flows: Africa as well as the highly populous to countries with isolated air-travel markets of the Indian subcontinent. markets (such as islands and large • Europe – Within a four-hour radius, A range of destinations fall within geographical areas) where passengers the EU’s main hubs can draw mainly the scope of a 12-hour flight from have few viable alternatives to air travel. from European and possibly North Dubai, including China, Southeast However, a country’s geographical African destinations. On longer Asia, Australia, and the vast majority location can enhance its ability to haul routings, the EU is a convenient of the African continent. However, develop a well-connected network. intermediate point for (especially) the majority of the Americas lie East Coast6 North American traffic just outside this radius. to Asia.
5. PwC (2013), Econometric analysis to develop evidence on links between aviation and the economy, prepared for the UK Airports Commission, https://www.gov.uk/ government/publications/airports-commission-interim-report 6. Although West Coast North America is also within the 12-hour radius of Europe, flights can reach much of Asia direct in the westerly direction.
18 | PwC | Connectivity and growth Figure 4: Intercontinental transfer traffic
+2.4%
+0.5% 42m 57m +16%
33m 35m 10m11.7m 68m +4.4%
+6.4% 20m 35m
4m 9m
+5.5% –
6m 12m 3m 3m
2003
2016
Source: Milanamos PlanetOptim Future, PwC analysis Note: The chart only shows interregional transfer passengers; it excludes direct passengers between regions as well as any passengers requiring more than one connection and passengers travelling within the region. Turkey has been classified as Middle East. Latin America is defined as South America, Central America and Caribbean
Middle Eastern countries have Airport infrastructure Analysis of what’s happening in excelled at marrying a strong national emerging countries can shed light on Airports provide the connectivity and carrier with a route network that the importance of airport access required for a modern economy, supports it by leveraging the advantage infrastructure for improving air enabling businesses to capture overseas that comes from being located at the connectivity to foster economic opportunities and facilitating the mid-point of major traffic flows. growth. For instance, some countries coming and going of tourists – all of Inter-regional transfer traffic at such as Indonesia, India, and Brazil which fuel economic growth. Middle Eastern hubs has in fact grown have registered brisk growth in recent 16% per year since 2003 – the largest Transport infrastructure acts as a years, driven by increases in population such growth in the world. (See Figure 4.) facilitator of growth unlocking latent and economic wealth. But inadequacies The strategy adopted by Middle Eastern demand. Moreover, enhancement of in their current airport infrastructure countries has catalysed development of transport infrastructure, combined are preventing them from fully hub services, which provide passengers with development of an extensive capitalising on their growth. Such with benefits such as more convenient network, can decrease general travel infrastructure lacks the required travel itineraries, more frequent flights, costs for passengers and goods – thanks capacity, but boosting that capacity will and a wider range of destinations to lower fares, shorter travel times, and require considerable capital expenditure. available within specific flight times. more seamless connections.
Air connectivity: Why it matters and how to support growth | 19 Airline business models of low fares has opened the market to With the most recent global financial a wider group of consumers and has crisis, many business travellers have Airlines’ business models can directly enhanced connectivity by establishing gravitated toward LCCs for short-haul affect air connectivity. Indeed, over services to and from secondary airports. travel. To capture this new market, some the past decade, carriers have adopted airlines are transitioning to a hybrid new models to survive in the face of Network carriers mainly operate radial model, providing reasonable fares often unfavourable market conditions. networks centred on their main base combined with the flexible and frequent Such models fall into three broad or hubs. Their networks provide a wide service business travellers want. categories: low-cost carrier, network range of destinations and frequent and carrier, and hybrid. (See Figure 5.) flexible services that meet the needs of Countries that can rely on strong both business and leisure travellers. network carriers that use their hubs In the past, LCCs have targeted A hub-and-spoke model consolidates efficiently are more likely to achieve mainly the leisure passenger segment. traffic through a hub and allows for greater air connectivity than countries The low-cost model has traditionally lower-density routes to become viable served only by LCCs. However, this provided a ‘no-frills’ service that can that may not have been viable as a point- likelihood also depends on what type create demand by offering very low to-point service. This helps to provide of air connectivity is central to a fares and by serving destinations that a country (or city) with important links nation’s economy; specifically, what were previously not served or only and increased frequency of services to their leisure-and business-travel connected via a hub. The availability the global air travel network. markets want.
Figure 5: Three airline business models
Structure of Point to point Hub and spoke network (secondary airports) network
Short- to Domestic, Geographical short-to long- network coverage medium-haul intl haul intl
Homogenous Fleet Multi-fleet fleet
Lower Schedules High frequency frequency
Cabin class 1 passenger 2-4 passenger class classes
Fares One-way tari Multiple
Alliances and Alliance/loyalty No alliances loyalty programmes programmes LCC
Agents/GDS, Hybrid Sales and Online sales distribution online sales Network carrier
Source: PwC analysis
20 | PwC | Connectivity and growth Regulatory and economic especially if they’re not attractive to On the other hand, mature economies framework tourists or they don’t have the population would need to ensure that air density needed to build a competitive connectivity is sustained by: Public policy and regulation can air-transport network. powerfully facilitate air connectivity, or • Maintaining the current aviation hinder it, by constraining development Size and geographic location may infrastructure (such as airports) and of a country’s air-transport network. also influence a government’s attitude ensuring any need for additional Since the 1940s, international air toward liberalisation of airline ownership aviation capacity is promptly services have been governed by a provisions. Unfortunately, ownership addressed to avoid loss of air complex web of bilateral air services decisions can’t be made unilaterally. connectivity to other competing agreements (ASAs) between States. Countries need agreement from ALL neighbouring countries. Such agreements determine the number the bilateral partners who are most • Ensuring that airlines continue to of airlines that may compete in any significant to their markets – or they find new routes to enhance their given market, the routes that airlines risk having airlines with foreign network connectivity, which is vital may operate, capacity (in terms of ownership rejected. This is a problem to the success of an airline. These frequency and often the number of of growing significance for governments opportunities may be found in seats offered) that airlines may provide, seeking fresh capital investment in emerging markets. and airfares. In recent years, some their airlines. As former flag carriers States have moved to liberalise ASAs; experience distress, the need to • Ensuring that regulatory and for example, through so-called ‘open maintain air connectivity will raise economic frameworks enable skies’ agreements. Yet despite these new questions about the role of public – continued growth. open-access models, restrictions remain. and private-sector investment in The importance of air connectivity Notably, when it comes to ownership the industry. and control of airlines, most ASAs to a country’s economic prosperity allow governments to reject the calls for stakeholders to work together designation of any airline that is not How can stakeholders and take the right steps to improve or owned and controlled by the designating facilitate connectivity maintain the global position of a country party. For the foreseeable future, growth? (or city) within the global air network. the prospect of ‘normalisation’ of air With the exception of external factors transport, particularly with respect to such as geography that are beyond consolidation or cross-border mergers one’s control, stakeholders have the of airlines, remains limited. ability to influence many of the factors Governments trying to decide the that enable achievement of greater air degree to which they want to liberalise connectivity. For instance, emerging their ASAs would generally take a countries can achieve greater air number of factors into account. connectivity by: For example, a country’s geographic • Focusing on the development of features influences the extent to which aviation infrastructure (such as liberalisation will boost air travel and airports) – attracting new investors connectivity. Geography also dictates and ensuring that enough capacity the features of a country’s air-travel is created to accommodate demand. market; in particular, whether it is mainly a domestic market, an international • Ensuring that airlines continue to market, or a transit point for global establish and build up their networks About the authors: Hayley Morphet and traffic flows. The attractiveness of the to support the linkages a country has with the rest of the world. Claudia Bottini are air traffic demand country to tourists and businesses also modelling professionals based in PwC matters, with population affecting the • Developing regulatory and economic Australia and UK, respectively. size of the potential market. For instance, frameworks which reflect the E: [email protected] geographically isolated countries may characteristics and needs of the T: +61 (0) 7 3257 5314 and, be more likely to see liberalisation as country, whilst at the same time E: [email protected] being in their economic interest, fostering air transport growth. T: +44 (0) 20 7213 5292).
Air connectivity: Why it matters and how to support growth | 21 Aeronautical charges and air traffic demand risk: what is within our control?
Claudia Bottini, PwC UK and Hayley Morphet, PwC Australia
Airports are an extremely high profile The global trend towards airport part of a country’s critical national privatisation and increased private- infrastructure and bring a complex sector participation continues as network of stakeholders, including governments look to transfer potential owners, operators, governments, capital costs to the private sector and regulators, airlines and local seek greater commerciality in airport community. Airports also provide a operations. Private financial investors wide range of transport and business look at airport infrastructure as a services, with extensive supply chains generator of stable, long-term cash intertwined with national and flows as well as an opportunity to regional economies. Governments participate in commercial and place focus on airport infrastructure property developments. This has led to as a facilitator for connectivity and a transformation of how airports economic growth – making it manage risk and optimise profits. important to understand the impact an airport has on regional and local Air passenger growth is the key driver economies and communities. of airport value and is subject to a range of demand and supply side Airports face increasing service factors and risks. (See Figure 1.) expectations (from both passengers and airlines); regulator-imposed constraints on aeronautical charges; and the need to fulfil a national, regional, or municipal development role to drive efficiency, service quality improvement, and passenger growth.
22 | PwC | Connectivity and growth Airlines and airports have very little In our paper ‘ Economic growth and control over many of the drivers air traffic: developments in Australia impacting their market – including and Britain’ (see page 6), we address fluctuating fuel prices, economic the key risk to demand – economic conditions that affect consumer and growth. In this paper, we explore the corporate appetite for travel, geopolitical question of whether aeronautical incidents and inconsistent regulatory charges set by airports and regulators costs and policies. How does the industry influence network decisions by better understand how to respond to airlines and therefore expose the these market conditions, what is within airport to demand risk. their control, and how do they account for risk?
Figure 1: Drivers of air traffic demand
Demand Passenger Airline Supply Drivers Drivers
•Fares •Economic growth •Market size
•Exchange rates •Geopolitical events •Yield (fare revenue and operating costs) •Attractiveness of •Regulation destination •Constraints
Source: PwC analysis
Aeronautical charges and air traffic demand risk: what is within our control? | 23 Impact of charges on passenger demand The Netherlands Air Passenger Economic regulation of Tax was introduced in July 2008 Manchester and Stansted Aeronautical charges are set by airports and imposed on departing passengers airports was removed in 2009 and and regulators (where applicable). (transfer passengers and freight 2014 respectively and Gatwick Changes in the level of charges are were exempt). The tax was levied airport regulation was transformed5 typically linked to regulation, market at the rate of €11.25 for short haul in 2014. It is worth noting that at power, expansion, cost of capital and traffic and €45 for all other traffic3. various points in their history, investment. There is empirical evidence From the point of view of the airline, Manchester and Stansted airports that the impact on demand of changes a tax can be seen as largely equivalent were unable to price up to their in passenger charges (either airport to an increase in aeronautical charges. regulated cap6. This suggests that charges or passenger taxes) can be Although the impact was disguised aeronautical charges can be an significant. Case studies have been by the downturn in the economy, important factor for airlines when considered in order to understand there was a substantial reduction considering where to fly. how demand may respond to changes in terminating (origin-destination) in passenger charges. It should be passengers around the same time noted that it is challenging to isolate (i.e. by 8%–10% more than the the impact from other factors. downturn in transfer passengers)4. After 12 months the tax was withdrawn, suggesting that the Stansted Airport increased its Dutch government considered that charges per passenger by 74% between 2006–2007 and 2007–2008 the demand reduction was caused, following the regulatory review. at least in part, by the tax; demand Between 2006–2007 and 2013–2014, appears to have recovered since. Stansted’s share of the London air (See Figure 2.) passenger market declined from 17.4% to 12.9%. Ryanair, Stansted’s key customer, reduced seat capacity from Stansted by 9% while Figure 2: Quarterly change in passengers at Amsterdam Schiphol Airport and Netherlands Real simultaneously doubling its total GDP Growth (compared with same quarter previous year) network capacity1. In the press, 15% Recovery coincided with an Ryanair has often cited increases in upturn in the economy and the aeronautical charges as the reason abolition of the tax 10% Less impact on for these reductions2. In 2013, transfer passengers Tax period Ryanair and Stansted signed a 10-year agreement to lower airport 5% charges and raise airline growth 0% targets. This resulted in a return to 2007 2007 2007 2007 2008 2008 2008 2008 2009 2009 2009 2009 2010 2010 2010 2010 growth of Ryanair services between Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2013–2014 and 2015–2016 of 26% -5% in terms of seat capacity. -10%
Introduction of tax – OD passengers -15% down significantly on previous year, also coinciding with the economic downturn
-20% NL GDP OD Transfer
Source: Schiphol Group, OECD
1. Source for Stansted Airport case study: ‘13. Cost and Commercial Viability: Funding and Financing’, PwC for Airports Commission, 2014 (https://www.gov.uk/ government/uploads/system/uploads/attachment_data/file/372807/funding-and-financing.pdf) 2. See for example: Josie Ensor (2 March 2013), ‘Ryanair to cut down flights from Stansted over landing fee row’, The Telegraph, http://www.telegraph.co.uk/finance/ newsbysector/transport/9904233/Ryanair-to-cut-down-flights-from-Stansted-over-landing-fee-row.html, accessed 11 November, 2016. 3. Source: IATA Airport Charges Monitor 4. Source: ‘13. Cost and Commercial Viability: Funding and Financing’, PwC for Airports Commission, 2014 (https://www.gov.uk/government/uploads/system/uploads/ attachment_data/file/372807/funding-and-financing.pdf) 5. Using a ‘Contracts and commitments framework’ where agreements are made between the airport and the airlines (where service level standards [‘commitments’] are monitored), rather than a price cap set by the regulator. 6. See for example: UK Department for Transport (2008), Decision on the Regulatory Status of Stansted Airport, pp. 11-12, http://webarchive.nationalarchives. gov.uk/20081231144027/http:/www.dft.gov.uk/consultations/archive/2007/consulstatusstansted/decisionstanstedairport.pdf, and UK Department for Transport (2007), Decision on the Regulatory Status of Manchester Airport, p. 6, http://webarchive.nationalarchives.gov.uk/http:/www.dft.gov.uk/consultations/archive/2007/ consulstatusmanchester/decisionmanchesterairport.pdf.
24 | PwC | Connectivity and growth Relative importance of We considered the relative importance In 2012, charges at AENA’s airports airport charges of airport charges compared with in Spain were increased, with the average per passenger revenues key airports of Madrid seeing an The position on demand risk is finely received by airlines for a selection of increase of 60% and Barcelona of balanced and varies from airport to 14 airports and airport groups with 50%7. While Barcelona’s traffic airport depending on their market greater than 10 million passengers per proved to be relatively resilient position, network and airline annum. Based on ticketing data from (largely as a result of the growth of customer base. Milanamos PlanetOptim Future, the Barcelona based carrier Vueling), current estimated average one-way How important the level of airport demand at Madrid declined fare (excluding taxes) for passengers charges are depends on the operating significantly over the years following at these airports ranged from US$112 model for the airport, the nature of the the increase (likely due, in part, to to $US526. Aeronautical charges range destination, and price sensitivity of restructuring activity at Iberia). from US$7.90 to US$33.90 per passenger airlines operating at the airport. For This suggests that demand responses for the airports included in the analysis. example, airport charges at an airport to aeronautical charge changes This implies the overall significance of with majority short-haul, LCC traffic is may be different across different aeronautical charges is 2.5%–12.5% likely to make up a comparatively airports, but also highlights the of average air fares. (See Figure 3.) higher proportion of fare revenue for difficulty in assessing precisely the flight – which means a shift in what is caused by the impact of Where airports have some freedom to airport charges is likely to be more changes in aero charges rather set charges, this needs to be considered significant. Also, airports where there’s than other factors (e.g. airlines at in the context of its customers and the a potential substitution for a different Barcelona may have absorbed the market in which the airport operates. destination (e.g. leisure) also may face increases, while at Madrid, these The challenge for airports is how to higher price sensitivity for its airlines. may have been passed through to optimise charges without negatively the passenger). impacting on revenues. For example, can an airport differentiate their charging or offer incentives to target specific types of traffic (such as those Figure 3: Aeronautical charge as share of average one-way fare (2015) that are more/less price sensitive)?
14.0% Capacity constraints 12.0% There is a question of whether airports
10.0% that are constrained have more market power and hence can charge a higher 8.0% rate for use of the airport. One argument is that the airport with higher utilisation 6.0% is more efficient and can better cover its investment and operating costs. 4.0% However, in some cases, higher utilisation drives complexity and 2.0%
Aeronautical charge as % of average fare increases required investment; 0.0% therefore, charges are increased in - 20 40 60 80 100 120 140 order to cover current (or future) Millions capacity costs. Airport (group) total passengers We looked at runway utilisation Source: Milanamos PlanetOptim Future, Centre for Aviation and level of charges for a selection Notes: Average fare is based on one-way segment revenue and passengers for point-to-point passengers of European airports over time. originating at each airport. The analysis indicates that congestion is associated with higher aeronautical charges. (See Figure 4).
7. Source: Centre for Aviation (CAPA), 2013
Aeronautical charges and air traffic demand risk: what is within our control? | 25 Figure 4: Runway utilisation (%) vs aeronautical charge per passenger Conclusions
120% There is clear evidence that changes in aeronautical charges impact on airline
100% network decisions; however, the level of impact varies from airport to airport depending on a range of factors such 80% as market power, regulation, route network and airline customer base. 60% We found that capacity constraints are associated with higher aeronautical 40% Runway utilisation charges and higher air fares – impacting The correlation coefficient on consumer benefits and demand. between airport charge 20% andutilisation is 0.36 This usually results in the economic regulation of capacity constrained
0% airports. 0510 15 20 25 Aeronautical charge per passenger (USD) The structure of aeronautical charges need to be aligned with an airport’s Source: PwC analysis of airport annual reports and various sources for runway utilisation estimates strategy and what they are trying to Note: A correlation coefficient of 0.36 indicates a clear trend/relationship originating at each airport. achieve in terms of services offered. Capacity constraints may also affect Given the many airport and airline Setting the level of charges requires a the fares that passengers pay for travel specific factors that affect fares, we delicate balance to optimise revenues. as constraints may put a limit on conducted an analysis on behalf of the If you reduce your charges too much, supply, which theoretically would UK Airports Commission8 in 2013, are you throwing away revenue? And increase prices. Where the supply of which attempted to isolate the effect if you increase them too much, are you available seats is limited – be that of capacity constraints on fares. throwing away growth? Identifying through constraints on airline capacity We have updated this analysis to cover this ‘sweet spot’ is challenging. or limitations on airport or airspace the period from 2004–2015. This study For example, the value in lowering infrastructure – it is expected that the used ticketing data from Milanamos charges may be disproportionate to the price paid, either by the passenger PlanetOptim Future for a selection of benefits in terms of overall financial through air fares or the airline through European airports9 (both constrained10 performance. It needs to be considered airport charges, may be higher. and unconstrained) and a variety of that throughput drives non-aeronautical analytical techniques to examine revenues; therefore, even if there is a the relationship. (See Case Study on net negative impact on aeronautical page 27.) revenues as a result of reducing aeronautical charges and increasing demand, this may be offset by positive impact on non-aeronautical activities.
About the authors: Hayley Morphet and Claudia Bottini are air traffic demand modelling professionals based in PwC Australia and UK, respectively. E: [email protected] T: +61 (0) 7 3257 5314 and, E: [email protected] T: +44 (0) 20 7213 5292).
8. https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/372332/economic-analysis-consultants-reports.zip. (‘PwC Fare Differentials’) 9. All airports with scheduled passenger services in France, Spain, Italy, Germany, Netherlands and the UK were included in the analysis. 10. Constrained airports were defined as those operating at above 95% of their stated capacity in terms of air transport movements in any given year.
26 | PwC | Connectivity and growth Case Study – The impact of capacity constraints on air fares
Hypothesis Variables Scheduled airline data – seat capacity, frequency and seat miles Capacity constraints may affect the fares that passengers pay for travel. by route, airline and year Where the supply of available seats is limited, be that through constraints on airline capacity or limitations on airport or airspace Airline ticketing data – point-to-point passengers and average infrastructure, it is expected that the price paid, either by the air fare by route, airline, class of travel and year passenger through air fares or the airline through airport charges, Air passenger taxes – air passenger taxes by country have also may be higher. been considered in the analysis Aeronautical charges – aeronautical charges have also been Given the many airport and airline specific factors which affect fares, sourced based on the average aeronautical revenue of the origin and we conducted an analysis to attempt to isolate the effect of capacity destination airport constraints on fares at European Airports (UK, Germany, France, Spain, Italy and the Netherlands) for the period of 2004 to 2015. Other derived key indicators – competing airlines on route; revenue per air passenger mile with and without taxes and charges for all classes, as well as for premium and economy classes; origin Ho: Capacity constraints lead to higher fares and destination airport size; seats per movement Economic indicators – origin and destination country GDP per capita, crude oil prices Data sources: Airline ticketing and schedule data: Milanamos Planet Optim Future Air passenger taxes – IATA charges monitor Aero-charges and economic data – various
Approach Trend analysis
As part of our approach to understand the impact of capacity As a first step we analysed trends to identify key drivers in air fares constraints on air fares, we conducted two types of analyses: (e.g. route distance, competition, frequency, etc.) and the impact of airport capacity constraints. The trend analysis, however, did not • Trend analysis provide any clear indication of the impact of constraints on air fares.
• Detailed econometric analysis based on a panel data approach. Capacity utilisation data for a sample of airports This type of approach was selected given the nature of the data in Europe and its availability, e.g. limited time series, non-continuous data, wide variety of variables and use of dummy variables in the dataset. We conducted various tests to determine the best approach between Random Effect and Fixed Effect models. The Fixed Effect model was deemed as the most appropriate.
Econometric analysis Results
Model: log-log model, capacity constraint dummy for all routes We found evidence of higher fares being associated with airports (excluding LCCs) with capacity constraints. Across all airports and routes included in the study, fare revenue per passenger mile was found to be circa 22% Dependent variable: Fare revenue per passenger mile, including higher for constrained airports relative to unconstrained airports. tax (total, economy, premium) The higher fare revenue per passenger mile observed at constrained Independent variables: capacity constraint dummy, frequency, airports might be the result of various factors, including the number of airlines, seats per movements, route distance, segment attractiveness of the destination served as well as the necessity by passengers, GDP per capita for the origin country, GDP per capita the airlines to cover higher airport charges and other operating costs. for the destination country
Coefficient for capacity constraint
Output Total 0.228*** Short haul 0.162*** Long haul 0.154***
Significant at *** for 1%
Aeronautical charges and air traffic demand risk: what is within our control? | 27| Are European airport valuations taking off? The impact of the EU referendum vote on airport valuation
Romil Radia, PwC Middle East Thomas Romberg, Constantinos Orphanides, PwC UK
2017 has been another active year for Figure 1: World GDP and traffic growth deals in the European airports market. Transactions have included Macquarie European Infrastructure Fund III 2017-2036 CAGR% (“MEIF3”) selling its stake in Copenhagen airport1 for a reported multiple of 20 times EBITDA2 , Balfour Beatty, the UK infrastructure and construction group, selling its majority stake in Blackpool airport to Blackpool 2.8% 1.7x 4.7% Council for £4.25m3 and HNA Group, the Chinese conglomerate and owner of Hainan Airlines Co acquiring an 82.5% stake in Frankfurt-Hahn Airport from the state of Rhineland-Palatinate. In October of this year we also saw AMP Capital purchase Leeds Bradford Airport from private equity firm Bridgepoint World GDPTraffic growth capital for an undisclosed amount4. Source: Boeing Current Market Outlook 2017 to 2036, PwC analysis This followed some large transactions in 2016 which saw Global Infrastructure consortia have been accepting lower A uniquely attractive Partners sell London City Airport for acquisition IRRs to secure the deal. asset class close to £2bn (c.US$2.8bn) and the With lower investor return expectations French government partly privatising becoming the norm it looks like Airports are a uniquely appealing class Nice and Lyon airports. transaction multiples at these levels of asset. That’s because airports may well be here to stay, for good typically offer fairly stable cash flows In fact based on transactions we’ve quality airport assets. with the potential to realise significant seen between 2015 and 2017, airport capital appreciation on disposal. transaction multiples are averaging At the same time, partial or full Moreover, traffic growth – the key value back at close to 20 times – levels last privatisations of other European driver for airports – has historically seen pre-global financial crisis. The government owned airports are demonstrated a high level of resilience, combination of the current low yield expected to gain momentum in 2017 generally recovering from political environment, the attractive asset class in countries such as France, Greece and financial crises in a fairly short fundamentals and the relative scarcity and Bulgaria. period of time. Indeed having at times of good quality airport investment enjoyed traffic growth rates in excess opportunities coming to market have Given current and imminent airport of 2x GDP, listed European airports made recent airport deals highly deals, it’s not surprising that airport have outperformed the Eurofirst 300 competitive and as a result winning valuations are a very current topic. index over the last eight years (Figure 2)
1. Source: www.cph.dk/en/about-cph/investor/Announcements/2017/9/atp-og-otpp-enters-into-agreement-on-acquisition-of-controlling-influence-in-kobenhavns- lufthavne-as/ 2. Source: Inframation News 3. Source: The Financial Times (www.ft.com/content/2e75883b-ec26-3588-b294-57bcc58e1dd2) 4. Source: The Financial Times (www.ft.com/content/a172dbf4-81f7-3156-bade-91adad34eafb)
28 | PwC | Connectivity and growth highlighting the attractiveness of the asset class. Looking forward, this traffic growth trend is set to continue with Given current and imminent airport deals, the long-term outlook for air traffic it’s not surprising that airport valuations volumes forecast to outpace world GDP growth by a factor of 1.7x. are a very current topic.
The strong traffic growth fundamentals and airport operating companies to airports, such as infrastructure or and resilience are supported by the private equity, infrastructure, pension pension funds, are interested in the high operating margins many airports and sovereign wealth funds. Each type stable cash flows mature operating enjoy. This is thanks to a combination of investor brings a specific set of core airports offer and often invest with of high barriers to entry, limited competencies and competitive their eye on the long term. Many focus competition and economies of scale. advantages to a deal, and is best on enhancing value by implementing For mature and operational airport positioned to invest in different stages optimal financing structures. assets, these factors result in a high of an airport’s lifecycle. level of cash conversion and potential We are observing deal consortia for the airports to deliver stable cash For example, trade buyers (such as comprising of an increasingly broad yields (see Figure 3). Even when air other airport operators) have strong airport investor base with the aim of traffic falls during economic slowdowns, experience in managing operating risk boosting value through operational airports are often able to continue and implementing operational best and financial structuring improvements. delivering dividends to shareholders practice. They are often best positioned Equally, we are seeing the European through the deferral of operating costs to manage airports and improve airport deal space being targeted by and rescheduling or reduction of operational efficiencies – by increasing an increasingly international investor capital expenditure. commercial yields and expanding the base, with active investors from airport’s route network, for example. Europe, North America, Asia and the Today’s airport investors Middle East in recent European Construction companies have core The appeal of the asset class has airport transactions. competencies in managing construction attracted a broad base of global risks and delivering large complex airport investors. In today’s world of developments on time and within low-yields, we are seeing an increasingly budget, giving them a competitive diverse range of investors interested in advantage in airport deals involving the European airport deal space. These large capital outlays and greenfield range from construction, engineering opportunities. Financial investors in
Figure 2: Listed European airport share price performance, 2009–2017
500 450 400 350 300 x 250 Inde 200 150
100
50
- -0 9 -1 0 -1 1 -1 2 -1 3 -1 4 -1 5 -1 6 -1 7 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15 Jul-16 Jul-17 Apr Apr Apr Apr Apr Apr Apr Apr Apr Oct-09 Jan-10 Oct-10 Jan-11 Oct-11 Jan-12 Oct-12 Jan-13 Oct-13 Jan-14 Oct-14 Jan-15 Oct-15 Jan-16 Oct-16 Oct-17 Jan-09 Jan-17
Flughafen Zuerich AG (SWX:FHZN) Aéroports de Paris Société Anonyme (ENXTPA:ADP) Flughafen Wien AG (WBAG:FLU) Fraport AG (XTRA:FRA) FTSEurofirst 300 Index - Index Value Listed European airport average
Source: Capital IQ, PwC Analysis
Are European airport valuations taking off? | 29 The appeal of the asset class has attracted a broad base of global airport investors. Each type of investor brings a specific set of core competencies and competitive advantages to a deal, and is best positioned to invest in different stages of an airport’s lifecycle.
Figure 3: Airport asset class characteristics
Long-term Dominant Diverse High Visible and Cash yield traffic competitive revenue operating stable cash and capital growth postion streams margins flows appreciation
• Global passenger • Often airports • Revenues are • Airports typically • Mature airports • As the asset growth averaged demonstrate derived from enjoy strong tend to have a high matures the 4.4% over the last monopolistic aeronautical and operating margins level of cash flow predictable and 15 years, exceeding characteristics and commercial sources that can exceed visibility stable cash GDP growth high barriers to entry 50% generative ability of by c.1.8x mean airports can • Aeronautical • The relatively stable airports is likely to enjoy market power revenue can be • With a relatively level of cash flow mean that the • Traffic has been over extended improved through high fixed cost lends itself to higher assets can return resilient to external periods of time route network base, airports tend leverage and can consistent cash economic shocks development to enjoy increasing service greater yields to investors reverting to positive • Where airports enjoy while commercial asset usage which levels of debt growth within a near monopolistic revenues can be drives the strength • As passenger 12 months of a market position, increased through of airport margins • Capital expenditures volumes and shock event tariffs may be optimising retail can be delayed airport earnings regulated such that space and the based on capacity grow, airport it is allowed to enjoy airport layout utilisation allowing investors typically a “fair” economic shareholders to see strong capital return smooth out appreciation distributions on exit
Source: PwC analysis
30 | PwC | Connectivity and growth Figure 4: Short-term airport pipeline opportunities
Belgium Denmark Brownfield opportunity: Brownfield opportunity: Brussels airport Copenhagen airport Lithuania United Kingdom Brownfield opportunity: Brownfield opportunities: Privatisation of Vilnius, Potential infrastructure fund divestments in Kaunas and Palang airports. Belfast City airport, Gatwick airport and possibly Heathrow airport Canada Brownfield Opportunities Toronto Pearson Bulgaria Serbia Brownfield opportunity: Brownfield opportunity: Sofia International airport concession Nicola Tesla airport (Belgrade) Saudi Arabia Brownfield opportunity: Riyadh airport minority stake sale United States (Puerto Rico) Brownfield opportunity: Luis Munoz Marin airport Japan Greece Brownfield opportunities: Brownfield opportunities: Six international airport Privatisation programme which includes Athens concessions (Fukuoka, airport and a number of regional airports Hiroshima, Hokkaido New India Chitose, Kobe, Mount Fuji Shizuoka and Takamatsu). Greenfield opportunities: Two airport concessions for Bhogapuram International airport and Navi Mumbai airport.
Sri Lanka Brownfield opportunity: Brazil Mattala Rajapaksa International Greenfield opportunities: airport concession. Philippines Four international airport concessionsin Greenfield opportunities: Florianopolis, Fortalenza, Five airport privatisations (Iloilo, Porto Alegre and Salvador. Bacolod, Laguindingan, Bohol and Davao airports) and expansion of Manilla’s Ninoy Aquino International airport.
Source: InfraNews, publicly available information, PwC analysis.
Airport assets that are expected to come to market over the next 12 to 18 months generally fall into two categories: government-led privatisation initiatives or infrastructure funds looking to monetise their airport investments as funds reach the end of their life. Deal pipeline Looking at the pipeline of airport investments that, based on publicly Financial investors – specifically, available information, are expected to pension and sovereign wealth funds – come to market in the short term tend to hold operationally mature (Figure 4) we observe that there are a airport investments for a longer term, number of short term opportunities in reaping benefits from the relatively European OECD countries – though steady cash yield. This means that the timing that these will come to airports held by these investors rarely market remains uncertain. come to market but when they do they are highly sought after.
Are European airport valuations taking off? | 31 Based on our assessment of the airport deal space, we expect airports that have higher traffic growth expectations or strong competitive positioning to continue to transact within a multiple range of 15 to 20 times, and larger, more mature airports to transact within a multiple range of 11 to 14 times.
Are European airport Figure 5: UK airport traffic and European transactions valuations taking off again? 350 35.0 x 30.0 x 300 Figure 5 shows actual UK passenger 2006 -2008 2015 -2017 Avg. 22.4x Avg. 21.72x 25.0 x traffic alongside EV/EBITDA multiples 250 2003 -2005 2009 -2012 20.0 x 2000 -2002 Avg. 17.1x Avg. 14.6x multiple
Avg. 15.0x A between 2000 and 2017 for European (million) 15.0 x 200 2013 -2014 Pax airports. Whilst there are challenges Avg. 14.6x in comparing transaction multiples 10.0 x EV/EBITD 150 between airports due to each airport’s 5.0 x specific operations and individual 100 - 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 growth potential, it is fair to say that, UK terminal pax Transactions multiples for European airports on average, airport transaction Average transaction multiple Long term pax trend multiples have been rising since the Source: CAA, PwC analysis global financial crisis and, based on transactions we’ve seen between 2015 and 2017, are back at pre-global Based on our assessment of the airport UK aviation sector: financial crisis levels. deal space, we expect airports that What’s the deal? The combination of the current low- have higher traffic growth expectations The EU referendum vote and yield, low-interest rate environment, or strong competitive positioning to subsequent triggering of Article 50 attractive asset class fundamentals, continue to transact within a multiple has undoubtedly raised concerns a broad international airport investor range of 15 to 20 times, and larger, around the attractiveness of UK base, and relative scarcity of good more mature airports to transact airports; specifically, the impact on airport investment opportunities within a multiple range of 11 to 14 the airports’ growth prospects and coming to market have made recent times. However, there is nothing that risk, and, by extension, value. airport deals highly competitive. precludes seeing higher multiples if there are asset specific reasons to As a result, we have seen airport deals Short-term traffic in the UK post justify it. transacting at increased multiples, referendum vote has remained very with the last three-year average While airport transactions clearly resilient, with UK traffic increasing by multiple rising to around 21 times. provide useful valuation benchmarks, more than 4% over the last year. This has also meant that, over time, it is imperative to undertake a However, certain carriers have winning consortia have had to accept comprehensive assessment of the signalled that they may slow down a lower acquisition IRRs to secure the comparability of transactions and expansion in the UK, and there are deal, with some of the most recent make appropriate adjustments if it emerging signs that some UK airlines deals reportedly completing for high- becomes apparent that they are are facing yield pressures. Indeed single digit returns. Of course the incorporating different ownership Monarch Airlines, the UK’s fifth reported returns for these deals must structures, levels of control, growth largest carrier, filed for insolvency in be assessed in the context of the bid expectations, capex requirements or October this year, reportedly due to case long term cash flows and the level profitability levels. A comprehensive intense competition in the European of risk assumed in these. assessment of comparable transaction short-haul market and a weaker pound multiples is therefore required if these following the EU referendum vote are being used as valuation benchmarks. which resulted in its US dollar and Euro expenses being greater in pounds.
32 | PwC | Connectivity and growth The longer-term direction of UK Figure 6: Brexit impact on the aviation sector airport valuations will ultimately depend on the broader implications of the Brexit deal negotiated for the aviation sector, the speed at which it is Visiting Friends Leisure segment and Relatives concluded, and the impact of the Brexit • Degree of border • Net migration formalities deal on UK and European economic Le • Constraints on R is • Attractiveness of UK F u activity. Consequently it may be too movement of labour V r for inbound tourism All Aviation e early to assess any significant longer- • Real wage impact term traffic trends resulting from the (combined w/fx) • Economic activity vote. Meanwhile, European-listed • UK plc reputation • Foreign exchange airports have outperformed the and brand • Access to single aviation market overall market since the referendum • Free aviation/Liberal vote, suggesting no material value traffic rights impact from the Brexit decision. Cargo and Freight • Infrastructure Business segment
• Level of s • Location of corporate C • Fuel price s In the short term, any lower economic international trade a e operations rg n o si activity and post-Brexit uncertainty • Extent of EU trade Bu • Strength of financial may lead to some reduction in UK barriers services passenger and freight traffic. In the • FTAs with non EU • Transaction cost of countries business w/UK event of a slowdown, discretionary outbound leisure demand is likely to be most affected, although higher Source: PwC analysis inbound traffic (from a weakening pound) will also cushion any decline. Equally, the short-term depreciation of the sterling makes UK airport assets The longer-term direction of UK airport more attractive to global airport investors with a longer-term investment horizon; valuations will ultimately depend on sterling depreciation will also stimulate the broader implications of the Brexit regional export-oriented UK economies, resulting in a positive impact on deal negotiated for the aviation sector, passenger and cargo traffic. the speed at which it is concluded, and At present there is uncertainty around the form any deal negotiated between the impact of the Brexit deal on UK and the UK and EU for the aviation sector European economic activity. may take; however, some of the factors that will determine the outcome include the extent of access to a single aviation market, the direction of aviation market Indeed, depending on the outcome of destinations, which could strengthen liberalisation and free trade agreements the Brexit deal negotiated for the demand for long-haul travel, favouring signed with non-EU countries (see aviation sector, there may be winner larger UK airports with some hub Figure 6). In the event that airlines and loser airports within the UK. For connectivity. More long-haul flights face increased regulatory costs to example, UK airports with a higher attract higher aeronautical charges access the UK/EU markets or face proportion of outbound traffic and a and increase throughput, particularly higher US$-denominated oil prices, route network with a higher exposure for capacity constrained airports, while these costs could in turn be passed to European destinations will likely be intra-EU Duty Free could be an important on to passengers through higher air impacted to a greater extent. UK route new revenue stream for both airports fares with a consequential impact on networks may shift focus to non-EU and airlines. traffic demand.
Are European airport valuations taking off? | 33 34 | PwC | Connectivity and growth If you’re thinking about investing...
2017 has shown that UK and European airports continue to attract significant interest among airport investors, with strong expected demand for UK and European assets coming to market in the short term. Our key messages around airport valuations in the current environment are the following:
1. Given the attractiveness of the 3. Cyclicality should be built into airport asset class, the broad long-term cash flow projections – international nature of airport when assessing the value of an investors, long-term investment airport, it is essential to recognise horizons of funds and scarcity in the cyclicality of the industry, the opportunity pipeline, we expect consider where we currently sit in European and UK airport multiples the economic cycle and build to be maintained at current levels sensitivities into cash flow in the short term, absent any projections to reflect economic economic slowdown or shock. downturns and other risks. One impact of the Brexit vote has been 2. A broadening base of international to increase uncertainty around airport investors are joining forces to future potential outcomes for the deliver airport value enhancements – UK and European aviation sector, we are observing an increasing making sensitivity testing around trend of construction, engineering possible post Brexit scenarios even and airport operators forming more important. consortia with financial investors with the aim of delivering value 4. Brexit may create winners and enhancement through both losers in the UK airport sector but operational and financial the relative impact will depend on structuring improvements. the Brexit aviation deal negotiated.
About the authors: Romil Radia heads PwC’s Middle East valuations practice and leads airport and airline sector valuations at PwC. He is currently based in Dubai. Thomas Romberg leads the PwC UK infrastructure valuations team and is based in London. Constantinos Orphanides is an airport valuations professional at PwC UK based in London. Contacts: E: [email protected] T: +971 1 304 3723; E: [email protected], T: +44 (0)20 7804 0860; E: [email protected], T: +44 (0)20 7213 3929).
Are European airport valuations taking off? | 35| To have a conversation about how this subject may affect your business, please contact:
Michael Burns
+44 (0)20 7804 4438 [email protected]
36 | PwC | Connectivity and growth Are European airport valuations taking off? | 37 www.pwc.com
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