Pandemic-weary consumers want to fly again, and the global aviation industry is regaining the use of its wings. Restrictions are easing, and vaccination rates are high. We expect airline capacity to reach pre-pandemic levels by at least early to mid-2023. By 2024, domestic traffic should fully recover to pre-pandemic levels, with its international equivalent following a year later. Australia and New Zealand airports are already seeing a steady and strong rebound on the domestic leg, which stands at 70%-90% of pre-pandemic levels. The increase in international travel is also positive for airports as from April to June 2022, it was at 30%-50% of pre-pandemic levels.

Domestic and international airlines are responding by adding capacity to match demand. In the absence of a return of restrictions, we believe the recovery in traffic will build over the next 12 months and beyond. S&P Global Ratings believes this will provide crucial cash flow support and rating stability to the airport sector.

The recovery will vary across the airports and regions. There remains some residual risk of a fragile recovery. This includes economic uncertainties, geopolitical factors, the impact of inflation on discretionary spending on travel, still high airfares, volatile schedules, and consumer anxiety around long-haul travel. In contrast, there is still strong pent-up demand among leisure, education, and visiting-friends-and-relatives (VFR) travelers; the return of business travel is slow.

Over the next two to three years, Australian and New Zealand airports face significant operational decisions as they resume full activities. We anticipate these decisions will influence the balance sheets of the airports as they prepare for reinvigorating investment at their facilities. Traffic is the immediate focus, but we believe operational aspects are equally important as some of these will evolve over the next two years. These include negotiation of aeronautical charges, long-term retail management and strategy, the prioritization of the approach to capital expenditure (capex) and funding, and managing shareholder expectations.

Domestic Traffic To Rebound By Fiscal 2024, International By Late 2025

We have modestly improved our recovery trajectory for domestic travel. The international timeframe remains unchanged for now (see table 1) compared with our prior estimates (July 2021). We base these forecasts on the assumption of a very low likelihood of border closures--state or international.

Table 1

Chart 1

Domestic travel has picked up strongly over the past few months in both Australia and New Zealand (chart 1). The average run rate in the April to June 2022 quarter has been at around the 70%-90% mark of pre-pandemic levels. This resembles the trend observed in the U.S., India and Latin American countries where domestic traffic is a big proportion of total traffic. Once all restrictions were removed in these markets, it took only about six to nine months to return to pre-pandemic levels. This is largely attributable to, on the one hand, free movement of people due to lack of domestic border closures; and on the other, the quick response of the domestic airlines in restoring capacity.

Despite this, we expect a slower pace of recovery for Australian and New Zealand airports than for global peers. We base this on the assumption that the recent momentum could slow because of challenging economic conditions, the effect of high fuel prices on airfares, and a slow pick-up in business travel because of health precautions enduring for longer. Further, the Pacific airports derive some domestic travel from international tourists; this is rebounding more slowly. While airline capacity is increasing and is likely to be at 100% of pre-pandemic levels by the summer travel season in November-December 2022, a lack of strong competition among domestic airlines could also restrain capacity and keep airfares high. Based on this, we now believe domestic traffic at most rated Pacific airports could return to pre-pandemic levels by mid-2024--six months earlier than our prior expectations in July 2021.

Chart 2

International travel is showing a slow but steady return (chart 2). Driving this are the leisure, VFR, and student segments as well as the relocation of people to their home countries. In the 12 months from July 2021 to June 2022, most rated airports should reflect about 12%-15% of pre-pandemic levels. This is at the lower end of our previous forecast of 10%-30%. This is not surprising given restrictions were fully lifted only over February 2022 to April 2022. In fact, the run rate over the April to June 2022 quarter has averaged 30%-50% depending on the airport--which augurs well for our forecast trajectory.

This underscores our belief that international traffic could reach 60%-70% of pre-pandemic levels over July 2022 to June 2023 (fiscal year 2023) despite some major travel markets for Australia remaining restricted or less predictable. These include China/Hong Kong, Japan, and Korea--which together represented about 15%-20% of international traffic into Pacific before COVID-19. Other major markets such as the Americas, Canada, the U.S., Europe, the Middle East, and Southeast Asia are now fully open.

We base our forward recovery trend on high vaccination rates in various markets, a low probability of a return of restrictions, and improving airline capacity. Major airlines that service the Pacific market are looking to restore capacity to pre-pandemic levels in the next few months or latest by early 2023. These airlines include Australia's national carrier Qantas, Singapore Airlines and most Asian airlines, Emirates, Qatar Airways, Air New Zealand, and Air India. United and Delta Airlines, which connect the east coast of Australia to the US west coast, are increasing their services. Chinese carriers are yet to restore services, while Korean and Japanese carriers are yet to ramp up. Short-haul flights could benefit from competitive airfares whereas long-haul will pin its hopes on VFR/business segments, despite high fares. While there will be month-on-month variability or periodic slowdowns, on average the upward trajectory should continue and accelerate into 2024 and beyond.

Operating Margins To Regain Altitude By 2024 While Retail Lags Behind

Among the revenue streams, retail revenues will pick up slowly and will follow international traffic. Retail revenues are not forecast to regain pre-pandemic levels by 2025 at most airports (chart 3). International travelers contribute roughly three to five times the revenue generated by domestic travelers. The chief drivers of this are duty-free spending, currency exchange, and dwell-time at the airports. The forecast delay in the return of high-spending Chinese/Japanese/Korean tourists will also determine the improvement in retail revenues.

Chart 3

Further, during the pandemic the airports granted concessions to retailers in the international terminals; for instance, they waived maximum annual guaranteed incomes and provided other forms of relief to most retailers without breaking tenancy. We expect a slow unwinding of these concessions, and it could be one or two years before new arrangements are reached. We do not expect major changes to retail operations in the future.

We expect new aeronautical agreements to lead to a modest increase in rates, increasing with inflation, for a tenor of three or five years. Most airports are negotiating the aeronautical charges because they lapsed over June 2020 to June 2022. Besides passenger numbers, aero-related capex plans and increased security-related costs will dictate the rates. Aero-charge agreements at Melbourne, Sydney, Auckland, and Adelaide airports lapsed over June 2020 to 2022. Perth airport has charges agreed to 2025; Wellington airport to 2024; and Christchurch airport to 2027. Brisbane airport has most of the aero charges set to 2026. We currently see no demerits for short-tenor agreements because they can pave the way for a change as the travel market improves, and airports and airlines can discuss forward capex plans with confidence.

Car parking and rentals remain strong and are close to pre-pandemic levels. This is because of increased use of self-transport instead of public modes and the associated health concerns. We expect the pace in this revenue segment will return to modest growth as travelers shift to public transport. Property revenues remain strong and will post continued growth at most airports because of the strong demand for industrial space.

The combination of increasing operating costs and a slow rise in retail revenues will cause the operating margins to return to pre-pandemic levels by late 2024 or early 2025. We see limited flexibility in the operating costs for the airports over the next one to two years because of the adoption of many efficiency measures during the pandemic. At the same time, we think the airports will be careful in their efficiency and discretionary spending at least over the next two years should traffic recovery falter.

Capex Ambitions Remain Grounded

We expect airports to remain cautious and flexible in the timing of their capex. Airlines are unlikely to agree to large investments until they see a firm rebound in traffic. Therefore, we believe that the forward aero-related capex plans of the airports will comprise discrete projects, spaced over time, and underpinned by aero-charge agreements.

All the airports are revisiting their capex plans in sync with the passenger recovery. Our forecast reflects this increase (chart 4), after significant curtailment in 2020 and 2021. The focus remains on security, safety and maintenance-related capex; aeronautical growth/expansion projects are being rolled into the discussion with the airlines as part of the negotiation of aeronautical charges. Most airports undertook cash-accretive property investments during the pandemic, and we expect this segment to grow in a cautious and non-speculative manner.

Chart 4

In our view, large-scale strategic projects won't begin in the next few years--not until there is clear visibility on travel conditions and appropriate recovery tariffs and funding arrangements. Before the pandemic some of the rated airports had large strategic plans such as building an additional runway (Melbourne and Auckland), integrating the domestic and international terminals (Perth, Auckland), or revamping their terminals and facilities (such as baggage-handling, check-in, retail layout). We also foresee Brisbane airport improving their airport terminal and facilities ahead of the 2032 Olympics and Commonwealth Games.

In our view, to preserve the current ratings, some of these projects--when implemented--will need support from shareholders and cannot be accommodated on the balance sheet via debt funding. This is because airlines are unlikely to prefund such projects and provide progressive cash flows. However, they would agree to a forward-pricing mechanism once the projects are operational. Among the rated airports, we see Perth airport as having the least flexibility to fund its larger strategic capital works on their balance sheet, while Brisbane airport may also need shareholder support depending on when it accelerates the reinvestment ahead of the Olympics.

How Differences In Financial Flexibility Affect Metrics

We anticipate the financial metrics of most rated airports--except Perth--will return to the threshold levels by fiscal 2023 on the back on traffic and improving cash flow (chart 5). Perth airport will be constrained by a lift in interest costs (benefits of swap monetization falls away); but management has indicated it will restrain capex spending and shareholder returns to reach their threshold metrics no later than fiscal 2024.

Chart 5

However, most airports remain extremely careful in planning their capex and have indicated that any form of shareholder return is not likely until the fiscal 2023 performance is visible. This includes accrued interest on shareholder loans and dividends. Such policies support the ratings and are a key driver of the stable outlook on most airports.

Benefits of swap restructuring over 2020-2022 will erode in 2023 or 2024, and interest rates have increased. It is therefore important to focus on the financial metrics beyond the next one to two years, and we have assumed escalating interest costs as maturing debt is refinanced. All the Australian airports used some of their in-the-money cross currency and interest rate swaps during the pandemic to lower the cash interest payments over fiscal 2020 to 2022. The reduced payments helped them meet their covenants when cash flow dwindled. All the airports will see an increase in cash interest payments from fiscal 2023 or fiscal 2024 and beyond as the swap benefits fall away. A few airports used most of their debt book to reduce the interest whereas others used this flexibility in a limited way.

Lastly, we have assumed a certain level of shareholder returns.

For example, if our forecasts show airports reaching their thresholds metrics, distributions are assumed to be paid. This may not be the reality because some airports such as Adelaide and Brisbane generally assess the metrics one or two years ahead; and Melbourne airport has indicated it will look to consolidate its balance sheet before resuming returns.

In our analysis, Sydney airport has good flexibility because we have factored in above-average capex and high shareholder returns; and Perth airport has the lowest headroom. Melbourne airport has some flexibility on capex and could exercise discretion on the large shareholder returns in the later years. Adelaide and Brisbane airports have discretion in both aspects. The New Zealand airports have exercised discipline on both parameters, and we expect that to continue.

Potential Risks

We see the following residual risks to the sector. Some of these will put the focus on leverage tolerance and may force airports to maintain higher metrics for a given rating over the medium to longer term.

• The potential emergence of infectious coronavirus variants, which could undermine the confidence in travel--even without border closures.
• High airfares, particularly long haul, due to the high fuel costs and slow increase in high-margin business or first-class travel. This is not likely to ease at least in the next 12 months.
• Disruptions affecting consumer sentiment. Global airports and airlines are facing severe disruption of services as they balance operating costs and restoration of services. Airlines' focus on profitability and liquidity could prolong the time to get to pre-pandemic service levels.
• Extra costs to airports. Ongoing health concerns can lead to mandatory capex such as contactless check-in and security measures, further affecting the cost of travel or investment needs at airports.
• Possible changes to retailing arrangements over the longer term due to the popularity of online shopping and retailers desire to retain flexibility in the contractual arrangements.
• Environmental, social, and governance (ESG) factors. Global businesses are looking at ESG implications and operating costs, as too are airlines. This could lead to some permanent erosion of business travel in the post-pandemic phase. Additional costs to cover emission and regulatory requirements will flow to consumers, affecting propensity to travel.
• On the ESG factor, the Dutch government recently announced its intention to lower the capacity cap to 440,000 air traffic movements (ATMs) per year, down from 500,000 ATMs at Royal Schiphol airport (Royal Schiphol Group N.V.; A-/Stable/A-2) from end 2023. The objective is to decrease aviation emissions and noise at the airport. We believe this may hinder the airport's growth prospects and competitive position as a hub from 2023 and lowered the rating on the airport by one notch (see "Royal Schiphol Ratings Lowered To 'A-/A-2' On Reduced Capacity Cap; Outlook Stable," July 22, 2022).

Playing Catch-Up With European Airports

Our forecast traffic recovery for Australian and New Zealand airports is not unlike our expectation for rated European airports. While it is not easy to compare airports in different countries, certain peculiarities must be noted when comparing the traffic recovery.

• The Pacific airports have a high proportion of domestic travel whereas most European airports have a greater proportion of international or intra-Europe travel.
• Several European markets are connected by high-speed rail--an option not available to Australian and New Zealand cities.
• All the rated Australian and New Zealand airports are origin and destination airports, meaning that unlike transit airports there is very limited threat of traffic loss due to competition.
• European markets benefit from the proximity of various high-value travel markets and better airline connectivity (and hence attractive airfares) than the Pacific.

In June 2022, we revised upward our expectation of passenger recovery for the European airports. We now expect European airline passenger traffic in calendar 2022 will reach 60%-70% of 2019 levels, 70%-85% in 2023, and getting to pre-pandemic levels by 2024. This is roughly six to 12 months ahead of our forecasts for the Pacific markets.

Table 2

Related Research

• Royal Schiphol Ratings Lowered To 'A-/A-2' On Reduced Capacity Cap; Outlook Stable, July 22, 2022
• European Aviation Is Set For A Strong Summer Before Brewing Macro Headwinds Blow In, June 8, 2022

Editor: Lex Hall, designer: Halie Mustow