Description

Company overview

Flughafen Wien (FLU) is the developer, builder and general operator of Vienna International Airport, which was privatized in 1992. Vienna airport has successfully positioned itself as one of the key hubs to the rapidly growing destinations in Central and Eastern Europe.

FLU has a market cap of €1.0bn and net debt of €0.65bn; the stock trades €1mn/week.

Summary of Opportunity

Following an 8-year construction period for the extension of Check-in 3 (also known as Skylink), we believe FLU is poised to reaping the benefits from its investment, as it now has ample capacity to accommodate traffic growth, as well as benefit from growth in retail operating space. Furthermore, the new management team focus on cost control should further support EBITDA growth which, in turn will help delever the balance sheet from FY12 net debt/EBITDA of 3.3x to 1.6x in FY15 . Our base case implies 45% upside over the next 12-18 months.

We forecast FCF to triple over the period 2012-15 leading to an attractive FCF yield of 15% in FY15 (at the current share price), in addition to a FY15 dividend yield of 4.4%. On an EV/EBITDA base, the shares trade on 7.4x and 6.6x in FY13/14, at a large discount to peer average of between 8.5x and 9.0x and recent private transactions multiples well in excess of 10.0x.

Key downside risks to our thesis are: (1) weaker than expected traffic and/or airlines capacity cuts, (2) capex overrun and (3) strategic investor selldown.

Brief Recent History

Flughafen Wien experienced turmoil in 2011, as it had to recognize significant impairment charges and exceptional costs in relation to delays and deficient performance by contractors in building the terminal extension Skylink (for a total of €90mn vs pre-exceptional EBITDA of €205mn). These issues, together with high financial leverage - FY11 net debt / EBITDA of 4.0x - led to a 50% cut in the dividend in 2011 and a large decline in the share price (-44% in 2011).

In September 2011, a new management team came on board to stabilize the company. Through a focus on cost reductions and downward revisions to capex plans, the new leadership completed the construction of Terminal 3 and managed to put the financials back on the sustainability track. We believe Flughafen Wien is now well positioned to benefit from a new growth phase, following the opening of the Skylink terminal in June 2012.

Summary Investment Thesis

FLU is a compelling long in our view, trading on FY14 EV/EBITDA of just 6.6x at a discount to peers (8.5-9.0x) and history (mean 8.0x), despite prospects of improving free-cash generation and rapid deleveraging over the period 2013-15.

Improved traffic figures (2H 13 scheduled airline capacity is set to increase), growth in retail revenues following the opening of Terminal 3 (with as many as 90% of shops now open) and continued cost control on behalf of management (1H 13 costs down yoy) , should support further earnings and cashflow growth.

Under our base case, we forecast +2.9% CAGR 2012-15 passenger growth (vs 2006-12 +4.6%) and contained operating costs growth of +1.6%, to lead to FCF in FY15 of €159mn, 3x FY12 FCF of €53mn, and yielding 15%. Assuming an EV/EBITDA FY14 multiple of 8.5x in line with peers, our forecasts imply 45% potential upside to €72.4/share.

Conversely our bear case, assumes a trough valuation FY14 EV/EBITDA multiple of 6.5x (Lehman’s recession) and 0% passenger growth in FY13 and FY14, which gets us to a value per share of € 37.9, that’s 24% potential downside. We note on our estimates, a -1% ceteris paribus change in passengers growth impacts EBITDA and FCF respectively by -5mn and -6mn or -2% and -6%.

Catalysts

Flughafen Wien is due to report its next monthly traffic stats on Oct 15^th and its 3Q13 results on November 14^th,.  Following a slightly disappointing 1H13 traffic decline of -1.7%, due to severe winter weather, strikes in Germany and capacity cuts by Austrian Airlines and NIKI, we expect traffic to show an improvement,  given announced airlines capacity schedules for 2H13.

Furthermore, news regarding outstanding compensation for the delays in building Terminal 3 should be disclosed before the year-end. The company stated that in order for it to enter in an out of court settlement management would seek to recover a “substantial amount contributing to a cost reduction of Check-in 3” (2Q13 conference call), otherwise FLU would take the case directly to court.

Business Segments

FLU is organized across 4 main divisions: Aviation, Ground Handling, Retail & Property and Other. The breakdown of group revenues and EBITDA (for FY11) is discussed below:

In the Aviation division (51% group revenues, 60% EBITDA), revenues are mainly generated by passengers fees (42%), security controls fees (30%), landing fees (19%) and infrastructure fees (9%). This division runs all services that are required to manage the airport, from operation and maintenance of aircraft movement area, to operating the terminal and the baggage handling facilities. The fees for these services are for the most part subject to regulation.

In the Ground Handling division (26% group revenues, 3% EBITDA), revenues are generated as follows: apron handling (67%), cargo handling (20%) and other (13%). This division performs security controls for passengers, as well as a variety of other services for the handling of aircraft. The contribution to group EBITDA of these businesses is insignificant (3%).

Finally, in the Retail & Property division (19% group revenues, 30% EBITDA), revenues are roughly equally split between Parking (35%), shopping/gastronomy (34%) and Rentals (31%).

Favourable Fee Structure and Capex Cycle

The fee and annual adjustments at Vienna Airport are based on a price-cap formula that was accepted by the airlines, the Austrian civil aviation authority and FLU; the formula equals the inflation rate minus 0.35 times the average traffic growth over the last 3 years. Most importantly from an investment perspective, such fee adjustment structure is anchored in law by the Airport Fee Act (enacted on July 2012) and provides therefore additional stability.

In terms of the capex cycle, FLU has the option of undertaking two new projects, namely (1) the extension of Terminal 2 and (2) the construction of a new runway. However management has repeatedly emphasized during conference calls that the capex bill is not going to increase before 2016. Indeed, on the 2Q13 conference call the COO stated clearly that “we don’t expect significant capex in the next 3 to 5 years, definitely not before 2016”.

Specifically related to Terminal 2, the CFO further added “You cannot expect any capex in regard of measures connected with Terminal 2 before 2016 and realistically even if you would start in 2016, I think we could not spend very much money in the first year […]; it will have to be divided into 4 maybe 5 years and it’s not very likely to start with the bulk in 2016”. With regards to building a new runway, the CFO commented on 2Q13 call that “any need for additional runway, definitely will be shifted several years down the timetable”. We are thus confident in the promising outlook for increased free-cash generation, given the limited capex commitment over the next several years.

Valuation

We believe FLU is currently trading at a particularly compelling valuation. On our numbers, FLU trades on FY14 EV/EBITDA of just 6.6x, at a discount to the historic peer average of 8.5-9.0x as well as to its own history (avg 2006-12 of 8.0x).

Our view is that such discount is no longer justified. Whilst historically the discount reflected FLU previous poor capex management, as well as the company high financial leverage, we believe that the restructuring undertaken by the new management team should support FLU’s re-rating.

In addition, we note recent private transactions within the sector should indeed support share prices re-rating; recent transactions we are aware of include: (i) the acquisition of ANA airports (Portugal) by Vinci for 15x EV/EBITDA (announced in Dec-12), (ii) the disposal of a 9.5% stake in ADP from the French government on 10x EV/EBITDA (in June 2013) and (iii) the sale of Luton airport from Abertis to Aena and Axa Private Equity for 11x EV/EBITDA (in August 2013)

Focussing on an asset-based valuation approach (which generates an of 0.79 over the period 2006-12), we find that FLU has significant upside potential.  Plotting FLU  EV/GCI (Gross Cash Invested) against CROCI (Cash Return on Cash Invested) shows that the stock is materially undervalued.

Importantly, also on a FCF yield basis FLU is highly attractive, yielding as much as 13% in FY14 given the decreasing capex bill and the improvement in cash generation.

Finally, we highlight that we see scope for increasing the dividend in the mid-term. Indeed, FLU publicly stated that once it would reach its mid-term goal of leverage no greater than 2.5x net debt/EBITDA - which we forecast will be reached by end of FY14 - it will reconsider the company’s dividend policy; as of today FLU pays out c. 40% of net income in dividends, we conservatively forecast this to rise as of FY14 and FY15 to 50% of net income, implying a FY14 yield of 3.6%.

Risks

Key downside risks to our thesis are:

(1) Weaker than expected traffic and/or airlines capacity cuts:

As discussed above, on our estimates a -1% ceteris paribus change in passengers growth, impacts EBITDA and FCF respectively by -5mn and -6mn or -2% and -7%.  However we note that capacity schedules for Vienna airport main airlines customers (Austrian Airlines, NIKI, Air Berlin) are poised to increase in 2H13.

In addition, we note that Austrian Airlines in particular – which is FLU largest customers (50% passengers) – is at risk of capacity cuts as it is currently undergoing a restructuring process; having said this, encouragingly its financial turnaround has recently showed good progress.

(2) Capex overrun:

In 2011 FLU share price performance was negatively impacted by significant capex overruns for the construction of Skylink. The new management team though, has clearly stated its goal to contain capex (2011-15 total bill €590mn), which indeed has already declined in FY12 to €127mn, and is forecasted to decline further in FY13 to €100mn and thereafter to €70mn in FY14/15.

(3) Strategic investor selldown.

C.40% of FLU shares are under Austrian Government and Wien Local Authority ownership. Our view is that they are unlikely to exit anytime soon, although private transactions at high multiples in the airport space from other strategic holders (French government with ADP) could tempt action.

Catalyst