(News Bulletin 247) – The HSBC bank has downgraded to “lighten” its advice on the airport operator, due to its valuation considered high and uncertainties about the evolution of the rates of fees collected. This while the pandemic has deprived the company of an economic regulation contract which is vital to give visibility to investors.

After two or even three years undermined by the pandemic, Groupe ADP is doing much better. The operator of Paris airports is returning to traffic levels that are now relatively close to those prior to the health crisis.

According to its projections, this traffic will be between 95% and 105% of that of 2019 for the entire company (which includes international airports) and between 87% and 93% on the perimeter of Paris Airport.

The company’s stock has recovered. Even if it has fallen by 9.6% since January 1, over three years it shows an increase of more than 30%.

There remains a complex unknown that prevents the market from fully planning for the future of society: regulation.

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The regulatory contract in question

Normally, Paris airports (Orly, Charles de Gaulle and Le Bourget) are subject to a sort of major specifications, called an economic regulation contract (CRE) over five years. This document defines, within the regulated scope of airports (to simplify activities excluding real estate, services and shops), the investments that the company must make and the evolution of airport fees, based on traffic forecasts. A rate of return, called weighted average cost of capital (WACC), is determined to guarantee that the company’s investments are fairly remunerated, therefore via increases in the fees that airlines pay to ADP. This WACC is therefore extremely important to the market.

The previous CRE covered the period 2016-2020. But due to the pandemic which completely wiped out visibility on air traffic, the 2021-2025 CRE could not be established. The evolution of prices has since been fixed on an annual basis, with the approval of the Transport Regulatory Authority (ART).

ADP has now regained more visibility. But this does not mean that a CRE will see the light of day quickly. The evolution of traffic from China has been a significant unknown in recent months and the company indicated to News Bulletin 247 that it had not yet started the development of a new CRE. Theoretically, it takes between a year and a half and two years to prepare internally the proposals included in this contract. Then a dialogue with the airlines, the regulator and the State takes place, before validation of the contract, which adds around an additional year. Knowing that the CRE covers a period of five years, ADP therefore needs a total of seven or even eight years of visibility. Hence the complexity of the subject…

Note that the Transport Regulatory Authority (ART) and ADP do not always agree. This is what happened during the development of the 2021-2025 CRE which was therefore not completed. The company had assumed a WACC, therefore the profitability rate, of 5.6% when the authority had retained in its opinion a rate of between 2% and 4.1%.

HSBC is worried about prices and does not believe in privatization

The differences between the Authority and Groupe ADP, as well as the absence of CRE, were mentioned on Friday by HSBC which downgraded its recommendation on ADP from “keep” to “lighten”. The Sino-British bank is particularly concerned about the evolution of airport fee rates.

“As part of the pandemic, Groupe ADP was authorized to increase its prices by 2.2% on average in 2021 and by approximately 1% in 2022. However, the company had mentioned during its conference call on the activity of the first nine months of 2022 that the regulated WACC which it assessed at 6.3% was higher than the range estimated by the regulator of 2.6% to 5%. Consequently, Groupe ADP did not propose “tariff increase for 2023”, explains the bank.

Moving forward, “Groupe ADP has indicated in previous conference calls that it expects the regulator to issue its opinion on the regulated WACC in the coming months. In the meantime, we assume fixed rates in our model, but we cannot rule out that Groupe ADP’s regulated WACC will be set at a lower level, which could lead to lower rates in the future,” explains HSBC.

Another reason for caution on the part of the bank: valuation. ADP stock trades, based on HSBC estimates, for nearly 22 times expected earnings in 2023 and nearly 23 times expected earnings in 2024, representing a 30% premium to the overall airport operators sector.

HSBC believes that this premium is due to speculation on a potential takeover, while Groupe ADP is 50.6% owned by the French state which, with the pandemic, has postponed a privatization of the company indefinitely. However, HSBC does not expect privatization to become a political subject again in the medium and even long term…

In the world of airport groups, HSBC prefers the German operator Fraport, on which it has a buy rating. His advice is also to “keep” on the Spanish Aena and the Swiss Flughafen Zurich.