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Fixed-Income Insights

Robust U.S. economic growth has been fueling a strong credit outlook for the sector.

By Yeida Reyes, Research Analyst

This article is from the second-quarter 2019 edition of The Muni Quarterly.

The U.S. airport sector, a significant segment of the municipal bond market, appears positioned to perform well.  Passenger enplanements were up 5% in 2018 thanks to general U.S. economic expansion, low oil prices, and added seat capacity and we project continued growth, albeit at a slightly more moderate rate, in 2019.  Based on these factors, credit fundamentals remain strong in the sector.

Fueled by improved corporate profits and consumer confidence, demand for air travel remains elevated. Despite expanded seat capacity from the airlines, load factors—which measure the percentage of available seating capacity filled with passengers—are at historic highs, with no signs of abatement.  The low and ultra-low cost carriers remain the fastest-growing segment of the industry, which should benefit small- and medium-sized airports, where these carriers tend to operate. 

Airport Revenues: Headwinds and Tailwinds
As traffic across the country grows, airports have been able to capitalize on other sources of revenue such as concessions (food and beverage/retail, parking, etc.) allowing for less reliance on fees charged to airlines and further supporting credit profiles across the sector.  With traffic gains poised to exceed budgeted expectations (most airports incorporated the Federal Aviation Administration’s 1.9% annual growth projection into their plans), we believe the sector is likely to see revenue growth and strengthened financials including improved liquidity and higher debt service coverage ratios. Headwinds for airport credits center on increased leverage from capital improvement projects tied to aging and inadequate facilities.  Most of these projects are focused on improving or expanding terminal space and concession schemes rather than enhancements to runways and other airfield infrastructure. The facilities that will see the largest increases in rates charged to the airlines to fund capital projects include Los Angeles (LAX), Chicago O’Hare, San Francisco (SFO), Denver, Ft. Lauderdale, Salt Lake City, and Seattle. 

 

On the Runway: A Sampling of Major Construction Projects at U.S. Airports

Source: Engineering News-Record (based on reports published during 2018).

 

Although distress in the sector has been rare, there have been airline consolidations in the past which have resulted in airlines deciding to eliminate connecting activity (“de-hubbing”) at particular airports. When this occurs, credit stress is heightened as the remaining airlines are under increased pressure to cover operating expenses and debt service. With the likelihood of further airline consolidation in the short term being low, we believe de-hubbing risk is somewhat mitigated.

Construction: Waiting on an Infrastructure Bill
It is possible that construction plans could accelerate should a U.S. infrastructure funding plan come to fruition this year, or if Congress moves to make a long overdue increase of the passenger facility charge which is currently capped at $4.50 per enplanement.  Even if a plan is enacted, much of the financial burden of capital projects is likely to fall on the shoulders of the airports rather than the federal government. Nevertheless, we generally do not see a risk of overbuilding, which in the past has placed some operators in uncompetitive financial positions.

Risks related to escalating construction costs stemming from the U.S.-China trade conflict and tight labor markets should also be noted.  Such cost escalations could pressure airport finances, but we believe this risk is substantially mitigated by the prevalence of fixed-price contracts and airline-managed projects whereby airports agree to pay the airlines a fixed price upon project completion and are thus insulated from such cost overruns.

Furthermore, despite strong demand and large capital projects addressing capacity constraints, long- term growth potential for airports in large metropolitan areas may be constrained by airspace traffic congestion and scheduling restrictions.  While we don’t believe this presents a near-term risk for such facilities, it is something we will monitor.  

Summing Up: Opportunities in Airport Bonds

While we expect strong performance in the airport sector as a whole, security selection remains a key factor in capturing value. From a credit perspective, we continue to favor airports that demonstrate a trend of strong enplanement growth, serve a robust and diverse metropolitan region, have manageable airline costs, and a stable carrier base.  We will be selective regarding airports that are located in slower-growing service areas, and those that have less capacity to accommodate a capital program.

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THE MUNI QUARTERLY

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The Second Quarter 2019 edition offers insights from our analysts on key topics for municipal bond investors, along with essential market information.

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