Case 014Credit analysis and lendingHard

You are asked to rate an airport. What would you look at, what is its debt service coverage, and what happens if traffic falls 30%?

Moody'sNew York · 2018Moody'sNew York · 2018

The situation

Gaganpath Airport handles 12 million passengers a year. Aeronautical revenue, landing, parking and passenger charges, is set by a regulator and works out at Rs 250 a passenger, Rs 300 crore. Non-aeronautical revenue, retail, food, car parking and property, is Rs 200 crore and tends to move with passengers. Operating costs are Rs 180 crore and largely fixed. Debt is Rs 2,000 crore at 9%, amortising Rs 60 crore a year, and 25 years remain on the concession. Ignore tax and capex for now.

Your task

List what you would assess for a rating, compute the debt service coverage, and show what a 30% traffic fall does.

Quick check

If traffic falls 30% and non-aero falls with it, roughly what happens to DSCR from 1.33x?

Worked solution

Try it on paper, then open one step at a time.

30-second answerThe answer to give first

DSCR today is 1.33x, Rs 320 crore of cash against Rs 240 crore of debt service, and a 30% traffic fall cuts it to 0.71x because costs are fixed. Coverage hits 1.0x after only a 16% fall. The rating then rests on what cushions a shock: regulated tariffs that can be trued up, reserves, and concession terms. The debt tail matters most: at Rs 60 crore a year, Rs 500 crore is still owed when the concession ends.

Step 1What does a rating analyst look at for an airport?

Split the question in two, the way agencies do. Business risk asks whether the cash will keep arriving; financial risk asks how much shock the balance sheet can take. For an airport, business risk is traffic size and mix, how the regulator sets aero tariffs, how much comes from non-aero, the remaining concessionA government grant giving a private company the right to run an airport or road for a fixed period, after which the asset returns to the state. life, and competition from nearby airports. Financial risk is coverage, leverage, liquidity and the debt's maturity against the concession.

The rating rests on two columns, and the concession links themBusiness risk: will the cash arrive?Traffic12 m passengers; origin vs transfer mixAero revenueRs 300 cr, tariff set by a regulatorNon-aeroRs 200 cr: retail, parking, propertyConcession25 years left; termination termsCompetitiona second airport in the catchment?Financial risk: can it absorb a shock?CoverageDSCR 1.33x; 1.0x at -16% trafficLeveragedebt 6.25x EBITDA of Rs 320 crDebt tailRs 500 cr left when concession endsLiquidityreserve account, undrawn linesStructurering-fencing, distribution lock-upDebt that outlives the concession is the first question: who repays the last Rs 500 crore?
A rating view of Gaganpath splits into business risk, traffic, regulated aero revenue, non-aero income, 25 years of concession and competition, and financial risk, 1.33x coverage, 6.25x leverage, a Rs 500 crore debt tail beyond the concession and liquidity.
Step 2What is the coverage today, and why does it fall so fast?

Cash available for debt service is Rs 300 crore of aero plus Rs 200 crore of non-aero, less Rs 180 crore of costs, Rs 320 crore. Debt service is Rs 180 crore of interest plus Rs 60 crore of amortisation, Rs 240 crore. DSCR is 1.33x, but with Rs 180 crore of fixed costs every rupee of lost revenue comes straight out of coverage. A 30% traffic fall takes revenue to Rs 350 crore and cash to Rs 170 crore: 0.71x. A bus operator with a fixed depot rent and salaried drivers knows the feeling: lose a third of the passengers and you lose half the profit.

The relationship
DSCR=Aero+Non-aero−OpexInterest+Principal=300+200−180180+60=1.33×\text{DSCR} = \frac{\text{Aero} + \text{Non-aero} - \text{Opex}}{\text{Interest} + \text{Principal}} = \frac{300 + 200 - 180}{180 + 60} = 1.33\times
Aero + Non-aeroRs 500 crore of revenue, both moving with passengers
OpexRs 180 crore, largely fixed
Interest + Principal9% on Rs 2,000 crore plus Rs 60 crore of amortisation
What it says in wordsCoverage is the cash left after running the airport divided by what lenders are owed that year; today it is 1.33x.
DSCR against traffic change: fixed costs make coverage fall fast0.5x1.0x1.5xDSCR 1.0x: cash just covers debt servicetoday 1.33xbreakeven at -16%-30% traffic: 0.71xwith tariff true-up: 1.08x-40%-30%-20%-10%0%+10%Change in passenger traffic; non-aero revenue moves with it
Gaganpath's DSCR falls from 1.33x at today's traffic to 1.0x at a 16% traffic fall and 0.71x at minus 30%; if the regulator trues up aero revenue, coverage at minus 30% is 1.08x instead.
Step 3What carries the rating through a shock like that?

Three things the formula does not show. First, regulation: where aero tariffs are set to recover an allowed return, lost aero revenue may be recovered in later years, which would lift coverage at minus 30% to about 1.08x. Check the current tariff framework and how true-ups work; it changes between control periods. Second, liquidity: a reserve account holding six to twelve months of debt service buys time for traffic to recover. Third, the debt tail: Rs 2,000 crore at Rs 60 crore a year takes 33 years to repay, against 25 years of concession, so Rs 500 crore depends on refinancing or a termination payment.

Leverage of 6.25x EBITDA would be high for an ordinary company, but airports carry it because the asset is a near-monopoly with regulated revenue. That is the judgement to state: a monopoly with thin coverage can still earn an investment-grade view if regulation, reserves and the concession terms protect the cash; without them, 1.33x is too thin for a business whose traffic can fall a third in a bad year.

Where candidates lose it

Candidates list generic credit metrics and never compute anything, or compute DSCR and assume a 30% traffic fall means a 30% coverage fall. With fixed costs, coverage falls almost half as fast again.

The other miss is ignoring the concession. Debt that runs longer than the right to collect revenue is the single most important structural fact in an airport rating.

What the interviewer asks next

  • How would you size a debt service reserve for this airport?
  • Which is more resilient in a downturn, aero or non-aero revenue, and why?
  • How would a major expansion capex programme change your view?

Asked at Moody's, Utilities, New York, 2018 (Wall Street Oasis): If you were to evaluate an airport for a rating, what items/categories would you look at?
Asked at Moody's, Project Finance, New York, 2018 (Wall Street Oasis): If you were to evaluate an airport for a rating, what categories would you look at?

Company names and figures are illustrative.