Heathrow’s 2022 results
Britain’s biggest airport returns to profit, perhaps
We recently got Heathrow airport’s full year results for 2022. The small profit before tax figure of £169m was the first full year profit the airport has reported since before the pandemic.
It was outgoing CEO John Holland-Kaye’s last set of results, and you might have thought the company would have taken the opportunity to celebrate getting back into the black. But instead, the headline from the company was “We continued to be loss-making throughout 2022”. That’s because the company prefers to focus on their own version of profit called “adjusted loss before tax”. On that metric, the company lost £684m in the year. The actual profit before tax figure I referred to above doesn’t make an appearance in the report released to the press until the bottom of page 8.
Usually, when a company produces an “adjusted” version of the figures, they are motivated by a desire to make them look better. Heathrow’s management has the opposite bias, as it continues to plead poverty to its regulator in the ongoing battle over airport charges. I wrote about the adjustments that Heathrow makes to get to their own version of the truth in an earlier article (Heathrow: the hedge fund with an airport attached). I’m not going to reiterate all that detail here, but the “bottom line” (no pun intended) is that I don’t find either the reported numbers or Heathrow’s own version of the truth particularly helpful in understanding whether the airport is making or losing money on an underlying basis.
The company has a huge amount of debt and is big user of financial derivatives. The accounting for those is both complex and volatile, and that’s the area that gives rise to most of the adjustments made by Heathrow. They primarily affect the cost of financing, so I prefer to focus first on profit before financing costs and then to compare that with the capital employed in the business to see if the return looks good, bad or indifferent. That approach does “gloss over” how good a job the company is doing in practice with its financing arrangements and whether its financial derivatives are working as intended. Heathrow’s lenders and shareholders will undoubtedly be very interested in that, but for the most part the airlines that pay to use the airport, and the regulators that set the allowable fees, are not that interested in Heathrow’s financial engineering.
Operating profit for the year
Profit before financing costs and exceptional items was £914m in the year. That was down just over 20% from the profit recorded in 2019. This was actually a lower drop than the fall in passengers, which declined by 23.9%. So operating profit per passenger actually went up a bit.
Heathrow likes to complain that airlines are doing much better than it is, but most airlines were still well down on pre-pandemic operating profit levels in 2022. For example, British Airways, Heathrow’s biggest customer, recorded operating profits for the year of £303m, down 84% on 2019.
Part of the reason for Heathrow’s fall in profits was lower revenue, which was down overall by 5.1% compared to 2019 (see next chart). The biggest decline came from lower retail revenues, which fell 21.9%, slightly less than the reduction in passenger numbers. Aeronautical revenues, which are the charges levied on airlines and their customers for using the airport, were actually up by 2.6%. “Other revenue” fell by 9.1%, but about half of that revenue category is in the form of “other regulated charges”, which are fees levied on airlines for things like baggage systems. That element of charges also went up slightly. The decline in the overall “other revenue” number was due to drops in Heathrow Express revenue and income from investment property rentals.
Source: Company reports, GridPoint Analysis
Whilst revenue fell, operating costs went up by 4.1% relative to 2019. The main culprits were the two least well defined cost categories of “operational costs” (up 18.6%) and “utilities and other” (up 10.9%). I’m sure that utilities costs were up, but quite what is driving the other cost increases is not at all clear. Certainly the company provides no useful commentary. I would expect that at least one of the explanations would be a significant spend on consultants and lawyers to support their lobbying of the CAA.
Source: Company reports, GridPoint Analysis
Financing costs
An operating profit of £914m sounds like a lot of money, but was it enough to cover Heathrow’s financing costs and provide a decent return on capital?
The average capital employed in the business on a historical cost accounting basis in 2022 was £13 billion, so the operating return on capital was 7.0%. Not stellar, but as a low risk regulated utility which can leverage up with cheap debt, that should more than cover its weight average cost of capital.
The reported operating profit would represent a lower return on the company’s Regulated Asset Base (“RAB”) of £19.2 billion. But if you are going to adjust the capital employed for inflation every year (which is how the RAB works), you also have to reduce the depreciation, which would be positive to profits and provide an offset.
When it comes to covering interest costs, the regulated entity had net debt of £14.6 billion at the end of 2022, up from £13.3 billion a year earlier, so an average of £14 billion. £914m of operating profit ought to be more than enough to cover interest costs on that, at any reasonable interest rate. To make a pre-tax profit only needs average interest rates to be less than 6.5% (0.914/14). Whilst interest rates have gone up, they haven’t risen that much and most of Heathrow’s debt is at fixed rates anyway.
The reported net finance costs were £690m, which would equate to an average effective interest rate of 4.9% (0.69/14). But Heathrow airport would like us to believe that their “real” net finance costs for the year were over double that at £1.6 billion, an effective rate of 11.4%. Remember this is just the cost of their debt, there is no allowance here for a cost of equity. This £1.6 billion figure is what lies behind the adjusted loss before tax of £684m that had them bleating about the unfairness of the world and how badly they are being treated by their regulator.
I’ll let you make up your own mind whether you believe what they are saying.
What do the next couple of years hold?
Of course, the CAA has now issued its decision on airport charges for the 2023 - 2027 period. I covered that in this post if you are interested in the details. I thought it would be interesting to do a quick “fag packet” forecast for Heathrow’s profits in 2023 and 2024.
Charges were set on an interim basis for 2023 at £31.32 per passenger, even higher than the 2022 figure and a whopping 37% higher than the 2019 level. When it announced its final decision, the CAA decided not to amend those charges part way through the year, despite recognising that they had been set far too high in retrospect, given the passenger recovery. As I set out in the article referenced above, I believe that passenger numbers will hit at least 77 million in 2023, 95% of 2019 levels. January came in at 92.5% of 2019 and we just got the figure for February, which was 94.8%, so I remain quite confident of my forecast.
With user charges of £31.32 per passenger and 77 million passengers, aeronautical revenues will rise to £2.4 billion, a 28% increase on 2022 and an extra £533m of revenue. If retail revenue goes up by 5% per passenger, which doesn’t sound that unlikely given the inflationary environment, we’d get another revenue increase worth £687m. If “other revenue” goes up 5% (e.g. through Heathrow Express revenues recovering to 2019 levels and the other elements remaining flat), that’s a further £24m. These assumptions would translate into a revenue growth of a cool £732m. If operating costs go up by 5% too, that’s only an extra £100m of costs, meaning that operating profit would rise to over £1.5 billion, over 25% more than the airport made pre-crisis.
In 2024, the aeronautical charges will fall by 19% compared to 2023, but will still be 11% higher than 2019. The CAA “nominal charges” figure for 2024 of £25.43 per passenger is based on inflation of 0.6%, I think. Personally, I doubt that inflation will be that low, but let’s run with the CAA assumption and also apply that inflation rate to retail revenues per passenger, other revenue and to operating costs for the purpose of illustration. I believe that passenger numbers will at least get back to 2019 levels by then, which would be a growth of about 5% in volume compared to my 2023 number. That would give us an operating profit forecast for 2024 of £1.2 billion. This would be a big drop compared to what I expect to be a bumper 2023, but it is still more money than Heathrow made in 2019 and easily enough to cover any reasonable estimate of their financing costs.
A challenging public relations position
Assuming the airport’s owners eventually accept the verdict of the CAA on charges or run out of legal avenues on which to challenge the decision, they will at some point have to find a way out of the corner they’ve painted themselves into. At the moment their position is that they won’t be able to finance their business and will have to slash investment and customer service at the charging levels which have been set by the CAA. As we’ve seen, their predictions of financial doom lack credibility, as long as passenger numbers don’t collapse again.
The airport could still of course go on an “investment strike” or deliberately erode customer service by under-resourcing the airport, in order to avoid admitting that they were bluffing. But they will have to do that whilst reporting very healthy profit levels, which would be somewhat challenging from a public relations perspective and unlikely to stand them in good stead in future relations with airlines or their regulator.
The official position of the airport is also that the third runway is still a viable project, despite the fact that airline support has evaporated in the face of spiralling cost estimates. Challenges to aviation growth on sustainability grounds have also grown massively since the project was first put forward. John Holland-Kaye continues to insist that the project will still go forward, despite increasingly looking like a work creation scheme for lawyers and consultants which will never see the light of day.
Time for a reset?
The arrival of a new chief executive would be the perfect time for a reset in Heathrow’s position on airport charges, its relationship with airlines and the CAA, and on the third runway project. I don’t know whether the increasingly pressing need to execute such a series of U-turns had anything to do with the decision to make a change at the top. After several gruelling years battling protestors and dealing with the consequences of the pandemic, I can certainly imagine that John Holland-Kaye had just had enough and fancied a new job or a break.
I don’t suppose it will be difficult to find someone willing to take on the task of running the UK’s biggest airport. Fortunately, the world is not short of people who fancy a challenge. Finding someone who can rebuild trust with airlines and the CAA, whilst also delivering on the financial expectations of the airport’s shareholders, may be more of a tall order.
