A Slump in German exports may weaken Fraport earnings
In any country, the financial health and wellbeing of the transportation infrastructure industry is tightly linked to the health of the economy, to the extent that stock market transportation indices often are used as an early signal that an economy is contracting or expanding. In the case of major exporting nations, like Germany, the link between the health of the transportation infrastructure and that of not just the local but also the global economy is even tighter. And in the case of Germany, the storm clouds certainly are clustered on the horizon. While the German economy remains the most robust of its fellow eurozone members (see the chart below), all EU nations rank high on any list of Germany’s major trading partners and it’s hardly surprising that their own economic weakness is taking a toll on German exports (represented by the brown line in the chart below).
That weakening of exports is a worrying sign for Fraport Ag (FRAG.DE), which owns and operates Germany’s largest airport in Frankfurt am Main. The company’s debt has grown fivefold since 2007, as it expanded and updated the airport’s facilities. But the collapse in the rate of growth of German exports raises anxiety that those investments may not pay off in the short run. Certainly, the StarMine Earnings Quality Score of 10 indicates that the earnings at Fraport may not be sustainable in the coming quarters.
StarMine uses computer-driven models to analyze the financial statements of thousands of publicly-traded companies, and to calculate a proprietary StarMine Earnings Quality (EQ) scores for each of those businesses. Those companies recording the lowest StarMine EQ scores are the least likely to be able to sustain their past earnings track record. (For a more detailed explanation of this model, please refer to this recent article about the earnings quality of American Express.) This examination of Fraport’s earnings is the next in a series of articles looking at the earnings quality of companies across Europe that rank either especially low or high by our quantitative measure.
Fraport’s free cash flow (FCF) has been consistently negative, lagging the company’s net income, as indicated by the red bars in the left-hand chart below. Although it continues to generate profits, the company is burning through its cash: that, in itself, is one reason Fraport’s EQ score is so low. Studies show that strong FCF – free cash flow that exceeds a company’s net income – is a hallmark of sustainable earnings. Alas, the reverse is true of Fraport’s finances.
Moreover, in the last five years Fraport’s capital spending (CapEx) has exceeded its cash flow from operations, to the tune of €2 billion since 2007. That kind of heavy spending – unsupported by a similar surge in cash flow – isn’t sustainable, and to fund it, Fraport has had to increase its debt from €800 million to €4 billion in the same period. If German companies end up confronting the same illiquid debt markets or sharp increases in interest costs that have confronted corporate borrowers in other European countries, this could further weigh on Fraport’s growth prospects.
Fraport’s higher debt load also means that the company must devote a larger portion of its operating income to cover the interest owing on that debt. As can be seen in the chart below, the company’s operating income reached €70 million in 2011 – but it had to pay out €59 million in the shape of interest. Those interest payments are unlikely to decline any time soon, given the size of the company’s debt load. If the rate of growth in German exports continues to weaken as dramatically as it has been, then Frankfurt’s airport is bound to see both revenue and earnings fall, in turn raising the possibility that interest payments might exceed operating income. That kind of situation is, needless to say, an unpleasant one for any company to confront and a bad sign for earnings sustainability.
Germany’s economy is one of the strongest in the eurozone today, but it isn’t immune to contagion. While Fraport has interests in many other airports around the world (including a 10% share of the Delhi Airport and a 70% stake in the Lima airport in Peru),it derives a majority of its revenue from Frankfurt, the ninth busiest airport hub in the world. About 55 million passengers pass through its terminals annually and it is the headquarters for Lufthansa Cargo. The airport is aggressively expanding in order to accommodate the growing traffic, both of passenger flights and cargo shipments. Still, as this recent Reuters News article notes, there are other factors at work that may limit the ability of the Frankfurt airport to continue boosting its revenues and profits, including a ban on night flights recently upheld by German courts.
Overall, the company is struggling under the cost of making necessary expansions to the Frankfurt airport. While those are needed, the hefty interest payments required to finance the debt the company has used to cover the cost of that overhaul is one major reason Fraport’s StarMine EQ score is only 10 out of a possible 100.
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