Brian Gaynor: Monopoly - or another board game?

The spat between Air New Zealand and Auckland International Airport has been one of the highlights of the annual meeting season.

It is not as melodramatic as Russell Crowe's latest movie, Cinderella Man, but the airline is trying to portray itself as James J. Braddock, the popular boxer played by Crowe, while representing the airport as Max Baer, Braddock's mean and prosperous ring opponent.

Air New Zealand, which has been throwing punches at Auckland and Wellington airports for a number of years, opened the latest round at its annual meeting at the SkyCity Convention Centre on October 19.

Chairman John Palmer argued that local airports were unconstrained monopolies. He claimed that airports imposed charges at a much higher level than was appropriate to achieve an adequate return on their investment.

As he spoke, a graph appeared on the big video screens showing that landing charges for a B747 at Auckland Airport were $5016, compared with $4257 at Nagoya, $3889 in London, $3770 in Singapore, $3322 in Brisbane and only $2655 at Los Angeles International Airport.

He noted that profit margins at Auckland Airport were more than twice those achieved by European airports, mainly because the latter faced more competition. Palmer argued that the inappropriate regulatory framework for local airports resulted in a consumer impost of more than $50 million a year.

The attack on Auckland Airport immediately preceded his announcement that the company's engineering division could be downsized, with significant job losses.

The conflict was reignited on Tuesday when the Board of Airline Representatives New Zealand (Barnz), of which Air New Zealand is an important member, issued a media release urging Auckland Airport shareholders to caution the company on the long-term consequences of monopolistic behaviour.

Barnz executive director Stewart Milne was quoted as saying: "Auckland Airport is well-recognised for charging its airline customers way above international industry averages. Ultimately, this short-sighted, monopolistic behaviour will have a negative effect on growth."

Milne went on to say that the airport was unable to accept that the huge profits made on its commercial activities were due to the number of people attracted to its facility by the airlines.

Auckland Airport's annual meeting, which was held at the TelstraClear Pacific Events Centre in Manukau City on Wednesday, clearly illustrated that the company was adopting a charm offensive in response to the Air New Zealand and Barnz criticism.

Chief executive Don Huse greeted shareholders with a warm smile at the front door of the centre. Senior executives stood around the foyer chatting among themselves or with shareholders.

Company secretary Chris Curley disclosed that the addresses to shareholders would contain strong rebuttals of Air New Zealand claims a week earlier. He gave the clear impression that this was going to be one of the key features of the annual meeting.

The informality at an Auckland Airport function is in sharp contrast to Air New Zealand, where directors and executives make a staged entrance before annual meetings or results presentations.

Airport chairman Wayne Boyd gave an upbeat assessment of the group's prospects. He said revenue and operating earnings for the three months were ahead of the same period in the 2005 year but net earnings were down from $25.2 million to $24.9 million, mainly due to higher interest costs associated with the recent capital repayment.

As far as the full June 2006 year was concerned, the company expected to achieve after-tax net earnings in excess of $100 million, barring any material adverse events or unforeseen circumstances, compared with $106 million last year.

Interest costs are expected to increase by about $8 million after tax this year, reflecting the cost of the funding of the special distribution and share buy-back.

Huse was given the task of defending the airport against the "monopolistic" accusations.

His comments were straight to the point: "With respect to Auckland Airport, we absolutely refute Palmer's allegations. They are false. They are misleading."

The large video screens reproduced the landing charges graph shown at Air New Zealand's annual meeting. Huse argued that the graph was misleading as it only showed landing charges when the total cost of landing and taking off should be included.

Sydney Airport, for example, has a specific noise levy, whereas Auckland has none.

It cost $5016 to land at Auckland but nothing to take off, but at Brisbane it cost $3322 to land and the same to take off, for a total of $6644 (terminal charges are included in the Brisbane figure but not at Auckland).

When total turnaround costs - including bag reconciliation, security, departure fees, terminal charges and landing and takeoff charges - are taken into account, the cost at Auckland is about $14,000 a flight, compared with $18,000 at Brisbane.

One shareholder was sceptical about this analysis, but Huse and Boyd turned on the charm for her and other shareholders. Every question was either "very good" or "very interesting" as far as the chairman and chief executive were concerned and were all answered with broad smiles.

Although Air New Zealand and Auckland Airport operate in the same industry, they face totally different competitive situations. The airline industry is extremely cut-throat and demand is enormously sensitive to fare increases.

By contrast, airports, particularly in Australasia, face almost no competition and airlines, passengers and visitors have little choice but to accept price increases.

As the accompanying table demonstrates, this means that airports are exceptionally profitable whereas airlines struggle to achieve an adequate return for shareholders.

In the June 2005 year, Air New Zealand had total revenue of $3.61 billion compared with only $283 million for Auckland Airport yet the airport had earnings before interest and tax (ebit) of $189 million, compared with $212 million for the national carrier.

This reflected a whopping 67.1 per cent ebit margin for Auckland Airport compared with just 6 per cent for Air New Zealand.

The gap will widen this year as the airport is forecasting higher ebit, whereas the airline is predicting that pre-tax earning will fall from $232 million year to about $100 million - mainly due to higher fuel costs.

As one would expect, the huge difference in margins is reflected in shareholder returns.

When Auckland Airport was listed in July 1998, it had a sharemarket value of $756 million based on the $1.80 issue price. Since then, its sharemarket value has risen to $2.33 billion while it has distributed $813 million in dividends and capital to shareholders.

By contrast Air New Zealand's market value has fallen from $1.15 billion to $1.09 billion since Auckland Airport's listing date, even though shareholders have contributed more than $1 billion of new equity.

Huse argues that the strong performance of Auckland is due to its operating effectiveness rather than any monopolistic position. There is some truth in this argument, but one of the video screen projections showed that Huse, who was previously chief executive of Wellington Airport and Sydney Airport, hasn't had much experience in low-margin environments.

The projection stated that airlines were "game-playing" and airport charges represented only 4 per cent of airline operating costs.

When a company has an ebit margin of only 6 per cent and the margin is falling, then every dollar counts. That is why Air New Zealand is considering downsizing its engineering division and will continue to put pressure on Auckland Airport and the other domestic airports over landing charges.

* Disclosure of interest: Brian Gaynor is an executive director of Milford Asset Management.