Fitch Ratings-London-03 July 2017: European airports' renewed efforts to increase their non-aeronautical revenues can have a mixed impact on credit profiles, Fitch Ratings says. The strategy could help some airports perform better in a downturn if it results in a genuine diversification of revenue streams, but it can also expose them to new risks.

Non-aeronautical revenues have been part of airports' business models for many years, but a desire to maximise returns is driving new approaches to income diversification. Some airports have gained exposure to commercial real estate. For example, Brussels Airport has increased revenues by offering long-term land leases to third party real estate investors or developers to develop and commercialise office buildings that house blue chip tenants like Deloitte, KPMG and Microsoft.

Airports operating close to capacity such as Heathrow are also continuously increasing their focus on more traditional ancillary operations like retail concessions, because of the limited potential to increase aeronautical revenues. In 1Q17, Heathrow's Terminal 4 retail development helped increase retail revenues by 8.8% yoy to GBP148 million, while aeronautical revenues were flat at GBP389 million.

In rating airports we assess the impact of these revenue streams on the credit profile on a case-by-case basis. Key factors in this assessment include whether non-aeronautical revenue drives overall revenue growth; how closely these alternative revenue streams are linked to passenger numbers; and whether they are exposed to the same risks as aeronautical revenues.

Projects such as real estate development are the most likely to provide genuine diversification as revenue is not directly linked to passenger numbers and lease agreements are long-term. This can be positive for credit risk profiles as their revenues may prove more resilient in adverse economic conditions. However, depending on how they are structured, projects of this type could also expose an airport to risks associated with the commercial real estate sector, which could outweigh the benefit from diversification. These risks include the loss of a major tenant or the failure of a third party involved in the development. Any positive or negative impact on the airport's credit profile would also depend on the scale of the development relative to the airport as a whole.

Other non-aeronautical revenue sources, such as hotels, retail space and car parking, provide less diversification because their performance is largely driven by passenger numbers. Where airports are focussing on these types of commercial income, their exposure to the risk of weak economic growth may increase, as these revenues tend to perform worse than aeronautical income in a downturn.

For example, travellers may seek cheaper transport to/from the airport, trade down to the lowest cost car park or increase advanced parking bookings at a lower yield, all of which affect parking revenues. This happened at Gatwick, Manchester and Stansted, with the latter's net car parking income per passenger falling 14.8% to GBP1.4 in 2009, even though aeronautical income per passenger grew by 1.9% to GBP6.6. These risks can be mitigated, for example, through concessions contracts that include a guaranteed minimum annual payment.

Efforts to increase non-aeronautical revenue are also a major driver behind airports' technology investments, including the provision of Wi-Fi and more online services. This is intended to help create a direct relationship with travellers, who are currently customers of the airlines, rather than the airport.

The impact of non-aeronautical revenue on airports' business models was one of the key themes that arose during a recent Fitch-hosted Infin Breakfast Club with investors, bankers and representatives of major European airports.