Is Sydney Airport bluffing?

Max Moore-Wilton must be one hell of a poker player.

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Chairman Max Moore-Wilton must be one hell of a poker player. His Sydney Airport (ASX: SYD) pulled off some political sleight of hand this week with by unveiling a plan to double the airport’s capacity in 20 years.

That headline-grabbing claim no doubt threw cold water on the hopes of many who would like to see a second airport open in the Sydney area.

When you start to dig into the claim a little bit, though, the new Master Plan loses some lustre. As my Foolish colleague Tim McArthur said yesterday:

Amazingly the Master Plan assumes no change to curfews, no change in aircraft movement cap, no change to noise sharing arrangements, no change to access arrangements for regional airlines and no new flight paths or runways.

It’s a bold plan — so bold it strikes me as bluster. This would mean Sydney Airport could grow capacity by 3.5% annually for two decades mostly by wringing the operational towel and fine-turning existing systems and infrastructure.

As a frequent traveller, you don’t have to convince me that there’s room for operational improvement at airports. But a 3.5% annualised improvement is an audacious goal what with a few critical factors outside the airport’s control. Think weather, the tricky coordination of international flights, and that the airport’s true customers — airlines — are not only famously inefficient but also might want not play along with the airport’s new plans.

This is a high-stakes poker game for Sydney Airport. The monopolist is fending off political and business interests that rightly believe a second Sydney-area airport would create jobs, lower travel costs, and give travellers more choice.

Moore-Wilton knows the financial score. A monopoly is worth a lot more than a duopoly. Yes, a second airport would increase the size of the overall market. And, yes, a second airport would probably focus on domestic and low-cost tickets because of Sydney Airport’s existing relationships and ready access to the heart of Sydney. That would leave most prized, well-heeled international travellers for Sydney Airport’s keeping. Anyone who has navigated the gauntlet of Sydney Airport’s duty free shopping area for inbound international travellers knows all too well that the airport is very successfully earning every last dollar from global jetsetters. It’s hard to escape without a bottle of Scotch and some Toblerone.

Despite what would still be a plum competitive position, though, a second airport would cripple Sydney Airport’s profits. Profits would fall off faster than volumes because of the fixed nature of some airport expenditures. Perhaps more ominous, the business is levered up to its eyeballs so that it can squeeze every ounce of returns on equity possible. The airport would have plenty of time to adapt and streamline its capital structure before a second airport opens, but the overcapacity would permanently wash away a large chunk of profits.

Overcapacity is the bane of capital-intensive businesses. Simply look west to how years of zealous overinvestment in building out iron ore supply by the likes of BHP Billiton (ASX: BHP), Rio Tinto (ASX: RIO), and Fortescue Metals Group (ASX: FMG) are just now coming home to roost. Iron ore prices could be hobbled for several years because of this frenzied supply growth peaking just as iron ore demand is cooling. Much the same fate could await Sydney Airport if it can’t keep politicians and the public confident it can keep up with Australia’s growth.

The bottom line is that, so long as it keeps playing its cards right, Sydney Airport should be able to fend off the construction of a new local rival for a long time yet. That should keep the profits flowing and the 5.9%-yielding distribution growing. If — when — a second Sydney airport eventually gets a green light, though, Sydney Airport’s shares could be in for a rough decade.

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Motley Fool advisor Joe Magyer does not own shares in any of the companies mentioned in this article.

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