Infrastructure company Sydney Airport Holdings Pty Ltd (ASX: SYD) is a favourite of dividend-seeking shareholders because of the perceived reliability of its earnings and dividend payments.
The company has also well and truly thrashed the market over the past 14 years, rising 500% before dividends. This is what happens when you have a monopoly, growing traffic, and a large degree of control over the fees your customers pay:
With current low interest rates, the company's shares have been bid up to the point where it pays a 4.8% dividend. This is an attractive yield in today's markets, but probably too low if interest rates were to return to, say, 4%. In that case, shares could theoretically fall until the dividend became larger. However, we're probably a couple of years away from 4% interest rates. If traffic continues growing at the rate that it has been, it's likely that dividends will grow enough to reduce the impact of higher rates on share prices.
That said, higher interest rates have an important secondary effect, because Sydney Airport is also in debt to its eyeballs. It has net debt of 6.9x its earnings before interest, tax, depreciation, and amortisation (EBITDA; most companies are limited to 3.5x), and cash flow coverage of the interest payments of 2.7x. This appears sustainable, even with higher interest rates, as long as traffic keeps growing. However, in the unlikely event that air traffic falls significantly for a prolonged period of time, Sydney Airport and its dividend will find itself in a very difficult financial situation.
I'd consider buying Sydney Airport both for its dividend and its ability to earn more over time. Due to its location in the heart of Sydney, the airport will continue to enjoy most of its competitive advantages even if a second airport is constructed, preserving its ability to earn above-average returns over time. However, investors would be wise to be aware of the risks.
