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3 key risks facing Sydney Airport Holdings Pty Ltd (ASX:SYD) investors

Dark clouds are gathering for Sydney Airport Holdings Pty Ltd (ASX: SYD) and its outperforming share price could be in for some turbulent times after UBS downgraded the stock.

The news hasn’t hurt the stock though as it gained 0.5% to hit a fresh seven-month high of $7.57 in lunch time trade when the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index has slipped 0.1% into the red.

This takes Sydney Airport’s three-month share price rally to a whopping 16% when the top 200 benchmark is only up 5%.

Investors are still cheering yesterday’s May traffic report that showed robust growth in international passengers going through our nation’s biggest airport.

But this could be the time to lock in some profit after UBS cut its “buy” recommendation on the stock to “hold” even though its survey of 1,419 residents in tier 1 and 2 cities in China voted Sydney as their second most popular destination after Tokyo.

“Growth in Chinese visitors has been a material driver in Sydney Airport’s international traffic growth, accounting for an estimated 2%pa [per annum] over the last three years. This growth has a multiplier effect on revenue due to Chinese visitors spending [circa] 3x the average of most nationalities,” said UBS.

“Every 1% additional growth in international traffic from Chinese travellers adds an estimated 2% to group cashflow, all else equal.”

While the trends remain supportive for Sydney Airport over the next year or so, there are three key risks that could take the shine off the stock over the medium term.

Tax is one of them with Sydney Airport expected to start paying tax in 2022. UBS notes that management has not said how it plans to pay its tax obligation.

It could start trimming its dividend distributions to meet its tax payment or take a bigger one-time cut. Either way, investors should start factoring this into their deliberations.

The second issue is the renegotiation of international aeronautical charges, which will likely start in 2019 as the current agreement expires in mid-2020.

“Higher-than-expected traffic and 3.8%pa inflation in aero charges over recent years could lead to a weaker inflation outcome in this new agreement,” warns UBS.

The third risk investors will need to keep an eye on is debt. The projected growth in debt and the timing of maturities mean that around 60% of forecast group debt in five years will be unhedged.

Sydney Airport has around $9 billion in debt on its balance sheet and the rise in global bond yields will leave a large proportion of this debt exposed to higher costs.

UBS estimates that a 1% increase in spot-funding rates will cut cashflow by around 6% in 2023, assuming there are no changes to the company’s hedging.

I’m not a big fan of infrastructure stocks in this rising bond yield environment as stocks like Sydney Airport, Transurban Group (ASX: TCL) and Spark Infrastructure Group (ASX: SKI) face rising risks.

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Motley Fool contributor Brendon Lau has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of and has recommended Sydney Airport Holdings Limited and Transurban Group. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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