View from City Road: BAA shows how to make sidelines take off

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The Independent Online
BAA is the stock market's favourite privatised monopoly. Its shares enjoy a rating normally associated with high-quality growth stocks rather than a utility. Indeed, foreign operators, used to seeing airports as a millstone, are flocking to BAA to ask them if they are interested in running their own airports.

What a contrast BAA is with other privatisation stocks. British Telecom has laboured under an unforgiving regulatory regime on its pricing. The signs are that Ofwat will begin to make waves over water company pricing in next year's review. And it is a fair bet that the electricity distribution companies are also in for a nasty shock next year when Offer draws up its own set of pricing rules.

But BAA is coping skilfully with the first two tough years of the pricing regime laid down by the Civil Aviation Authority, and the company can look forward to three considerably easier years from next March. The price cap on airport traffic charges, currently 8 percentage points below changes in the Retail Price Index, will ease to 4 points below and then to 1 point below.

Regulation is having a predictable effect on BAA's revenue from traffic charges, which fell slightly from pounds 245.7m to pounds 244m in the six months to 30 September. The CAA pricing formula forced price cuts of 0.7 per cent, which offset almost all the rise in passenger volume. A shift of airline traffic from peak- time Gatwick slots to off-peak slots at the more popular Heathrow cost another pounds 5.3m in revenues.

Rigorous cost control means that BAA is surviving the pricing squeeze even before it eases. But it is its non-regulated, retailing operations that have caught the imagination of investors and rival airport operators. Unlike the water companies and the regional electricity companies, BAA is proving that it can make formerly non-core activities work. From an admittedly rock bottom base in 1987, BAA is now generating more revenue from airport retailing than airport charges.

Each passenger spent 4.6 per cent more in BAA's 400 shops in the latest six months. Since BAA is expecting traffic to grow by 4 per cent a year into the next century, revenue growth looks assured. Meanwhile, the traffic charge cap will loosen. Even with a yield of only 2 per cent and a prospective price/earnings ratio of 20 (assuming pre-tax profits of pounds 325m), BAA looks a solid investment for the second half of the decade.

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