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Edited Transcript of SYD.AX earnings conference call or presentation 15-Aug-19 1:00am GMT

Half Year 2019 Sydney Airport Holdings Pty Ltd Earnings Call

Sydney, New South Wales Sep 17, 2019 (Thomson StreetEvents) -- Edited Transcript of Sydney Airport Holdings Pty Ltd earnings conference call or presentation Thursday, August 15, 2019 at 1:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Geoffrey Culbert

Sydney Airport Limited - CEO

* Greg Botham

Sydney Airport Limited - CFO

* Hugh Wehby

Sydney Airport Limited - COO

* Vanessa Orth

Sydney Airport Limited - Chief Commercial Officer of Non-Aeronautical

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Conference Call Participants

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* Cameron McDonald

Evans & Partners Pty. Ltd., Research Division - Head of Research

* David Lloyd

Citigroup Inc, Research Division - Director & Analyst

* Ian Myles

Macquarie Research - Analyst

* Nathan Lead

Morgans Financial Limited, Research Division - Senior Analyst

* Owen Birrell

Goldman Sachs Group Inc., Research Division - Metals and Mining Company Analyst

* Paul Butler

Crédit Suisse AG, Research Division - Director

* Richard Barry Jones

JP Morgan Chase & Co, Research Division - VP

* Robert Koh

Morgan Stanley, Research Division - VP

* Scott Ryall

Rimor Equity Research Pty Ltd - Principal

* Simon A. Mitchell

UBS Investment Bank, Research Division - MD and Head of Research for Australia and New Zealand

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Presentation

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Operator [1]

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Thank you for standing by, and welcome to the Sydney Airport HY '19 Results Conference Call. (Operator Instructions) I'd now like to hand the conference over to Mr. Geoff Culbert, Chief Executive Officer. Please go ahead.

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Geoffrey Culbert, Sydney Airport Limited - CEO [2]

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Thank you, and good morning, everyone, and welcome to the 2019 Half Year Results for Sydney Airport. So as usual, I'm joined by our CFO, Greg Botham. And today, we also have a couple of guest appearances. We're joined by Hugh Wehby, our Chief Operating Officer; and Vanessa Orth, our Chief Commercial Officer. So Greg will run you through the numbers, and Hugh will give some insight into the aviation business. And then Vanessa's going to run through the latest on the commercial nonaviation business. So it should be interesting to hear directly from both Hugh and Vanessa in addition to Greg.

So let's jump straight into it, and move to Page 3. As you can see from the passenger numbers on the top left of this chart, it has been a challenging year to-date. This comes as no surprise to anyone, given we release monthly pax numbers. International was up by 1.9%. Domestic down by 1.5%. And overall, passengers for the half were down by 0.2%.

Just to put that in context, this is the first time that passenger numbers have been down in a half year since the GFC, so almost a decade. So as I said, it has been a challenging half year. Having said that, even in this tough environment, we were still able to grow revenue by 3.4%. We grew normalized EBITDA by 4.1%, and net operating receipts grew by 4.8%. And we're on track to more than fully cover our full year distribution of $0.39 per share, which will be 4% up on 2018.

I mentioned in the full year results that this is a resilient and robust business that can deliver across all cycles. And I think it's a validation of that resilience and robustness that we can still post solid growth numbers even in the most challenging operating environment that we've seen in a decade. And it hasn't happened by accident, it hasn't happened by accident. We've actively built resilience into the business model over time by diversifying revenue streams. And Hugh and Vanessa in their sections will touch on how we've done that.

In addition, over the past 12 months, we've introduced greater cost discipline into the organization, and that has enabled us to react quickly to the challenging and changing market. And that's reflected in the fact that we are able to take costs down by 1.4% in the first half, which you can see on this page. There's more cost out to come in the second half of the year as we get the benefit of the actions that we took in the first half, and Greg will take you through that in more detail later on.

Before we go to the next page, I want to take a moment to thank the entire team at Sydney Airport for the role they have played in delivering these first half numbers. They've all worked incredibly hard in a tough market and shown a genuine willingness to embrace change and find new ways to deliver for our investors. It's been an outstanding effort by everyone, so thank you.

Let's move to Page 4. As you can see from this page, we're paying our first half distribution today at $0.195 per security, and we're reaffirming our full year guidance at $0.39 a share. It's our expectation that this will be more than fully covered by net operating receipts. $0.39 a share will represent 4% growth year-on-year, and it will also mean a 10.7% CAGR over the last 5 years, which is a great result for our investors.

As I said before, this is an extremely strong and resilient business. As you can see from the chart on the right-hand side, we've been able to grow revenue and EBITDA every year since privatization even in tough environments like we're facing at the moment, and this year is no exception. And that gives us confidence in reaffirming guidance for the full year 2019.

So I'll now hand over to Greg, who will run you through the numbers in more detail. Over to you, Greg.

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Greg Botham, Sydney Airport Limited - CFO [3]

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Thank you, Geoff. So we'll move across into Page 6 and run you through some detail for the half. So here, we have a statutory view of income and also for the prior corresponding period. Total revenue there is up 3.4% including security recoveries on the prior half. And Geoff will run through that a little bit more detail in terms of the primary drivers of growth later on in the presentation.

Total OpEx here on this page, $147.9 million, was up half-on-half $0.5 million versus the pcp, but that includes all security recoverable expenses. If we back those out, we reduce OpEx half-on-half, as Geoff flagged earlier, which is really pleasing, and I'll take you through that in some more detail on the next slide.

Two other expense items here, other expense items for the half, which I'll explain now in a bit more detail, too. So firstly, $181.7 million indemnity expense; this relates to historical Danish tax indemnities provided on the sale of Copenhagen Airport back in 2011. We foreshadowed this last week in a market announcement.

The indemnity expense here represents 2 items. Firstly, we've taken a conservative view and written down to nil the noncurrent receivable that we held on balance sheet of $119.1 million, and we had that on balance sheet as at December '17 and again in 2018. This related to an amount we paid already under a core on the indemnity back in 2017 in respect of Danish tax, specifically interest withholding tax.

Secondly, today, or in this half year, we recognized a provision for a potential further claim under the indemnity in respect of dividend withholding tax for a further $62.6 million. This includes primary amounting dispute over in Denmark, plus all accrued interest with the passage of time up to 30 June 2019. Note, there's been no call on this under the indemnity, no cash moving, but we have prudently recognized the prospect of a potential further call.

As further background to this, we disclosed back in May this year that there had been a number of recent decisions made by the European Court of Justice since our full year financial report that had prompted reconsideration of the status of these indemnities. The decision by the ECJ or the decisions weren't specifically in relation to our disputes. However, given the uncertainty and the time frames involved, the SAT1 Board felt it was prudent to expense the full $181.7 million while these matters continue to work their way through the Danish courts. We want to make it clear though that expensing these amounts now in no way impacts the final outcomes on these matters, which we will continue to vigorously pursue.

The other expense item here is $2.4 million, which we reported here as restructure and redundancy expenses. This cost was incurred at the very end of the first half. So we didn't see savings accrue in the half year as we report today, but we will see savings from that over the balance of this year and beyond.

So headline EBITDA including all those items was $465.1 million for the half, impacted by those expenses. Backing those out, we had $649.2 million of EBITDA, up from $623.4 million or 4.1% growth on the pcp.

Depreciation and amortization were $211.4 million, reflecting charges on additional capital investment.

Net finance cost for the P&L, $204.6 million, down versus the pcp, supported by better borrowing margins following our successful bank refi earlier this year, lower noncash borrowing cost amortization charges and lower interest rates. Income tax expense for the half was $31.8 million. This was noncash.

Looking beyond the accounting number there on tax. In terms of tax losses, taxable income we generated was again fully offset by losses during the half year. The estimate of taxable income for the half was $152 million. So accumulated losses still stand at $562 million as at 30 June 2019. We're still expecting to start paying cash tax based on our current assumptions in the 2022 calendar year. So no change to that since we provided that color back in February at full year.

Just a final comment, if we just go back to that slide for a moment, just a final comment on that. The noncontrolling interest item at the very bottom, this is just a function of the consolidated group accounting. This effectively adds back any losses made by the SAT1 Trust, which is usually very small, but obviously, in this half year, reflects a larger number due to the indemnity expense.

So if we move across now to Slide 7. As Geoff mentioned, we did focus really hard during the half year and even just before that, given the challenging environment, on cost. Cost is absolutely something we can manage tightly, and we've worked really hard on this over the last 6 to 12 months. The slide outlines the operating expenses excluding security recovery for the half year, what you might call controllable operating costs. We had a decrease half-on-half in controllable OpEx of about 1.4%. We're also confident we're on track across the full year for a pleasing decrease in controllable operating expenses.

In this half year, we did realize savings from a range of initiatives. Some of those are smaller, some are larger. Some of these initiatives take time to plan and implement such as the savings we're now enjoying from reprocuring our electricity via PPA announced last year, but effective from January this year.

Briefly on the walk across this page and calling out some of the more significant increases and decreases that contributed. Starting at 1H 2018, you've got $102.8 million for the prior half; then we had an additional cost of around $1.9 million in the half year; additional investment in technology and cyber resilience across a range of factors on the IT side; we had higher land tax costs this year, which reflected step-ups in valuations that play into our bill on commercial land; we add also here for illustration, the effect of price increases on nonlabor items assuming CPI at around 1.5% across the year.

Hotel operations, we had higher occupancy costs or -- and occupancy levels, in fact, which drove some increase in cost. And we also had 78 new rooms coming online during the half for ibis. We had some step-ups also in insurance premium. There are also a range of savings and other items to bring us back very pleasingly, as I said, to $101.2 million for the half year.

Moving on to Page 8. We have the standard reconciliation here of profit to net operating receipts. Our proxy, of course, is net operating receipts, and we talk about free cash to equity available to cover distributions to securityholders.

Profit before tax comes from the statutory income statement on the previous slide. We add back various noncash items and adjust for cash funded maintenance CapEx. You can see here on the slide, the noncash elements of net interest expense being backed out as well.

You can also see here that we back out the indemnity expense as a nonoperating item. It doesn't impact NOR. It's a historical legacy divestment item. In addition, as I mentioned earlier, there were no cash flows on that item in the period, all noncash. Overall, for the half, we achieved net operating receipts of $431.2 million, which is a 4.8% increase half-on-half. NOR per stapled security was $0.191 measured in the half year. Half year distribution doesn't quite cover that, but we certainly expect the full year distribution guidance that we're providing or reaffirming today to be more than fully covered across the full year.

Moving on to Slide 9, a little bit of a look into the CapEx story for the half year. Here's a snapshot across the half. We invested $116.1 million across that half, less than the prior period. Main areas of spend: we focused on delivering, again, of course, key aeronautical infrastructure as well as customer service improvements. Over the past 18 months, Sydney Airport has been strengthening its program management office as well, which has been implementing a range of improvements about how we manage our CapEx program. This has further strengthened also our project management practice across the organization. This gives us all the levers we need to be nimble in managing our CapEx program.

We undertook a detailed review of the entire program during the half with a goal of making sure it is absolutely fit for purpose for the current environment. We reduced the number of projects in the pipeline. In addition, strong governance, analytics and execution enabled savings to be realized on a number of projects. So we're absolutely focusing on delivering cost savings and value for money on CapEx as well as OpEx.

We have revised down our expectations of CapEx guidance or outcomes for the year across 2019 to be between $300 million and $350 million, so a step-up in the second half versus the first half run-rate. The 3-year guidance as well for 2019 to 2021 inclusive remains unchanged at $900 million to $1.1 billion.

Just noting a few items of spend on the slide. The first 3 projects noted here are larger projects and will be delivered across multiple stages, particularly the Northern Ponds and Southern Bag Room. We're currently in the planning stages for both these projects. But once delivered, they'll create a step-change in passenger facilitation. The Northern Ponds project should add an additional 3 active remote gates, gates where you can arrive and depart aircraft without needing to tow. The Southern Bag Room will increase the volume and speed of bags facilitated in Sydney airport while also introducing importantly a step-change in safety and the automation of baggage handling. We've also continued runway and taxiway resheeting programs across the half and also invested in T2 retail at Pier B, as previously mentioned.

Our new advertising contract commenced in January with JCDecaux. And as part of that, we took the opportunity to invest in some digital assets increasing the number of advertising turns and maximizing the return on that investment. Lastly, the 78-room ibis expansion was completed back in March, and this has been trading well.

Moving to capital management, so Page 10. Our balance sheet continues to be in really good shape. Our net debt stands at $8.4 billion as at 30 June 2019. It increased over the half year due to ongoing funding of our growth CapEx. Our cash flow cover and net debt-to-EBITDA ratios continue to strengthen, yet again representing the strongest point since the airport was privatized. Our cash flow cover here is now at 3.2x as at 30 June, up from 3.1x half-on-half. Our net debt-to-EBITDA stands at 6.6x, down from 6.7x again half-on-half.

Our credit rating was unchanged at BBB+, Baa1. Our average cash interest rate reduced by just over 10 basis points to 4.7% supported by the roll-forward of our bank debt facilities at better margins. More about that on the next slide.

Lastly, our interest rate exposure was highly hedged again at 96% measured on a spot basis at 30 June. We didn't execute any new interest rate swaps in the half year. We were very active across 2017 and 2018. So we are well placed on that front. But in line with our policies, we'll certainly keep a close eye on opportunities to do further hedging in the near term.

Now I'd like to take you through one of the really fascinating and exciting initiatives during the half year. So the sustainability linked loan that we completed back in May. So if we move on to Slide 11. In May, we completed this transaction, Australia's first multiback sustainability linked -- multibank sustainability linked loan and the largest of its type in the Asia Pac. We linked the pricing of our bank debt to measurable sustainability outcomes, reinforcing our commitment to sustainability leadership. From a refinancing perspective, it's a really good outcome. We refinanced $1.4 billion of bank facilities at lower margins. The deal extended our weighted average debt maturity by 3 months to mid-2025 and reduces our debt maturities importantly over the 2021 to '22 period by almost 40%. On top of this, it allowed us to maintain strong liquidity where we had over $1.1 billion of undrawn facilities at 30 June 2019.

From a sustainability standpoint though, the transaction enables a 2-way link between Sydney Airport's cost of debt funds and our sustainability outcomes. If certain sustainability metrics are met, we will improve the cost of our bank debt marginally, but the reverse is also true if our metrics decline. It's a great outcome. The finance team and the sustainability teams here are particularly proud of it to be involved in this innovative refinancing during the last period.

Now back to Geoff.

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Geoffrey Culbert, Sydney Airport Limited - CEO [4]

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Thanks, Greg. (inaudible) loan. This is such a great thing for us to be doing. So before I hand over to Hugh and Vanessa, I want to take a deeper look at our businesses and I also want to take a moment to talk about the restructuring that we've done in the organization. So if you go to Slide 13.

We started to see softness in the passenger numbers in the middle of last year. It built over the back end of last year and then accelerated in the first half of this year. We were alert to it early. And going back to the middle of last year, we started to think deeply about our cost profile, our structures and the disciplines in the business that would enable us to not only manage through the cycle, but also to grow through the cycle. So over the past year, we've made a significant number of changes that have enabled us to run the business more efficiently, reduce cost and implement processes and procedures that give us the ability to more effectively control the levers in the business. And you can see some of the major changes here on this page. We've collapsed 4 business units into 2. We now run with 2 main P&Ls, aero and nonaero commercial. This has reduced silos and bureaucracy. It's improved speed of decision-making. And importantly, it's created better linkages between the businesses and helped us to reduce cost.

Overall, we have reduced head count by 8%. But importantly, we did it thoughtfully. When we looked at head count, we analyzed our spans and layers. We consolidated some roles. We removed others. We created a functional services team, rolling HR, communications and legal under the Chief Operating Officer. We also moved IT into the construction and facilities management team, which is now known as assets and infrastructure. We did this because our IT is so heavily embedded into our infrastructure, and we wanted better alignment in that area. And all of this was designed to deliver greater organizational efficiency and cross-team collaboration, and it gives us a much better handle on cost in the business.

As part of this process, I've reduced my direct reports from 10 down to 5. 10 direct reports at my level translates into significant operational complexity, layers and bureaucracy as it cascades down the organization, and you end up with hidden factories that drive up costs and slow down decision-making. We're now much leaner and more effective as a consequence of these changes, and we have put a huge focus on cost control and implemented better procedures to manage costs and drive repeatable savings, and that's a really important point. We've been going after repeatable savings as opposed to one-off savings.

A good example of this is the project management office, which Greg spoke about. We've built that over the past 1.5 years and to put real discipline around our project spend and project management. We had far too many projects in the pipeline. Too many of them weren't a priority, and it was causing churn and driving up costs. In the past 12 months, we've reduced the project pipeline by 12%, and we're now genuinely prioritizing the projects that matter. And importantly, we have the right team and the right processes to go after this on a consistent basis. We're confident that disciplined cost control and efficient management of the operations will enable us to grow through the current cycle, and it will also position us to take maximum advantage of the next growth cycle when that happens. And at some point, it will happen.

I now want to step you through the individual businesses in more detail. So if you turn it to the next page, you'll see the results for the 4 sub P&Ls, Page 14. So as you can see from this page, aero revenue was up by 4.7% driven primarily by the growth in international passengers. We had 8.3 million international passengers in the first half of the year, which is 200,000 more than last year, which is a good result. I think it's interesting and positive that international has continued to grow despite the decline in domestic passengers, and we continue to see some good news here. In fact, today, Malindo Air launched a new daily service from KL to Sydney via Bali. And we're also really excited, we're really excited about the progress we are making on South American routes.

So in November this year, Lat Am is converting 3 of its daily services, which currently go via Auckland to a direct service to Sydney. They're using a Dreamliner on that service, which is a great product. And just last week, Qantas announced it will go from 4 services a week to daily services on the same route, also on a Dreamliner starting in the middle of next year. So we identified Latin America as an emerging market 3 years ago, and we've put a lot of effort into it over that time. So it's really great to see these developments happening. And we think it's just the tip of the iceberg, and Hugh will talk more about that later on.

So retail's up by 4%, which came from a number of sources. We opened 14 new stores in T2. We had favorable lease escalations and performance-based rent from specialty stores, and duty-free grew on the back of international passenger growth.

Property was up by 1.8%. We delivered an additional 78 new rooms in the ibis hotel, which Greg mentioned, and the hotels continued to deliver strong occupancy levels. We also had over 100 rent reviews across the property business, a number of lease renewals, all of this contributed to the growth.

Parking and Ground Transport was down by 1.4%, which you can see on this page. But as we said previously, this is primarily a domestic business and tracks largely in line with domestic pax, which were down 1.5% for the half. So this was no surprise.

So I'm now going to hand over to Hugh, our Chief Operating Officer, and Hugh's going to give you more color on what we're seeing on the aero side of the business. And following that, Vanessa is going to walk you through the commercial nonaero business. So Hugh, over to you.

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Hugh Wehby, Sydney Airport Limited - COO [5]

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Thanks, Geoff. It's a real pleasure to be back talking to our investors and analysts for the first time since our 2016 full year results. As Geoff mentioned earlier, it's been a challenging passenger growth environment, especially when compared to the past 3 years. Whilst almost all sectors have slowed, international continues to outperform domestic. And as Geoff mentioned, we're up 200,000 passengers in the first half. This is important given international is our largest driver of financial performance.

While we continue to report our monthly numbers, we actually have the airport leased until 2097. And a number of key factors give us ongoing confidence in the medium to long-term picture. And the common word connecting these factors is diversity. We have 47 airlines flying to more than 100 destinations with a broad mix of both foreign residency arrivals and Australian outbound destinations, all traveling for a wide range of purposes. These are not just statistics for the sake of it. These fundamentals make us attractive to airlines and passengers. They drive resilience. They expand our ongoing opportunities for growth, and they help to make our business and indeed our city and our state globally competitive.

Looking at the slide in some more detail. Chinese nationals traveling to Sydney continue to top the foreign arrivals list with 7% share of international pax, closely followed by U.S.A. nationals at 6% and New Zealanders at 5%. Beyond that, the spread is relatively even. So there's always a lot of talk about China, but we're clearly not just a China story. That's borne out by the stats on this chart and the specifics of growth markets that I'll cover on the next slide.

Aussies traveling abroad account for 53% of all international passengers, and they grew by 50,000 in the first half. This is interesting because it's decoupled from the domestic market, as Geoff mentioned. Even in uncertain markets like we're seeing now, Aussies still want to travel overseas. However, we see them flex their plans in response to global dynamics. For example, if the Aussie dollar is weak or if there's geopolitical challenges in a particular region, Aussies will tend to pivot and go to an alternative international destination. Importantly, they still want to and do travel.

There's also a good spread of foreign purpose of travel, which somewhat inoculates us against specific shifts in demand. Leisure travel remains a big feature at 44%, but more than 1/4 of all trips to Sydney are now to visit friends and relatives, which is a very resilient passenger set and has high-value repeat visitation. Two other important travel purposes are business and education, which, together, account for 25% and also include a high proportion of regularly returning customers.

If you turn to the next page, we have a bit more detail on the diversity of the passenger base and where the growth is coming from. Interestingly, Nepal was our fastest-growing market in the first half. With 121,000 passengers now traveling between Sydney and Kathmandu in the last 12 months and a compound annual growth of 25% over the last 4 years, it is now our largest unserved destination with no direct flights nor an air services agreement in place between Australia and Nepal. A big driver of this is the fact that Nepal is the source of our third largest international student population, a stat which surprises me and often surprises everyone else. Given the market dynamics of Nepal and the growth in both directions on this route, we see tremendous further opportunity, and we're working really hard to capture it.

We've also seen very strong growth out of the U.S.A. at over 11%, despite it being one of our most mature markets. Airline ticket pricing and currency dynamics have created some tailwinds here.

India, Vietnam and Indonesia round out our top 5 fastest-growing markets. The good news is India and Indonesia both sit in our top 10 markets by absolute passengers so have a really material effect on our growth rate.

Geoff mentioned it, but I want to reiterate, we're really excited about Lat Am and Qantas' recent announcements to increase direct capacity on the Sydney-Santiago route. This is a game changer for the Australia and South American market. The resulting increased connectivity on both ends will make travel to the region significantly easier, faster and more convenient for Sydney passengers who will find Chile, Brazil, Argentina, Peru and Colombia at their doorstep. With both airlines operating their Dreamliners on the route for next year, this will also mean a consistent and premium product offering for our passengers.

We identified South America as an emerging market opportunity a few years ago, particularly in light of the aircraft technology advancements and regulatory changes and have seen strongly invested in our presence and commitment in the region. We believe the direct services are the tip of the iceberg with passenger volumes and growth being strong indicators for solid pent-up demand to destinations such as São Paulo, Buenos Aires and Lima. Again, variety and highly diversified passenger mix are the keywords here with Peru, Brazil and Chile, for example, being highly popular destinations for Australian holidaymakers and Brazil and Colombia representing 2 of Australia's top 10 international student markets.

In terms of our largest markets by absolute passenger numbers, these have remained broadly consistent. And outside of the Australian outbound market, we've seen diversity strengthened over the past 5 years. So we're now 12 months into the weaker passenger growth cycle, and we don't have visibility on when it will turn. But we're running this aviation business for the long term, and we need to plan through the cycles and not let the short-term softness distract us. Related to that, I want to take you through the way we view the aero business and how we're managing it from a strategic point of view.

If you go to the next page, you get a sense of what I'm referring to. We've placed our opportunities in 3 broad buckets that will define our long-term success. Firstly, capacity. New ultra long-range aircraft are creating opportunities in underserved markets, and we have been actively targeting new routes that will be opened up. These aren't just the ultra long-haul markets for wide-body aircraft like the A350 or the B777X, but also the myriad of opportunities presented by the emerging ultra long-haul narrow-body aircraft like the A321XLR. These narrow-body aircraft have the potential to access significant secondary markets and provide direct services that previously were untapped or coming to Sydney via an intermediate point. It's worth mentioning just given they launched today, Malindo, has actually come on a narrow-body aircraft for its Bali-KL service.

We've restructured our aviation business development team to take advantage of these growth opportunities while also improving the support we provide to our existing airlines. And we've also added significant airline marketing experience and are already seeing benefits for our customers. To support existing operations and ongoing traffic growth, we will continue to invest in highly efficient infrastructure to meet customer needs including a new outbound baggage system with improved productivity and safety outcomes, additional international contact desks in the north of Terminal 1 and apron parking spaces to meet the ongoing growth in airline demand.

Secondly, we're focused on competition. Competition for new airline services continues to be fierce and has only increased over recent years. Airports in Australia and globally, along with government partners, have become increasingly active in their aviation business development activities. We also have Western Sydney Airport opening in the mid-2020s that will bring direct competition for services to the Sydney basin. Collectively, these factors are shaping how we invest to create a world-class, but uniquely Australian experience while sharpening our focus on service. Investments will include transformational changes to both terminal precincts, which will target redefining our airline partnerships and reshaping the passenger journey.

We also recognize the passenger journey commences well before you enter the airport precinct. As such, we're investing in land side projects, including Sydney Gateway, which will make journeys to and from the airport easier, faster and safer and enable passengers to drive from Parramatta to the airport and back without passing through a single traffic light.

Finally, we want to put the customer at the center of everything we do. As we focus on delivering a world-class experience for our passengers, we are developing terminal infrastructure and products, which will deliver a seamless experience. Through investment in technologies such as biometrics and upgraded security screening, we see passengers being able to more seamlessly manage their journey, and we are focused on the elimination of pinch points, which can create anxiety in the airport experience. These strategies will also contribute to lowering costs for our airlines and importantly, optimizing our terminal footprint.

With that, let me hand over to Vanessa. Thank you.

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Vanessa Orth, Sydney Airport Limited - Chief Commercial Officer of Non-Aeronautical [6]

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Thanks, Hugh. It's pleasing to report strong results across the nonaeronautical business, and what we've tried to highlight in this slide is the diversity of our revenue streams. As you can see, we have multiple operating businesses sitting under the nonaeronautical banner that are operating successfully in the airport ecosystem. We continue to see strong performance across our retail portfolio reporting solid sales growth across all terminals.

Domestically, categories such as food and beverage, fashion and travel services continue to outperform. Whilst internationally, the growth in duty free, namely cosmetics and technology along with luxury brands, continues to drive performance. Our retail leases have an average tenure of 5 years with fixed rental increases delivering solid revenue growth. Our office portfolio is operating at 98% occupancy, and we have over 50 commercial tenants. Demand for small office premises remains strong. And within the broader Mascot region, office supply remains tight. We have a stable revenue stream growing above CPI across the office portfolio.

Moving to logistics, we're seeing strong demand for freight sheds. Both cargo terminal operators and direct freight providers are requiring on-airport sortation and distribution facilities. We've recently renegotiated new terms with DHL and are currently in discussions with a number of parties for on-airport freight sites. The growth in e-commerce is driving demand for distribution facilities located closer to the end consumer.

We're also continuing to improve our on-airport accommodation with the recent addition of 78 rooms to the ibis hotel. Year-to-date, our combined occupancy is running at 85%. And our focus over the course of the year is to hold higher occupancies whilst driving a stronger average daily room rate across both hotels. And that's just -- Geoff has mentioned that whilst the Parking and Ground Transport business has been challenged with the decline in domestic passenger numbers, we continue to focus on building a stronger prebook business, enabling greater certainty of revenue streams and future occupancy, allowing us to dynamically price our remaining supply.

As you can see across the portfolio, performance to-date has been strong and nonaeronautical business is in good shape, and we will continue to deliver reliable and consistent revenue growth.

As mentioned by Geoff, the recent consolidation into a single nonaeronautical business unit has created a dedicated team focused on driving operating revenue, enhancing the customer experience through new services and products whilst unlocking development opportunities across our real estate platform. We've highlighted in this slide a number of opportunities that we are currently pursuing.

Across the retail portfolio, we continue to experience strong demand from global luxury brands and local best-in-class retailers. We're seeing solid sales performance across all terminals. The new term lease expiry profile has provided us the opportunity to refresh and reposition the retail mix in T3 and to extend the luxury offer at T1 with both projects due to be delivered in 2020.

With the transition of T3 in July, our advertising and valet services now encompass an all-of-airport contract, providing greater control and incremental revenue uplift. We're also continuing to explore new ways to enhance the traveler experience, and we're excited to open our first-to-market arrivals lounge and transit hotel in 2020 featuring 12 sleeping pods and 14 hotel-style rooms, along with showering facilities and a food and beverage offering.

Demand and investment in departure lounges continues to grow. We've recently welcomed #1 lounge, The House, into the mix. We are relocating and expanding our AMEX member lounge and introducing a new first-class Plaza Premium Lounge, taking our total departure lounge numbers to 13.

On-airport accommodation continues to be an opportunity. Our current hotel portfolio appeals to the budget and mid-market segment, and we see opportunity to expand our offer into the mid to upper market. We believe that an offering of this caliber would benefit from close proximity to our terminals and our existing hotels, and we're currently determining the best location for additional domestic and international hotels.

As you can see from the results, our real estate portfolio across the sector is experiencing high occupancy and strong demand. Coupled with supply constraints, we're now focusing on how we can unlock our land holdings and our expiring leases to meet these immediate needs. We continue to expand and diversify our revenue streams, and we have a team in place that is focused on delivering robust and resilient future real estate solutions.

I'll now hand back to Geoff for the remainder of the presentation.

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Geoffrey Culbert, Sydney Airport Limited - CEO [7]

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Thanks, Vanessa. So look, Vanessa and Hugh both talked a lot about the customer, and we've made customer satisfaction a core pillar of our cultural goals and objectives as an organization. And as you can see from this chart, we're making really good progress, and we're being very targeted about it. We collect a lot of data from customers, and we focus on the issues that matter the most to them. So not surprisingly, when we fix the issues our customers raise, we see a positive uptick in our scores, and that's reflected on the numbers in this chart. These are our highest customer satisfaction scores on record, and it's the usual suspects that drive the results: bathroom upgrades, charging stations, water fountains, comfortable seating. We have a methodical program in place that ticked these off one by one. And each investment makes a tangible difference to the overall customer experience and is ultimately reflected in the customer satisfaction scores.

You can see on the right-hand side of the chart here some of the specific things that we've done in the first half of the year. There's no magic to this. It's all about getting the basics right. 1,000 new charging points across T1 and T2, new water filling stations -- water refilling stations, sorry, that are generating 2,000 free refills a day, which is a significant number. New bathrooms in T1. In fact, we received the rare honor of having one of our bathrooms in T1 being named as one of Sydney's best public bathrooms by Time Out Magazine. That's a refreshingly new experience for us. And we also launched a navigation app for vision-impaired passengers, which was really well received, and we're really proud of that one.

We're also very pleased with the positive feedback we have received on the new Pier B at Terminal 2, that's the Jetstar and Tiger pier. T2 is really buzzing now. It has a really great feel about it, and it's reflected in the scores. But as I always say, there's more to do, and we'll keep working hard on this. We'll keep working hard to get the basics right and to find new ways to continue to improve and provide a better experience for our customers. Another major area of focus for us continues to be sustainability. My goal for Sydney Airport is that we're a leader in sustainability, not just doing the bare minimum, but a leader.

I went through these pages at the AGM, but I want to restate them because they're critically important and increasingly topical given the focus this is getting in the industry. So we have a sustainability strategy that's built on 3 pillars. Number one, we want to be an ethically responsible and transparent business. Number two, we want to run our business for the long term by planning for the future. And number three, we want to work closely with our local communities to protect the environment in and around the airport and to make sure it's sustainable for years to come. And we have multiple initiatives under each of these 3 pillars, but I want to focus quickly on 3 flagship initiatives that we think will make a real difference.

First, we're building climate resilience in our assets and minimizing our carbon footprint. This includes setting an ambitious goal of achieving carbon neutrality by 2025. Secondly, we're investing in electrification of our vehicle fleet. By 2021, we plan to be operating electric buses on 100% of our land side fleet. And thirdly, we continue to look at ways to operate the airspace and the airfield more efficiently to minimize our overall environmental footprint. And this includes things like optimizing the movement of aircraft on the ground and reducing taxiing and holding of aircraft and ensuring efficient gate turnarounds. And I'm really pleased to say that we're making good progress in all of these areas, and we're seeing some really tangible results.

So we've reduced our carbon emissions intensity per passenger by 30.9% since 2010, and we're on our way to reaching our goal of being carbon-neutral by 2025. We recycle over 42% of the waste and 25% of the water used at the airport. We're eliminating single-use plastic bags and plastic straws. I've previously spoken about the power purchase agreement we signed up, which means we're now taking 75% of our energy from renewable sources, and that arrangement came online from January this year. And as Greg mentioned, we just recently signed up Australia's first syndicated sustainability linked loan. I like this because it's a case of us putting our money where our mouth is. It not only demonstrates our commitment to sustainability, but it also demonstrates the fact that we're confident in the measures we've implemented.

And I'm very pleased to say that our efforts are being recognized. If you go to the next page, you'll see some of the recognition that we have received. So we're ranked #3 globally by Sustainalytics in the airport category. We're ranked seventh globally by the Dow Jones Sustainability Index for the transport infrastructure sector. And we're rated AAA by MCSI, which puts us in the top 10% of infrastructure companies globally. So these are really important ESG measures, and they're global rankings. They're not just Australian rankings, they're global. So we're really proud of this.

We'll keep pushing this area. We'll set ourselves ambitious targets, and we're committed to hitting them because we know that strong ESG practices are vital for creating long-term value for our people and our investors and our stakeholders. And it's also critical for us to make our contribution to the aviation industry's action on climate change as a whole. There's a lot of really good stuff going on in the industry at both the airport and airline level, and we're making sure that we're doing our bit.

So if you turn to the last page we'll round that out. So the first half of 2019, look, it has been challenging from a passenger perspective, but we are successfully navigating through it. And the results today are testament to the strength and resilience of our business model and also importantly, the diversity and cost disciplines that we have built into the business. And all of that gives us confidence in reaffirming our 2019 distribution guidance of $0.39 per stapled security.

So thank you, everyone. We'll now open up the floor to questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from Cameron McDonald with Evans & Partners.

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Cameron McDonald, Evans & Partners Pty. Ltd., Research Division - Head of Research [2]

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A couple of questions, if I can. Previously, prior to the federal election, there was obviously a review done by the Productivity Commission, and that highlighted that there were some potential changes to the operating restrictions at the airport. Can you give us an update of where you're at now relative to that, pursuing some of those recommendations and in particular the 80 movements an hour?

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Geoffrey Culbert, Sydney Airport Limited - CEO [3]

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Yes. The Productivity Commission in their draft -- thanks, Cameron. The Productivity Commission in their draft report recommended that the operating restrictions -- it was probably timely for their operating restrictions to be reviewed, and we agree with that position. The important thing to note with respect to the operating restrictions is that they're 20-year old regulations. At the time they were introduced, the airport was doing around about 20 million passengers a year. We're now doing close to 45 million passengers a year. And so the environment is very different, and our view is that regulation should never be set and forget. We should be looking at it on an ongoing basis to make sure it's fit for purpose. And so we are having conversations about the possibility of getting change in this area, and it's an important conversation to have. But we're going about it in a smart way.

We actually think there's an opportunity to make some changes here that would have minimal impact overall. So what we're talking about is no change at all to the curfew and not one single flight more than we're currently allowed under the current regulations. But what we're suggesting is more flexibility. So if we move from a 15-minute measurement to a daily measurement, we believe that would give us the opportunity to manage the airport more efficiently and more effectively and would help us to deal with some of the challenges we have when we have delays.

So I'm sure everyone's had the experience of being diverted or delayed or having had their flight canceled. And when we have extreme weather events like we had over the weekend with lots of wind, it takes us a long time to recover. That means that flights get canceled, delayed, people miss their meetings, they can't get home to their families in the evenings, they're forced into overnight stays. It has a huge cost and impact to the overall productivity of the nation. And so what we're looking for is a -- more flexibility in the overall way that we can manage that. But as I said, no change to the curfew and not one more flight than we're currently allowed under the existing envelope.

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Cameron McDonald, Evans & Partners Pty. Ltd., Research Division - Head of Research [4]

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So the timing, do you think those discussions will be had and then ultimately finalized over?

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Geoffrey Culbert, Sydney Airport Limited - CEO [5]

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Well, that's hard to say. It's an ongoing conversation. The Productivity Commission's report will come out in October. So we imagine that they'll have something in there at that point in time. But this is an ongoing conversation. These are not straightforward issues. There's a lot of community stakeholder engagement that's involved. We want the best outcome for everyone not only the traveling public but the local community. And so we're going to go through this in a sort of methodical and reasonable fashion.

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Cameron McDonald, Evans & Partners Pty. Ltd., Research Division - Head of Research [6]

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Okay. And then the $90 million reduction in your CapEx profile for the next -- for this year, what projects are you sort of delaying?

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Greg Botham, Sydney Airport Limited - CFO [7]

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Yes. Thanks, Cameron, Greg. Not one specific project that would contribute to that. It's a range of things that we've either put on hold or reduced the activity in the pipeline, as Geoff mentioned. So not one particular item. There are those key projects that he was talking about in some more detail that we continue to push on with, but they remain in fairly early stage form at this point in time.

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Cameron McDonald, Evans & Partners Pty. Ltd., Research Division - Head of Research [8]

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Okay. And so my last question, just sort of highlighting, Geoff, that you've spoken a bit about the service standards and the measurement and stuff like that, that you've got in there. Can I just ask, I mean going back to the Productivity Commission, there were some submissions which specifically identified Sydney Airport, and in particular, the issue about FOD. And so what I want to know is where are you on that journey now in addressing the issues that were raised as part of that. And what have you done to address those issues? And are your airline customers and/or the regulator now happy with your response to that?

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Hugh Wehby, Sydney Airport Limited - COO [9]

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Cameron, thanks. Hugh here. I'll respond to that one. There were issues raised with the FOD management at Sydney Airport, although we are certainly regulatory compliant and have never had an issue in any inspections with CASA or the department. So never any historic issues. That being said, we are continually focused on FOD. So we're doing a couple of things. We've actually engaged with both BARA, and in particular, our ground handlers are responsible for most of the activities around the ramp area of the aircraft, to increase activity and FOD cleaning on a regular basis.

The other thing we're doing, which is more material and strategic around the culture out in the airfield, we're looking to implementing a new airport operator's license which actually holds people that operate in our airfield to account. Historically, we have had 26 organizations operating in our airfield that have no contractual relationship with Sydney Airport. And so we have no ability to control behaviors or respond to misdemeanors. So what we've done is actually worked to put in a structure in partnership with IATA, the airline body, to propose a new air side operator's license for those parties to sign up to. And they will also be held to account on things like FOD behavior but also some of our sustainability initiatives. So not offloading the problem. We're certainly throwing ourselves behind it as well but trying to engage our partners on airport, and previously, those operating on airport without a partnership to fix any issues that are going on out there.

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Operator [10]

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Your next question comes from Simon Mitchell with UBS Investment Bank.

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Simon A. Mitchell, UBS Investment Bank, Research Division - MD and Head of Research for Australia and New Zealand [11]

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A question on traffic outlook. If we look at airline schedules, it looks like there's about a 1% to 2% decline in international seats over the balance of this calendar year. Just interested if that's consistent with what you're observing.

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Geoffrey Culbert, Sydney Airport Limited - CEO [12]

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Thanks, Simon. It's -- we're seeing relatively flat capacity on seats over the remainder of the year. So I think consistent with what you're seeing. But the other factor, of course, which is relevant is load factor. And what we have seen over the past couple of months is some increase in load factor. Naturally, as you pull capacity out or you keep capacity flat if there's excess demand, it will be reflected in increasing load factor. So we'll see how that plays out over the next 6 months.

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Simon A. Mitchell, UBS Investment Bank, Research Division - MD and Head of Research for Australia and New Zealand [13]

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Okay. And just -- I know it's less of a driver for the overall cash flow of the airport but for domestic, I guess we're starting to now hit some months that have easier comps from last year. Are you expecting this negative trend to kind of dissipate as we get further into the calendar year?

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Geoffrey Culbert, Sydney Airport Limited - CEO [14]

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[We] do start to cycle some interesting comps as we move into the second half of the year. As I said in the formal presentation, we started to see softness in the market going back to around about April, May last year. So you do get some of that softness in the second half of the year. We actually thought we might see a little bit of an uptick in the domestic activity after the election and that's something that's been spoken about, not just by us, by others in the market, but we didn't see it. So domestic has remained soft.

It's interesting for me that it has remained soft because some of the economic indicators out there are still quite strong. You've got record low interest rates, you got tax cuts, housing prices have stabilized, unemployment is at relatively low rates. So I think the Aussie domestic traveler is just waiting to see which way it breaks. And there's a lot of negativity in the media which I think is causing that conservatism.

What's also interesting, though, which you touched upon is that I think we're seeing a decoupling of the domestic and the international activity. So whilst the domestic numbers are down, Aussies traveling abroad has gone up over the half year. And Australians still want to have their overseas holiday and they are just choosing where they go. When the Aussie dollar's battling against the U.S., you see people change from the holidays to the U.S. to destinations closer to home like Fiji and Bali. So there's some interesting dynamics going on in the market.

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Simon A. Mitchell, UBS Investment Bank, Research Division - MD and Head of Research for Australia and New Zealand [15]

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Okay. And just a question on cost of debt, I just see you've had a slight drop to 4.7% on your average cost of debt. Presumably, any financing activity you're doing in the market now is achieving a lower rate than that, than 4.7%. Just a comment on what you expect to see over the next couple of years if rates stay where they are.

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Greg Botham, Sydney Airport Limited - CFO [16]

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Thanks, Simon, Greg here, obviously. We probably see it, based on current indicators, trickling down perhaps a little bit further than where we are right now. But we are pretty well hedged in the shorter term so there's not a huge amount of change coming through on that side. And also from a refinancing perspective, we did get better rates on our bank refi earlier in the year, but we don't have a lot of refinancing activity in the shorter term, we got a bit of work to do late next year onwards. So there's not too many drivers of change in the next year or so. But I guess our expectation would it might track down a fraction more but you won't see a significant jump from here.

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Simon A. Mitchell, UBS Investment Bank, Research Division - MD and Head of Research for Australia and New Zealand [17]

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Okay. And just a last question from me, just on the international aero agreement. Just I guess a comment if you could on the timing and the process in the lead up to that. And also your thoughts on, I guess, risk from the collapse in the bond rate and just expectations from the airlines of some form of pass-through in the new pricing.

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Hugh Wehby, Sydney Airport Limited - COO [18]

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Yes. Thanks, Simon. In terms of the process, the international agreements, as you know, we have one with each airline rather than one single agreement expire 30 June 2020. So we're in the early stages of that engagement process with BARA and our local carriers. So it's a process we'll go through that obviously doesn't cover just cost of capital. It covers things like investment program, service levels and the future sort of engagement between airlines and airport. I think it's way too early to be commenting on the specific outcomes of that engagement. But we are entering with a positive environment. We've got some really exciting projects on the table as I mentioned in my discussion. So too early to comment on the specifics. But I think it's a positive engagement early on.

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Operator [19]

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Your next question comes from Richard Jones with JPMorgan.

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Richard Barry Jones, JP Morgan Chase & Co, Research Division - VP [20]

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Just a question, just in relation to Chinese passenger growth. Just interested in your thoughts as to the drivers of the pullback and I guess from here, what your expectations are in the short and medium term.

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Geoffrey Culbert, Sydney Airport Limited - CEO [21]

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Yes. So the Chinese passenger numbers were flat. But still very strong. They represent our second largest traveler group. And if you actually -- if you took the number of Chinese passengers that have come through in the first half of the year and put it over a, say, a 2015 denominator, it represents 10% growth. So in some respects, we're dealing with the law of large numbers. There has been some capacity rationalization out of China. We grew very rapidly on the Sydney-China route. We went from 3 destinations to 15 destinations in China over the course of 3 years. And there's been some rationalization of that over the past year which has led to a reduction in seat capacity. So that's a bit of a driver. But overall, the numbers are still pretty strong.

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Richard Barry Jones, JP Morgan Chase & Co, Research Division - VP [22]

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And your outlook?

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Geoffrey Culbert, Sydney Airport Limited - CEO [23]

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It's hard to tell. I think that you hear a lot of the commentary in the market around the fact that GDP growth is slowing in China, that the trade war is having an impact. But we don't necessarily see that in the way that the Chinese passengers engage with us. We're not seeing it in terms of their spend rates in retail. So look, it's a tough one to speculate on.

My long-term view on China hasn't changed. So you've got less than 10% of Chinese nationals have a passport. You've got 1.3 billion people. And as soon as -- and when -- as wealth grows in China, as soon as the middle -- as people get into that middle-class bracket, they want to go and see the world. They're no different from anyone else. And Sydney is a really attractive place for them to travel to and they've now got multiple options and ways of getting down here with the number of flights that we have from the cities that we operate from and to between Sydney and China. So overall, long term is still a very positive story.

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Richard Barry Jones, JP Morgan Chase & Co, Research Division - VP [24]

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Can I just have another question on retail for Vanessa? Just in relation to the expanded luxury offering, potentially in the international terminal, is that new GLA or is that just a repositioning of the existing tenants into luxury?

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Vanessa Orth, Sydney Airport Limited - Chief Commercial Officer of Non-Aeronautical [25]

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It's actually -- Richard, it's actually -- we have a tourist refund scheme. It's repurposing that space. So we'll be extending the luxury and adding 3 new stores.

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Richard Barry Jones, JP Morgan Chase & Co, Research Division - VP [26]

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Okay. And then -- and just on T3, just your expectations on a few things around sort of leasing spreads, retention, downtime, incentives. Can you just give us some insights given the high number of expiries coming?

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Vanessa Orth, Sydney Airport Limited - Chief Commercial Officer of Non-Aeronautical [27]

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I think we have a really unique environment out here at the airport. And in T3, our footprint is very small. So we have quite strong demand from local brands to come into the airport. So we behave very differently to I guess the general retail market. And when you're talking spreads, we are getting strong positive spreads. And our productivity here sort of benches in line with your top 5 big guns on a spec MAT per square meter basis. So we're -- T3, we feel that there's more opportunity in T3 and we can introduce a better retail mix.

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Richard Barry Jones, JP Morgan Chase & Co, Research Division - VP [28]

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Okay. So would downtime be an issue in the second half as you improve that mix?

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Vanessa Orth, Sydney Airport Limited - Chief Commercial Officer of Non-Aeronautical [29]

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Look, we're not doing it as a single complete remix. It will be as the expiries come up and as we have the right tenants, sorry. You normally get a 4-week downtime on each tenancy, but we're not doing 20 tenancies at once. We're doing it slowly and methodically.

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Operator [30]

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The next question comes from Ian Myles with Macquarie.

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Ian Myles, Macquarie Research - Analyst [31]

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Congratulations on the result. Just a couple ones. Firstly, you highlighted $6.2 million of sort of cost reductions, but you didn't really outline where they came from other than talking about power repricing. I was wondering if you can maybe quantify that. And also you alluded to in the presentation, you got further reductions. So value -- cost reductions to come through in the second half because of the labor restructuring. I was going -- I was wondering if you could actually quantify what that translates into the number.

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Greg Botham, Sydney Airport Limited - CFO [32]

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Yes, thanks, Ian. Greg here. So in terms of the savings, as you say, $6.2 million on the slide. The -- energy is a part of that, there's a few savings that we generated in energy. PPA from 1 January delivered saves. We also had a close look at our network costs and a few other areas of that. So that's probably a few million across energy for the half year. We made savings across a range of areas. Labor productivity in the half, looking at a whole range of discretionary spend items, making sure that the maintenance program was absolutely fit-for-purpose in terms of all of that. So there was a whole myriad of initiatives that were in play across the half year across pretty much all categories of OpEx. And that was the mindset we took into that. So there's not one item that sort of stands out as the biggest piece of that. Energy was a good contributor there.

In terms of looking at savings for the rest of the year, the point we're obviously wanting to make is we did make some adjustments on the labor side. Late in the half, very late in the half, that was probably later June, and we will see some labor savings coming through on that into the second half. Probably, perhaps only a few million dollars in a half year basis. So not huge saves but important savings here. So I think the mindset we have here is to keep chipping away at, frankly, all categories of OpEx spend. We are looking for a meaningful reduction year-on-year in terms of controllable OpEx. And the mentality continues to be looking for all sensible smart areas to contain and reduce cost. And that will go through the rest of 2019 and right into 2020 and beyond.

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Ian Myles, Macquarie Research - Analyst [33]

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Okay. Can you give us maybe also an update on the jet base and where that is? And I'm just thinking, Qantas has a couple of hangars there and the likes. Is there opportunity for you to do rebuilding hangars or opportunity for you to do the demolition and get paid for that?

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Hugh Wehby, Sydney Airport Limited - COO [34]

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Thanks, Ian, Hugh here. Good to speak to you again. The jet base has obviously got the expiry 30 June 2020. There's a lot of moving pieces, not just the hangars. There's maintenance facilities, the simulator buildings and a bunch of other things. We're in pretty deep discussions with Qantas on all aspects of their operation at Sydney Airport. You will have seen in the master plan the northwest portion of the jet base has actually been reserved for 3 A380-size hangars. So there's actually a lot of space for hangar maintenance facilities, engineering facilities in the future jet base as well, even if we put terminal in that area. So the discussions are continuing. There is always the opportunity for Sydney Airport to be involved in capital and then a return on that. But it's very, very early days. So we're just discussing the future requirements in the jet base for Qantas, but also ensuring that we're preparing it for the best possible common use of facilities.

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Ian Myles, Macquarie Research - Analyst [35]

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Okay. And maybe because you're talking there, Hugh, maybe give us some thoughts on the implications of [Bruce Vegas] opening up their next runway.

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Hugh Wehby, Sydney Airport Limited - COO [36]

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Yes, I -- it's great for airspace management on the Eastern Seaboard because we know that lack of runway capacity in some of the eastern ports does create airspace congestion and delays. So that's a positive. All that being said, it does, again, go back to the competitiveness point I made in my presentation, we actually need to be more competitive domestically, we need to be more competitive internationally. A lot of people think we're talking about Western Sydney Airport when we say that, and that will be part of it come the mid-2020s. But actually, we need to provide the best product possible, the most efficient operations possible for our airlines to continue to compete to grab the international services. Remembering that Sydney-Brisbane is the 12th largest air route in the world so we won't compete for that one. So we'll leave that on foot.

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Ian Myles, Macquarie Research - Analyst [37]

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Okay. And one more -- one final question. You've -- Vanessa, you alluded to through the presentation about repricing of leases, both retail and sort of some of the property leases. I was just wondering how far out of market are you in these leases which are coming up to repricing.

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Vanessa Orth, Sydney Airport Limited - Chief Commercial Officer of Non-Aeronautical [38]

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Sorry, Ian, was that how far above market we are?

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Ian Myles, Macquarie Research - Analyst [39]

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How far out of market are you. Well, I assume you're below.

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Vanessa Orth, Sydney Airport Limited - Chief Commercial Officer of Non-Aeronautical [40]

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No, we actually get an on-airport -- I guess for us because demand is so high and supply is limited, we are getting above market rates when it comes to retail, when it comes to freight and commercial. And I think our commercial footprint is very different to, say, the CBD sector where you're doing large floor plates. We're doing very small office spaces, and there's strong demand for aviation services to be here on-airport.

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Ian Myles, Macquarie Research - Analyst [41]

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I'm just trying to get an understanding how -- like what sort of repricing capability should we be expecting in there. Is that sort of a 5% or 10% sort of uplift in those leases?

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Vanessa Orth, Sydney Airport Limited - Chief Commercial Officer of Non-Aeronautical [42]

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Thanks, Ian. I guess we just sort of don't give guidance on that. But as the lease expiry profile comes through, we would be looking to get positive spreads on all of the deals that we do.

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Operator [43]

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The next question comes from Rob Koh with Morgan Stanley.

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Robert Koh, Morgan Stanley, Research Division - VP [44]

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So I think this question is maybe for Geoff and/or Hugh. I think when you're talking about the activities on the PMO, you mentioned a 12% reduction in your CapEx pipeline. And I just wanted to make sure I understood. Is that like 12% reduction of projects or 12% reduction in value of projects there? And I guess in the same frame, if you could comment on how you're thinking about cost escalation for construction activities at the minute.

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Geoffrey Culbert, Sydney Airport Limited - CEO [45]

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Yes, so it's a 12% reduction in the absolute number of projects, Rob. It's not the dollar value. The thing about the project pipeline is that we had a very significant number of projects in the pipeline. But a lot of them are really small and relatively insignificant and small in value and small in actual size. And they were just a distraction. And so we cleaned out the pipeline, as I said, reduced it by 12% in absolute number. So can you just repeat the second half of your question?

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Robert Koh, Morgan Stanley, Research Division - VP [46]

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Yes. I guess if you've reduced the number of projects but the overall CapEx envelope is the same then are you seeing cost escalation, I guess?

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Geoffrey Culbert, Sydney Airport Limited - CEO [47]

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Well, the reason why the overall envelope remains the same is because the projects we took out weren't big in dollar size. And so we got rid of a lot of rats and mice. We've got a range of contractors that we work with on the airport and we have a good and close relationship with them. And that enables us to be able to manage contract prices pretty effectively. If you think about the airport, it's a pretty unique environment on which to operate. Some of the activity is airside rather than landside, there's security clearances and a lot of the construction and maintenance work needs to be done after hours. Once the curfew hits at 11 p.m., the crews come in. They work until 5 a.m. and then they go off-airport. So we like to have a very tight group of preferred contractors that we work with. And that also enables us to get a tight handle on cost.

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Robert Koh, Morgan Stanley, Research Division - VP [48]

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Yes. Okay. It makes sense. All right. A question for Hugh in relation to the airport's on-time performance. And I do acknowledge that that's not a sole Sydney responsibility but it still hasn't been great for the last couple of years versus how it has been in the past. I wonder if you could just give us some commentary on how much of the impact is weather-related and how much is rather domestic airline yield management type stuff.

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Hugh Wehby, Sydney Airport Limited - COO [49]

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Thanks, Rob. The performance actually is pretty reasonable year-to-date. So it's 79% for domestic and 76% for international, which as you say, is slightly lower than previous years but certainly not poor from a global standards perspective. There's a few things in play there. There has definitely been some material weather events this year which led to mass delays. We've seen an increasing cancellation rate from the domestic carriers in addition to that which obviously skews those results as well. This is one of the reasons that Geoff was talking about, the operating restrictions and that flexibility and the application of the 80 movements per hour. It really would help recover much more quickly. And actually, the on-time performance issues that you would get would be constrained to much shorter periods. So look, there's some parts that are in the airport's control, as you say, some that are not. But the overall performance is actually reasonably robust given the weather conditions we've seen.

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Robert Koh, Morgan Stanley, Research Division - VP [50]

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Okay. Great, Hugh, and wish you well with the ongoing activities there. A question maybe for Greg, just about the sustainability loan and that looks like a great deal. Just ask a typical banker question without wishing to be too much of a downer, but the downsides that you guys have exposed you to there on the margin, is that limited or is that unlimited?

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Greg Botham, Sydney Airport Limited - CFO [51]

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It's certainly limited, Rob. It's meaningful. We don't disclose the margin flex up and down. It is limited, but it's relevant and meaningful. And so it is a good incentive for us to hit the numbers. It's a really good deal, as you say. We're really pleased with it. We did absolutely look very carefully around the status of all the initiatives on sustainability and how we could move the dial. And so we had a lot of internal diligence to make sure that we feel very confident of being able to reap the benefit of that deal from a financial standpoint.

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Robert Koh, Morgan Stanley, Research Division - VP [52]

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Okay. Cool. Sounds good. All right. So last question just with the long-term sustainability focus which is fantastic to see, just if you could give us an update on how the airport is thinking about the physical impacts of climate change on the airport and how you think about asset hardening and extreme weather events and things like that.

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Geoffrey Culbert, Sydney Airport Limited - CEO [53]

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Yes, well, the pages I covered in the presentation really go to that. So we've got a very clear sustainability strategy. And I talked about the 3 pillars of our strategy in our presentation and the activities that we're doing to support that. So the pillars of being a responsible business and planning for the future and supporting our communities underpin that. But this -- what we're doing around climate resilience, fleet electrification and airspace and airfield efficiency are very specific projects that have very tangible actions associated with them that will drive down our carbon footprint and move us closer to carbon neutrality. And I walked through those in the presentation so I'm not going to repeat them.

At the same time, we are also continuing to look at our resilience from an asset perspective and making sure that in the event that we do have extreme weather events that we have a good understanding of how that would impact the asset and also how we recover quickly from that. And so we're constantly reviewing that. We've actually significantly increased our capability and resourcing in the sustainability area, brought on some real capability and expertise into the airport over the past 12 months. And that's reflected in the pace of change and the progress that we're making. And we're building climate adaptation and resilience plans as part of that additional resourcing to make sure that we're just really ready to be able to handle whatever comes our way.

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Operator [54]

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Your next question comes from Owen Birrell with Goldman Sachs.

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Owen Birrell, Goldman Sachs Group Inc., Research Division - Metals and Mining Company Analyst [55]

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A few questions from me. Just quickly, just on CapEx again. The deferral of CapEx this year, but no change to that 3-year number, is it fair to say that, that means the deferral of the benefits as well?

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Greg Botham, Sydney Airport Limited - CFO [56]

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Not really, Owen. It's really about decluttering that pipeline, focusing on the most important projects, driving savings across the board. But the key aeronautical projects in particular that Hugh mentioned, a big focus for the organization over the next few years. So it's not about you're taking projects out that are going to be accretive or particularly attractive from a benefit standpoint. It's just really decluttering the activity level across CapEx to enable us to focus hard and deliver the best outcomes we can on the key projects. So certainly don't look at it from a benefits deferral or reductions perspective.

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Owen Birrell, Goldman Sachs Group Inc., Research Division - Metals and Mining Company Analyst [57]

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And so my next question would be why were you doing those projects in the first place if they weren't delivering any accretion.

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Greg Botham, Sydney Airport Limited - CFO [58]

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I think in any organization, you always benefit from looking from time to time at the full prioritization of what you're up to. That's a healthy process to go through. So we've done that thoroughly in the half year. And we've made some really good choices in terms of focusing our effort.

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Owen Birrell, Goldman Sachs Group Inc., Research Division - Metals and Mining Company Analyst [59]

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I'm going to start -- were any of these dependent on the next aeronautical agreement being signed or are they -- is this -- are these projects that you were looking to get some sort of financial compensation back from a raising of rates and that's what's driven some of the decision?

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Greg Botham, Sydney Airport Limited - CFO [60]

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Nothing at all to do with raising of rates. This is simply about -- there is a lot of activity in an airport such as ours in terms of the CapEx pipeline. It takes a lot of effort to get that right and manage that. On every project we do, we look very closely at the financial returns that will continue, that discipline continues, but also the returns to customer, sustainability, risk, et cetera. So we have certainly looked very hard at how we prioritize both from a financial and a nonfinancial perspective. But it's certainly not about the next aeronautical agreement per se. We are obviously mindful to being very close touch as we always are with the airlines in terms of what's important to them. And Hugh and his team are obviously having those conversations now and going forward for the next period of time.

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Owen Birrell, Goldman Sachs Group Inc., Research Division - Metals and Mining Company Analyst [61]

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Just a second question just looking on the passenger growth outlook, it sounds like it's going to be fairly flat or you've noticed flight capacity over the coming year. Over this past 12 months, I think we've seen Sydney's year-on-year growth to just appear worse than a lot of the other airports. Have you got any color on why that is? And how you can you arrest that trend?

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Geoffrey Culbert, Sydney Airport Limited - CEO [62]

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When you say all other airports, I assume you're talking about Australian airports?

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Owen Birrell, Goldman Sachs Group Inc., Research Division - Metals and Mining Company Analyst [63]

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The airports.

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Geoffrey Culbert, Sydney Airport Limited - CEO [64]

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I beg your pardon?

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Owen Birrell, Goldman Sachs Group Inc., Research Division - Metals and Mining Company Analyst [65]

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The Australian major airports like in Melbourne, Brisbane, Perth.

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Geoffrey Culbert, Sydney Airport Limited - CEO [66]

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Yes. One thing that we tend to see is, number one, we operate off a higher base. So when you talk about percentage changes that the higher base and the law of large numbers tends to play into effect there. Secondly, I would also say that there's a bit of a lag effect in the way that routes open up. If you look at the way that historically international routes have moved into Australia, they'll come to Sydney first. And then once a route thickens into Sydney, they might expand to Melbourne or to Brisbane and we've seen an element of that in the numbers down there in Melbourne and also in Brisbane. And then after they've done Brisbane and Melbourne, they might come back and do a second daily or a third daily back into Sydney. So it does cycle a little bit. We have seen, on the domestic side, we definitely have seen the weakness primarily in the major Eastern Seaboard routes, Melbourne-Sydney, Sydney-Brisbane. And so that impacts on both ends and so we're equally affected by that. So that's some of the color that we see.

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Owen Birrell, Goldman Sachs Group Inc., Research Division - Metals and Mining Company Analyst [67]

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I just kind of -- and the reason I asked the question is you've seen a lot of new outbound international flights going out of Brisbane, Melbourne and Perth, and I'm wondering whether that has any impact on the transit traffic that would have been coming the other way.

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Geoffrey Culbert, Sydney Airport Limited - CEO [68]

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No. The answer to that is no. It used to be the case, going back in the day, that if you wanted to fly internationally, you had to fly to Sydney and then you'd get the flight out. But if you look at this, the major cities in Australia, like Brisbane and Melbourne and Adelaide and Perth, they've now got good connectivity up to the hubs in Southeast Asia and the Middle East which then connect on to Europe. So the transit passenger numbers are much less significant than they would have been a decade or so ago.

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Owen Birrell, Goldman Sachs Group Inc., Research Division - Metals and Mining Company Analyst [69]

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Okay. And then just finally, on that sustainability-linked loan, can you give us a feel for what the actual hurdles are and where you're actually tracking relative to those hurdles at this point?

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Greg Botham, Sydney Airport Limited - CFO [70]

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Yes, it's quite a detailed calculation. It references our scores as measured by Sustainalytics, which is a globally recognized and preeminent ratings organization on the sustainability front. So when we get a third ranking, for example, as Geoff mentioned in the pack, that reflects a combination of factors that form up to a score, much like I guess a credit rating equivalent. We're scoring well right now. And so we need to strive to generate additional benefits or improvements across a range of areas in order to move that score forward.

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Owen Birrell, Goldman Sachs Group Inc., Research Division - Metals and Mining Company Analyst [71]

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Can you give us a sense of what the incremental interest cost up and down on that ranking is?

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Greg Botham, Sydney Airport Limited - CFO [72]

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I can't give you a specific basis point number, but it's not huge. We have got a meaningful upside and downside so -- but it's manageable but meaningful in the context of the overall margin.

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Owen Birrell, Goldman Sachs Group Inc., Research Division - Metals and Mining Company Analyst [73]

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Because it sounds like you're ranking pretty well on that already. So I'm just wondering where the upside is from here.

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Greg Botham, Sydney Airport Limited - CFO [74]

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Yes, well, certainly there's upside if we plan to deliver and deliver on those initiatives we've identified and have in train across this year and the next few years, certainly some upside. And then we can explore that again in future. It was a leading transaction in the market. We can certainly explore the risk/return on that if we go down that path again in the future.

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Operator [75]

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The next question comes from David Lloyd with Citi.

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David Lloyd, Citigroup Inc, Research Division - Director & Analyst [76]

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Just a couple of quick questions for Vanessa, if I could. Just looking at the non-aero side, the logistics now look focused at least 25% of revenues. Just wondering what's the potential there to expand the logistics portfolio and maybe via double story or multistory warehousing there.

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Vanessa Orth, Sydney Airport Limited - Chief Commercial Officer of Non-Aeronautical [77]

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Thanks, David. We are actually looking at our entire footprint at the moment. We sit on over 900 hectares of land and we do have a couple of precincts. In particular, the northern precinct that will be unlocked with the Gateway project. So we see that there are opportunities on a couple of parcels of land here at the airport. And that's something that the team is working on at the moment. But we do see that there will be growth in freight and freight sheds and the logistics solutions that comes off the back of those.

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David Lloyd, Citigroup Inc, Research Division - Director & Analyst [78]

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So would that include double or multistory warehousing? Could you put that on site or are there restrictions to that?

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Vanessa Orth, Sydney Airport Limited - Chief Commercial Officer of Non-Aeronautical [79]

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Look, there are restrictions, but we can on certain parcels of land get a higher building site. And the northern precincts, there are a couple of pockets within the northern precincts where we can actually get higher distribution facilities.

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David Lloyd, Citigroup Inc, Research Division - Director & Analyst [80]

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Okay. Terrific. And maybe to Ian's question, previously, I think you mentioned the DHL lease that you've just re-signed there, could you give us an indication of what the re-leasing spread was on the DHL lease just in percentage terms?

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Vanessa Orth, Sydney Airport Limited - Chief Commercial Officer of Non-Aeronautical [81]

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I can tell you it was positive.

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David Lloyd, Citigroup Inc, Research Division - Director & Analyst [82]

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Single digit? Double digit?

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Vanessa Orth, Sydney Airport Limited - Chief Commercial Officer of Non-Aeronautical [83]

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I can't disclose that. But look, for us, at the moment, we have really limited supply of land and it's in strong demand.

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David Lloyd, Citigroup Inc, Research Division - Director & Analyst [84]

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So would the rent be then in keeping with surrounding other logistics areas around that -- around the port?

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Vanessa Orth, Sydney Airport Limited - Chief Commercial Officer of Non-Aeronautical [85]

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All of these operators want to be on-airport. And therefore, they will pay a premium to be on-airport.

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Operator [86]

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The next question comes from Nathan Lead with Morgans Financial.

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Nathan Lead, Morgans Financial Limited, Research Division - Senior Analyst [87]

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Just a couple of ones from me. So first up, you've talked about the aeronautical negotiations to do with international agreement coming up. But my understanding was there was also domestic expiries coming through in the short term. Could you just talk about the progress on those and what the pinch points or the pressures are within those negotiations?

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Hugh Wehby, Sydney Airport Limited - COO [88]

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Sure. Thanks, Nathan. You're absolutely correct. Primarily our Terminal 2 agreements expire through to the end of 2019. So -- because we're working with our major carriers on international agreements as well, things like the jet base with Qantas, they're actually getting caught up in a positive way in a much wider set of negotiations. So we're keeping those agreements on foot. The ones that have expired, we have extended to allow us that time to negotiate new deals. And the rest of them, we just continue to work on them as part of our BAU workstreams. But much like the international side of the airport, we're looking at all those factors like service levels and investment. The interesting opportunity in T2 is that we haven't done material deals really since privatization. So it's a really exciting opportunity to materially change again the service levels and the quality of the terminals over that side of the airport.

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Nathan Lead, Morgans Financial Limited, Research Division - Senior Analyst [89]

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Okay. Great. What's the sort of aeronautical asset base that you're thinking about when you're going into these negotiations? What sort of size is it?

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Hugh Wehby, Sydney Airport Limited - COO [90]

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Look, we don't disclose it specifically. I would, in a helpful way, direct you to the ACCC accounts. They do disclose a return. We don't agree with the calculation they use, but it is one benchmark that is used in the public domain. We actually approach these deals, try and deliver value for money. So we need to get value for money for our investment. The airlines need to get value for money and for the service that was in the cost of operating at Sydney Airport. They're not single-aspect deals. They will be really, really complex. When we did Terminal 3 transaction with Qantas, it was actually because we did it at the same time as an international and domestic deal. So we like to have a lot of moving pieces on the table and really get to an agreement that works for everyone.

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Nathan Lead, Morgans Financial Limited, Research Division - Senior Analyst [91]

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Okay. And just final one for me. The $170 million for the Gateway proceeds. Has there been any projects that have been identified where that capital could get invested?

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Geoffrey Culbert, Sydney Airport Limited - CEO [92]

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Yes, we're working with the government, looking at a range of different things, but nothing specific at this time. We gave ourselves a 3-year window to land something there. But I would say overall, conversations have been productive. The government are completely aligned with us in terms of this. We're looking for a whole of transport solution for access to the airport. It just cannot be road, it's rail, it's bus, it's a bunch of different things. As we look out into the future, and we look at the way that people are going to use the roads and use public transport, we need to be thinking about how that plays into Sydney Airport and how people are going to reach the airport. So our discussions with government are across a range of different options in that regard.

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Operator [93]

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The next question comes from Scott Ryall with Rimor Equity.

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Scott Ryall, Rimor Equity Research Pty Ltd - Principal [94]

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Probably the first question for Hugh. On the -- you mentioned preliminary discussions around international airline pricing agreement to -- excuse me, I think concludes in mid next year. But just based on the interactions you've had so far with the international airlines, can you comment on how you see their needs and wishes and those sorts of things as different to, say, 5 years ago when the last agreement was reached, please?

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Hugh Wehby, Sydney Airport Limited - COO [95]

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Sure, Scott. Thanks for that. The key thing is, I think we're all surprised on the upside with growth over the period sort of 2016 to '18. So we're looking to deliver more particularly outbound capacity. That's been our biggest shortcoming. I mentioned 2 big projects, 1 being the new baggage facilities, which are outbound baggage facilities, and the other being new gates and aprons and that's both contact gates and remote gates. So absolutely focused on delivering the efficient baggage outcomes and reducing the level of busing that has grown over the past few years would be the key operational outcomes. On the service-level outcomes. We were first in Australia to move to a KPI-style agreement with our international carriers. I have no doubt we'll need to make additional commitments in the next -- and we'll be looking to make additional commitments and step up the service levels there. So those are the 2 key things that are being asked in those early days.

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Scott Ryall, Rimor Equity Research Pty Ltd - Principal [96]

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Okay. Great. And then Geoff, probably this is for you, can you -- firstly, a really quick one. When -- I just want to confirm in terms of your fleet, your on-airport fleet, you're talking about going to battery electric vehicles. Is that correct?

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Geoffrey Culbert, Sydney Airport Limited - CEO [97]

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Yes, we're talking about the electric-charging vehicles. So that could be bus or our car fleet.

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Scott Ryall, Rimor Equity Research Pty Ltd - Principal [98]

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Yes, yes, but it's by battery, as in like similar technology to Tesla, right?

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Geoffrey Culbert, Sydney Airport Limited - CEO [99]

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Right, yes. Yes, you got it.

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Scott Ryall, Rimor Equity Research Pty Ltd - Principal [100]

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Yes, okay. And then secondly, just in terms of your broader sustainability initiatives, you mentioned water fountains and their increased usage in Terminal 2. Have you ever thought of -- and you mentioned your recycling levels at 42% and a few things like that. Have you ever thought of banning the sale of bottled water in the airport?

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Geoffrey Culbert, Sydney Airport Limited - CEO [101]

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We haven't gone that far at this point in time. But we work closely with the industry. The industry -- the retail, the FMCG industry is attuned to this issue. We're attuned to it. We'll work closely with all the industry players as a whole to see what's possible. And for example, we're doing recycled coffee cups at the moment, which is a really good initiative given there's close to 5 million cups of coffee that's sold at the airport every year. We're on the way to banning single-use plastic straws and plastic bags across all terminals. So look, we're trying to stay right at the front edge of this initiative. And we want to make sure that we're doing all that we can.

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Operator [102]

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The next question comes from Paul Butler with Crédit Suisse.

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Paul Butler, Crédit Suisse AG, Research Division - Director [103]

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Most of my questions have been asked already. But just on Terminal 3, can you just remind us when does the agreement with Qantas expire on Terminal 3?

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Hugh Wehby, Sydney Airport Limited - COO [104]

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So the -- sorry, I just got a funny microphone. The aeronautical agreement was a 10-year deal struck in 2015 so the terminal agreement will finish in 2025.

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Paul Butler, Crédit Suisse AG, Research Division - Director [105]

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Okay. And just your comment, just before about international airlines wanting to see more investment in outbound capacity at the airport. With the -- I gather there was previously a difference in the capacity you had on inbound versus outbound. How is that -- I mean does the international airlines tend to have higher inbound load factors than outbound?

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Hugh Wehby, Sydney Airport Limited - COO [106]

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No, so just the requirements of infrastructure are slightly different, Paul. So baggage system inbound is really simple. A ground handler picks up a bag and puts it onto a belt, which comes to the reclaims hall, whereas on outbound, there's an immense amount of very complex screening and sortation and with multiple bag rooms and has to go to multiple gates. So that's why -- that's the big difference in the baggage. On inbound, there's a slight nuance there. There's some gates, when you don't have fuel, that are completely capable of taking inbound aircraft but can't take outbound aircraft because you can't actually refuel them and depart from those gates. So we've seen busing increase more on the outbound than we have on the inbound. And that's the key difference on the gate side of the equation.

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Operator [107]

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The next question comes from Nathan Lead with Morgans Financial.

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Nathan Lead, Morgans Financial Limited, Research Division - Senior Analyst [108]

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Just a follow-up one. Just on the aeronautical security recoveries. I mean obviously, at the moment, there's a positive EBITDA spread. But my understanding was that an agreement was going to expire soon. Could you just give us an update on how that's tracking, what that could look like going forward?

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Hugh Wehby, Sydney Airport Limited - COO [109]

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Thanks, Nathan. It's not an agreement expiring as such. That's the recovery of mandated security expense. The reason there's a slight EBITDA margin on the security is that historically, when checked bag screening first came in, we had a capital contribution. And therefore, that very small margin represents a recovery of that capital. As that capital is depreciated down to 0, that margin will disappear unless we need to put in new checked baggage screening, which is on the radar for the government. So it is merely a recovery of capital. It's still profit neutral for the airport.

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Operator [110]

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Thank you. There are no further questions at this time. I'll now hand back to Mr. Culbert for closing remarks.

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Geoffrey Culbert, Sydney Airport Limited - CEO [111]

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Well, thank you everyone for your time. Appreciate it. We'll now call it to a close.