Introduction This study examines the capital structure of Auckland Airport Limited (AIA), the largest and busiest airport in New Zealand. The company was formed in 1998, when the NZ government sold their 51.6% of equity interest to public at $1.80 per share. It is a major gateway to NZ and its revenue stream comprises of airport operations, terminal charges, rents and car parking. AIA is implementing a Faster, Higher & Stronger strategy where high levels of capital expenditure is been done to expand and significantly improve the airport (i.e. terminals), rental area and car parking to take full advantage of the growth opportunities in foreseeable future.

The purpose of this study is to analyze the capital structure of AIA during the period 2009-2010 to 2013-2014, as to identify factors that influenced the managements capital structure decisions and its impact on AIAs performance. The analysis is done by measuring the changes in equity and debt over the study period and the factors that influenced this changes. The capital structure changes are used to analyze its effect on AIAs financing costs over the five years, compared to the achieved performance.

Over the past five years AIA has been increasing its profits, debt capacity and overall revenue; these achievements give AIA a strong financial position which is clearly identified by the managements decision of taking an aggressive amount of debt to finance the 30 year expansion plan.

1.2 Sources of data.Secondary data is used for this study. NZX Company Research website was used to get the annual reports of AIA from 2010-2014. Yahoo finance website was used to get the analysts opinions and historical prices of AIAs shares. Interest.co.nz was referred to calculate the risk free rate, return of the market and get specific information regarding individual bonds of AIA.Equity Capital:

Changes in Equity2014 $0002013$0002012$0002011$0002010$000

At 1st July 2,499,5072,472,7672,467,5311,913,6341,841,147

Profit 215,881177,967142,284100,76129,694

Other Comprehensive Income740,3485,485(16,860)539,0037,641

Total income956,229184,452125,424639,76437,335

Shares issued6211,04325,141138,507

Share buy-back--(10,883)--

Capital Return (454,146)----

Dividend Paid(82,661)(156,714)(120,348)(111,008)(103,355)

Equity at 30th June2,918,9352,499,5072,472,7672,467,5311,913,634

Issued & Paid up capital $322,343$348,848$348,846$338,386$313,245

Number of Shares1,190,126,4871,322,371,6451,322,370,7451,322,158,2451,309,974,587

Over the past five years AIA has followed an increasing trend for equity as clearly shown in the above table. The increase in equity was attributable to the rise in the profits rather than increase in common stock. Even though from 2010-2012, new shares were issued by the firm but in later years were bought back to balance the mix of equity and debt clearly indicating managements preference of debt over equity as a source of financing.

The overall trend can be explained by the following events listed below:

A dividend reinvestment plan was introduced on February 2010, which gave shareholders the right to receive the value of their dividends in the form additional shares. The reinvestment plan offered great incentive to the shareholders and hence led to increase in equity and number of outstanding shares as most of the shareholders took part in the plan. However the plan was discontinued in the later years as it resulted in share dilution and reduction in stock price

Years20102011201220132014

Shares issued under the plan (in millions)$14.80$25.12$10.72N/AN/A

In January 2010 Auckland Airport introduced a right issue for existing shareholders in order to partially fund the investment in North Queensland Airports. Under this, eligible shareholders were entitled to acquire one new share for every 16 existing shares at $1.65 per new share. This resulted in an increase of equity of $122.620 million, net of issue costs.

On 12th October 2011, the company undertook an on-market buy-back of its ordinary shares. The purpose was to counteract the impact of dividend reinvestment plan. The total buy-back cost was $10.833 million.

On 12thFebruary 2014,AIA after the approval of shareholders carried out a planned capital return by way of a 1:10 share cancellation and a payment of $3.43 for each share cancelled leading to a total cost of $454.146 million as shown in the table above. As the management believed that the mix of equity and debt is less efficient than it has been in past, the capital return will improve AIA balance of equity and debt, returning it to levels achieved in 2011.

The remaining balance of shares issued by the company as shown in the table is the shares issued to employees under the employee share scheme. The plan is intended to encourage and incentivize employees by providing them with a stake in the company and a financial interest in the companys performance.

Debt: Year20142013201220112010

Debt ($000)1,507,6721,142,6901,109,4301,085,3531,092,529

Increase/Decrease31.94%2.99%2.22%(0.66%)

Debt/Equity (D/E)51.65%45.72%44.9%44%57%

The debt of the company comprises of Bonds (fixed & floating), Bank facilities, Commercial Paper and USPP notes. Bonds are the major sources of financing for AIA and has shown an increasing trend over the past five years (2014:58%, 2010:50%).

The above table shows the overall trend of debt borrowings increased from 2009 to 2014 because the purpose for debt borrowing was mainly to refinance existing debt programs, to provide funding for capital development projects and for general operational projects except for AIA 130 bonds which were issued on May 2014, with the purpose of mainly refinancing the capital return paid to shareholders on April 2014.

Management preference of bonds over other sources of debt (i.e. Bank facilities) is because most of them are unsecured and unsubordinated, giving the company more flexibility over utilizing their assets offsetting the higher interest been paid. Hence the cumulative effect of tax shield benefit and lower cost of debt in comparison to equity, clearly dictates the managements approach of financing their projects from debt.

Management Approach Based on the Tradeoff theory, AIA has decided to go for an aggressive debt financing especially during 2013-2014. As the company has steady and reliable cash flows and strong liquid assets, it can maintain a high level of debt and still have a low probability of default. Following this, the benefits from the increase in debt offsets the increase in the probability of incurring financial distress costs. The decision to increase the debt can also be explained using Modigliani and Miller proposition (with taxes), as AIA has increased its debt level seeking a reduction of its WACC with this decision. AIAs management has also announced that their upcoming 30 year expansion plan will be purely debt funded hence proving that AIA is committed to take more debt in order to maximize its value and therefore achieve the optimal level of leverage.

Table: Financing costs for AIA from the period 2009-2014.WACC from CAPM MODEL WACC from ROE/ROD model Debt Capacity (Interest Coverage Ratio)

YEARCost of DebtCost of EquityWACCCost of Debt Cost of Equity WACCAverage WACC

2009-20106.86%8.50%7.29%6.58%1.55%1.4%4.34%3.20

2010-20116.58%8.50%7.42%6.49%4.08%4.28%6.55%2.97

2011-20126.5%8.50%7.38%6.22%5.75%5.38%6.38%3.82

2012-20136.21%8.50%7.30%5.84%7.12%6.26%6.78%4.55

2013-20145.95%8.50%7.13%4.52%7.40%6.06%6.59%5.13

APPENDIX PAGE 3: (Assumptions and Calculation are stated in the appendix)

We are taking two different approaches in calculating WACC, however for the analysis purposes we are using the WACC from CAPM model as the benchmark. The WACC is fluctuating over the five years period; it is very high from the year 2009-2012, as the equity increased in comparison to debt, which led AIA to incur high financing costs.

However AIA took measures such as market buy-back of shares and return of capital in the later years to improve the mix of equity and debt leading to reduction of WACC. With that AIA also introduced more debt in the capital structure in form of both floating and fixed rate bonds to take advantage of lower cost of debt. AIA is maintaining a policy-mandated level of fixed rate borrowings to reduce the impact of interest rate fluctuations as well. These measures in later years reduced the WACC to its lowest level benefiting AIA with much higher earnings.

The debt capacity of AIA has also increased over the period of five years as stated in the table above. The ratio should be at least 3 times for comfortable service of debt. Even though the firm was increasing their debt in the later years, the strong performance of AIA has led to higher profits allowing them to pay their annual fixed interest payments easily. Overall it clearly indicates that AIA is in a strong position to take on more debt in future for their upcoming projects.

Appendix Calculation of WACC by Return on Equity (ROE) & Return on Debt (ROD):

Assumptions :