SHANGHAI International Airport Co. (Shanghai Airport), the world’s fourth-largest listed airport operator by market value, has seen its shares rally despite cooling passenger traffic growth.

Now, its duty-free shops hold the key for investors to determine if the stock deserves a valuation premium.

Shares of the operator of the Shanghai Pudong International Airport, the second largest by passengers on the Chinese mainland, have almost doubled since the start of 2017, driven by steady earnings growth. That compares with a 1 percent drop for the broader Shanghai stock index, and a 51 percent gain at Hong Kong-traded Beijing Capital International Airport Co.

As one of the most popular Shanghai-listed A shares among foreign investors, the company is trading at 24 times of earnings over the next 12 months, the highest among listed airports in China and above its average multiple of 19 times over the past two years. The stock is already trading near analysts’ 12-month consensus target of 54 yuan (US$8.41). The stock closed up 4.31 percent at 54.97 yuan yesterday.

“There’s just too much exuberance in the past year given market expectations of increased flights, rising non-aeronautical revenue and earnings growth, and the stock’s inclusion in the MSCI,” said Corrine Png, CEO of Singapore-based independent research firm Crucial Perspective Pte.

Shanghai Airport is among more than 200 A-share companies to be included into the MSCI index, a move likely to attract more overseas buying. But Png said most of the positive catalysts have been priced in and a significant correction will come even at minor “earnings disappointment.”

Analysts are already expecting the company’s profit growth to decelerate this year. Their consensus estimated annual earnings growth for Shanghai Airport is 14 percent over the next three years, below its average annual growth of 19 percent over the past five years.

To be sure, compared with many of its peers, Shanghai Airport boasts stronger profitability and growth prospect. Its trailing 12-month sales grew 17 percent year on year, still beating 84 percent of its peers. Its trailing 12-month earnings growth of 33 percent is higher than 68 percent of those peers, while it is still trading at a steep discount to overseas airport operators like Sydney Airport and Airports of Thailand PCL.

Some investors view Shanghai Airport as a proxy to play the Chinese consumption story. They are hoping Shanghai Airport’s slowing aeronautical revenue growth can be offset by potentially higher income from its retail business, said Wang Yichao, a Shanghai-based analyst at Capital Securities Corp.

Much like elsewhere, Chinese airports lease out space to merchants selling duty-free goods from Louis Vuitton bags to Toblerone chocolate bars and claim a share of the retailers’ sales revenue. This part of business is becoming increasingly important for earnings as their core business of handling flight take-off and landing has been hurt by Chinese aviation regulator’s moves to limit the number of flights at some airports last year to tackle delays.

The Pudong airport is entering a new round of lease renewal negotiation this year with retailing tenants that account for 50-60 percent of duty free sales at the Pudong airport, according to estimates by four analysts. The market is hoping it can cut a better revenue-sharing deal this year.

According to Wang, Shanghai Airport is expected to strike a deal similar to what Beijing Capital International Airport negotiated with its retailers last year — under which the airport takes as much as 47.5 percent of sales from shops at its terminals. That’s far higher than the maximum 25 percent Shanghai Airport currently has agreed with its merchants. (SD-Agencies)