Transurban Group (TCL) – BUY
|Date of Report||ASX||Price||Price Target||Analyst Recommendation|
|Date of Report|
|Sector : Industrials||52-Week Range: A$10.97 – 13.11|
|Industry: Infrastructure Construction||Market Cap: A$26,741.2m|
We rate TCL as a Buy for the following reasons:
- Hard to replicate critical infrastructure assets.
- Consistent growth in earnings driven by four key factors:
1) Traffic (with mature toll roads delivering on average 2-4% annual traffic growth);
2) Prices (with escalation set with agreements with governments);
3) Operational efficiency improvements; and
4) Development contribution from new assets.
- Attractive yield – steady and growing distribution stream.
- Integration of technology and systems to enhance operations.
- Growth by asset acquisition and/or development of greenfield and brownfield projects.
- Exposure to infrastructure assets in the US.
- Strong management team with experience in deploying the developer-operator business model.
We see the following key risks to our investment thesis:
- Bond yields experience a significant increase in the short term and track upwards over the long term.
- Valuation appears full at current levels.
- Project development cost blowouts.
- Reduced traffic volumes.
- Regulatory changes within the sector.
- Unfavourable financing arrangements.
- Poor acquisitions (derived from inaccurate modelling of traffic).
Transurban (TCL) again delivered a solid result with toll revenue and operating earnings (EBITDA) up +8.7% and +10.2%, respectively, on previous corresponding period (pcp). Margins across the segments improved, with group EBITDA margin expanding by 100bps to 74.9%.
Management have guided towards FY19 distribution of 59cps (including 2cps fully franked) versus current consensus (median) estimates of 60.5cps. Whilst this may disappoint some, we believe there is upside risk to this guidance in the event TCL is unsuccessful in bidding for WestConnex, as management noted this guidance will remain even if TCL wins the bid.
We maintain our buy recommendation. TCL offers attractive assets, growth in earnings / distribution stream and growth opportunities offshore. With TCL’s inflation protected revenue stream, a ~5% yield which is growing high-single digit per year is attractive, in our view. Further, we note the spread between TCL’s current dividend yield and the Australian 10-Yr bond yield is 2.34% versus 5-yr average of 1.88%.
- FY19 distribution guidance below consensus, but room for upgrade. Management provided FY19 distribution guidance of 59.0cps, equating to FY18-19 growth of 5.5%, which is below pre-results release consensus estimates of 60.5cps. Management specifically pointed out that this distribution guidance will be maintained even if TCL is successful in bidding for WestConnex. Even though management did not explicitly confirm this when questioned, it is our view that should TCL not be successful in winning the WestConnex there is the potential for the Company to increase this distribution guidance.
- Outcome on WestConnex in September. There were no new details on the bid for WestConnex at the results release. Management noted they expect the bidding to be competitive and have been working with the ACCC, with management sounding confident in achieving all regulatory approvals (ACCC / FIRB) should they be successful. Note the ACCC has delayed the decision to September 2018 (noting it required more time to consider competition issues) after initially raising concerns over TCL’s bid. Investors are keenly watching the outcome of this review as it could signal TCL’s ability to bid for future assets (note TCL already operates 7 of the 9 toll roads in NSW).
- Delayed ACCC decision and distribution guidance could suggest TCL in box seat. We may be reading too much into it, however, given the ACCC has delayed the decision and TCL has already accounted for the WestConnex decision in its FY19 distribution guidance, we believe TCL’s bid must be very competitive. Alternatively, the competing bids must not be as attractive that the NSW government is happy to go ahead with. TCL will likely need to undertake a capital raising to fund the project if the bid is successful.
- TCL has inflation protection. Whilst risk is currently being re-priced in the market (i.e. rising bond yields) TLC’s share price may see some weakness. However, as we have pointed out before, as interest rates rises are likely accompanied by rises in inflation, investors need to appreciate that TCL’s revenue is inflation linked. That is, rising inflation leads to higher revenue, whilst there is a lag for inflation to be reflected at the costs line.
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FY18 RESULTS SUMMARY…
For FY18, group revenue of $2.34bn was up +8.7% on previous corresponding period (pcp) and operating earnings (EBITDA) of $1.8bn up +10.7% on pcp, with EBITDA margins expanding 100bps to 74.9%. FY18 distribution of 59cps (including 5cps fully franked) was in line with guidance.
Figure 1: TCL Revenue by Geography
Figure 3: TCL Results Summary – by segments
Sydney. FY18 proportional toll revenue was up +8.3% to $994m off the back of a +3.1% growth in traffic. The NorthConnex project is tracking as planned, with the construction efforts expected to remain within TCL’s budget. Notably, the Company also agreed to acquire an additional 8.24% equity interest in the M5 motorway, taking its total stake to 58.24%.
Melbourne. Melbourne toll revenue was up +13.4% to $780m for the year, supported by a +1.4% growth in traffic. EBITDA growth also came in at a strong +15.7% at $688m compared to the pcp. The construction of the West Gate Tunnel project is moving along as expected, with completion being anticipated in 2022.
Brisbane. Proportional toll revenue increased by +2.1% over the pcp to $393m, with traffic growth at +2.56%. EBITDA was up +4.0% over the same period.
North America. The North America region saw the acquisition of the A25 in Montreal for a sum of CAD$858m – a 7.2km toll road and bridge. Full integration of the asset is expected for completion by FY19 and will grant TCL access to growing average annual daily traffic levels (44,616 in FY16, and 46,535 in FY17). Toll revenue was up +7.1% over the period, driven by a +1.9% bump in traffic growth. EBITDA was up +12.4%.
Connected Automated Vehicle (CAV) Trials. TCL is currently running trails in Melbourne, Sydney and the Greater Washington Area (GWA). TCL’s exploration of this type of technology comes on the back of the advent of automated vehicles which have an undeniable presence in the outlook of the transport industry. In both Sydney and Melbourne, TCL have undertaken programs alongside the Victorian Government and similar bodies (including Transport for NSW and RMS) to trial automated vehicle interaction with motorway infrastructure. Trials in GWA are also underway alongside the Federal Highway Administration and Virginia Department of Transportation, facilitating tests for roadside unit communication and vehicle-to-vehicle interaction. While this project is indeed in its preliminary stages, we see TCL’s efforts to both adapt and capitalize on an inevitable industry shift.
Debt position. The Company maintained its strong balance sheet discipline, keeping gearing levels consistent (35.2%) and improving the FFO/Debt (funds from operation) ratio to 8.9% (from 8.5%). Management on the analyst call also noted the small component of debt (less than $600m) that will be refinanced closer to current market levels of around ~5.0%, from existing levels sitting near the high ~6.0%.
Figure 4: FY18 Debt Profile
A25 acquisitions in Montreal, Quebec. In March, TCL agreed to acquire 100% of the equity interests in the A25 from Macquarie Infrastructure Partners for CAD840m + transactions costs of CAD18m. The acquisition in Montreal grants TCL access to a 7.2km toll road and bridge that has seen average annual traffic growth of approx. ~4% over the last 3 years. Additionally, the asset offers favourable demographics in the metropolitan area with stable population growth and density, which is significantly higher than the Company’s other existing operating regions. The A25 since financial close on 5 June 2018, has contributed $5m to toll revenue and $1m to total costs.
An expensive price to pay? The CAD840m investment represented an acquisition EBITDA multiple of 26.0x. On a financial headline basis, Transurban trades at a 1-year forward EV/EBITDA multiple of 21.6x which would indeed suggest that this was a slightly expensive purchase for the Company. However, we note the unrealised potetial that are achievable in an increasingly favourable demographic area. While Montreal’s population levels sit behind Melbourne, Sydney, and Washington at 4.0m, the region has a population density of over 1,000/km2, far exceeding TCL’s other operating geographical segments in Brisbane (~200/km2), Melbourne (~600/km2), Sydney (~500/km2), and Washington (~500/km2). So, while we admit the acquisition did come on the pricier end, the A25 asset offers TCL strong geographical diversification (in a portfolio that heavily concentrates itself in Australia) and exposure to favourable demographic trends.
Bond proxy theory. Whilst risk is currently being re-priced in the market (i.e. rising bond yields), TLC’s share price may see some weakness. However, as we have pointed out before, as interest rates rises are likely accompanied by rises in inflation, investors need to appreciate that TCL’s revenue is inflation linked. That is, rising inflation leads to higher revenue, whilst there is a lag for inflation to be reflected at the costs line. Further, as the chart below highlights, we note the spread between TCL’s current dividend yield and the Australian 10-Yr bond yield is 2.34% versus 5-yr average of 1.88%.
Figure 5: TCL yield versus Australian 10-Yr bond yield
Source: Bloomberg, BTIG
Figure 6: TCL Financial Summary
Source: Company, BTIG, Bloomberg
Transurban Group (TCL) develops, operates, and maintains urban toll road networks in Australia and the United States. The company holds interest in 15 roads in Melbourne, Sydney, Brisbane, and Virginia. Transurban Group is headquartered in Docklands, Australia.
Recommendation Rating Guide
|Recommendation Rating Guide||Total Return Expectations on a 12-mth view|
|Speculative Buy||Greater than +30%|
|Buy||Greater than +10%|
|Neutral||Greater than 0%|
|Sell||Less than -10%|
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