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I wrote last year why toll road operator Transurban (TCL:ASX) should be a core stock in your portfolio. It was trading at $11.62 at the time, and as the chart below shows, hasn’t done an awful lot since then.
It completed a discounted capital raising of $1.5 billion at $11.40 per unit in December to fund the West Gate Tunnel project in Melbourne, has been buffeted by concerns about the bond market and so called “bond proxy” stocks, and more recently, whether it will it or won’t succeed in acquiring a 51% stake in Sydney’s WestConnex project. Over the last 12 months, Transurban has paid distributions totalling 56c per unit and the units closed on the ASX on Friday at $11.90.
Last Tuesday, Transurban announced its full year results. Toll revenue rose by 8.7%, to $2.34 billion, on the back of a 2.2% increase in average daily traffic volume, more higher paying heavy vehicles, and toll indexation. EBITDA rose by 10.2% to $1.796 billion.
Transurban provided distribution guidance of 59.0c per unit for FY19, up from 56.0c in FY18. This was lower than some forecasts of up to 60.5c, but importantly, Transurban confirmed that it would be maintained in the event of a successful WestConnex bid.
At 5.4%, the growth rate of the forecast distribution, compared to FY18, is the lowest in many years, and well down on the CAGR (compound annual growth rate) of 11.0% over the last five years.
Transurban has a $10 billion committed development pipeline, which includes $4.0 billion for the West Gate Tunnel Project in Melbourne, $1.3 billion for North Connex in Sydney, and projects in Brisbane and greater Washington DC in the USA. These projects will come on stream over the next four years and deliver increased toll revenue.
Transurban says that all projects are on budget and largely on schedule, although the delivery timeframe for North Connex is currently under review.
In addition to its committed development pipeline, Transurban sees potential “next generation” opportunities with enhancements to current roads (for example, widening of the M7 is Sydney or upgrade of the M1 in Brisbane) and building the “missing links” (for example, the North-East link in Melbourne or the Western Harbour Tunnel in Sydney).
The big opportunity for Transurban is the WestConnex project. Estimated to cost more than $16.8 billion, WestConnex is a partially completed motorway development in Sydney. It comprises 33km of interconnected motorways and road upgrades, which will extend the M4 motorway from Parramatta to Sydney Airport and duplicate the M5 East corridor.
The project is being delivered in three stages and is about 40% complete. Stage 1B, the M4 East extension, is due to complete in early 2019 and a construction contract has just been let for Stage 3A, the M4 to M5 link tunnel.
The NSW Government is selling a 51% stake, with the majority owner expected to manage the remaining construction risk and the tolling (traffic) risk. Viewed as the natural owner of these toll roads, Transurban is leading a consortium comprising Australian Super, Canada Pension Plan Investment Board and Tawreed Investments, and submitted a formal bid in July.
The Australian Competition and Consumer Commission (ACCC), worried about competition issues, given that Transurban holds seven of the nine toll road concessions in NSW, has refused to give the bid the green light and has delayed its final determination until 6 September. On Thursday, to address the ACCC’s concerns, Transurban offered to publish detailed toll traffic data (by 15-minute intervals) for all its toll roads in NSW.
Buying a controlling interest in WestConnex would be a double-edged sword for Transurban. On the one hand, an opportunity for long-term revenue growth, on the other, execution and tolling risk, and the likelihood of a dilutive capital raising.
Transurban has almost $15.0 billion of net debt. While the debt has an average tenor of 9.2 years and is 98.5% hedged, if interest rates rise, Transurban will pay higher interest costs when it comes to roll over the debt or seeks additional finance for new projects. As almost 100% of free cash flow is distributed to unit-holders, higher interest rates would invariably lead to lower distributions. But with only $500 million due to be refinanced in FY19, any impact here is some way off.
The other obvious risks are construction and tolling risks associated with the new projects. There is also a question about whether most of the “traffic mix” improvements (a higher proportion of higher paying heavy vehicles) has already happened, and from Government, the Queensland Government’s Inquiry into the operations of Toll Roads in Queensland.
According to FN Arena, of the eight major brokers who cover the stock, five have buy recommendations, two have neutral recommendations and Citi is the lone broker with a sell. The consensus target price is now $12.62 (previously $12.75), a 6.1% premium to Friday’s closing price of $11.90.
While the brokers are, in the main, quite favourable regarding Transurban managing its growth pipeline, the guidance from Transurban of 59c per unit for FY19 was marginally below the consensus expectation of 60.5c per unit. Apart from the uncertainty of the WestConnex bid (which is seen as both a positive and negative), there are concerns about a potential delay to North Connex and the reliance on heavy vehicle traffic.
Transurban’s forecast distribution for FY19 of 59c (all but 2c is unfranked) puts it on a forecast yield of 4.95%. This is low risk, as are market expectations that this could rise to 62c in FY20. It is clearly not cheap, but few stocks have such annuity-like characteristics and that is why Transurban commands a premium.
However, until the fate of the WestConnex bid is known, the potential for a capital raise and increased execution risk will weigh on the share price. There is also a good chance that the ongoing expansion of the US economy, and tightening by the Federal Reserve, will push bond rates higher, causing markets to re-evaluate perceived “bond proxies” such as Transurban. The lesson from earlier scares is that dips will be bought.
Patient investors will be rewarded by holding Transurban. If you don’t already own it, put it on the watch list and buy in market weakness or on the next blip up in bond rates.