On Tuesday, toll road operator Transurban delivered another set of credible results. Guidance was re-affirmed for a full year distribution of 56c per unit – up 8.7% on FY17, with an interim distribution of 28c per unit – up from the 25c on the first half of FY17.
If Transurban (TCL) meets full year guidance, then unitholders will have witnessed their distribution grow from 29.5c in 2012 to 56c in 2018, a compound annual growth rate (CAGR) of 13.6%.
This is why some analysts consider Transurban to be a “growth” stock. Others look at its high nominal debt and the fact that each toll road is a leveraged proposition. The free cash flow it generates from tolls, after paying maintenance and interest expenses, is largely returned to unit-holders as a distribution.
So, if interest expenses increase, then Transurban won’t have the same free cash flow to pay distributions. Many characterize the stock as a “quasi” bond – and when bond yields rise, bond prices fall. With the recent increase in yields, Transurban units have pulled back from a high of $13.11 just prior to Christmas to yesterday’s $11.58.
But Transurban’s debt is fully hedged. It has an average tenor of 9.3 years and there are no maturities to be refinanced in FY18. Transurban’s current development pipeline is fully funded.
Ultimately, it is a refinancing risk. If bond yields continue to rise, then as current loans mature, they will be refinanced at higher interest rates. To meet this cost and continue to grow unitholder distributions, Transurban has an increasing revenue stream from higher tolls, and a very healthy development pipeline.
Transurban’s $11bn development pipeline
Transurban has a committed $11.0bn development pipeline. In Sydney, this includes the NorthConnex (the freeway linking the M1 Pacific Motorway to the M2); in Brisbane an inner-city bypass and enhancements to the Logan Motorway; in Washington DC express lanes to the 395 freeway; and in Melbourne the Monash Freeway upgrade.
The biggest project is the $5.5bn West Gate Tunnel Project in Melbourne (Transurban’s share is $4.0bn). It is aimed at relieving congestion in Melbourne, reducing reliance on the West Gate Bridge, providing a direct freight link to the Port of Melbourne and removing trucks from residential areas in the inner west. It is expected to complete in 2022.
The project comprises the following core components:
In addition to its committed pipeline, Transurban has identified many other development opportunities. These include “missing links” such as the north-east link in Melbourne and network enhancements such as the widening of the M7 is Sydney. In the USA, significant opportunities in public/private partnerships are expected if President Trump’s plan to re-build American infrastructure is funded.
The most immediate opportunity for Transurban is the massive West Connex project in Sydney and the sale of a 51% equity interest by the NSW Government. Transurban says that while it has registered an interest to submit a bid, no asset is a “must win” and that it will maintain a disciplined investment process. The West Connex sale process will play out over the next few months.
What Do the Brokers Say
The major brokers are positive on Transurban with 6 buys and 2 neutrals. Following the results announcement, brokers made minor revisions to their target prices. Deutsche Bank upped its rating from neutral to buy. According to FN Arena, the consensus target price is now $12.92, an 11.6% premium to yesterday’s closing market price of $11.58.
The brokers have Transurban trading on a forecast yield of 4.9% for FY18 and 5.3% for FY19.
How to play
If bond yields rise quickly, Transurban shares will come under further pressure. But the market is also aware that it made the mistake of too readily labelling Transurban a “bond proxy” last May/June, and then watching the shares bounce as bond yields stabilized.
Many investors see Transurban as a core portfolio stock, with monopoly assets, a guaranteed increasing revenue stream, and genuine growth opportunities. The company’s performance continues to support this view.
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