Transurban Readies For Busy FY18

This story features TRANSURBAN GROUP LIMITED. For more info SHARE ANALYSIS: TCL

Transurban maintains a full development pipeline for its toll roads and FY18 guidance implies lower growth than previous years.

-Guidance may be conservative and capital raising considered highly likely
-Corporate costs expected to be sustained at higher levels
-Focus on expansion and constructing new toll roads
 

By Eva Brocklehurst

Transurban ((TCL)) maintains a full development pipeline in FY18 and strong employment, car registration growth and fuel usage continue the growth trend on its toll roads. Sydney is stable but there is the potential for further ramp up in Melbourne and Brisbane as the effects of roadworks diminish.

Nevertheless, FY18 guidance implies a lower growth year versus previous years. FY17 results were marginally weaker than many brokers expected because of an acceleration in costs. A combination of around 3% growth in journeys, CPI, toll increases and capital investment delivered around 11% growth in proportional toll revenue. Free cash flow per security increased 9%.

The company has provided FY18 distribution guidance for the first time, at $0.56 per security, up 8.7% on FY17. This is below the double-digit growth rates experienced over the last four years.

Free cash flow was covered 99% and this suggests some underperformance versus guidance provided back in February, although UBS acknowledges this is hard to pin down exactly. Distribution guidance for FY18 implies 9% growth versus the 13.5% growth experienced over the last four years. This reflects the run-off of a number of toll enhancements and funding costs for developments. UBS retains forecasts that imply 101% coverage of guided distribution, suggesting some potential upside.

Capital Raising?

Morgans suspects guidance is intentionally conservative, in order to sustain, or upgrade, the distribution into a capital raising. A trend of strong corporate costs growth continues, with heightened investment in business development acquisitions, customer initiatives and technology.

The company expects to fund current commitments from its balance sheet, supported by its distribution reinvestment plan and a possible future release of capital. Hence, equity capital may be used to fund the proposed West Gate Tunnel project (Melbourne), which has commercial close targeted for the end of the year.

Morgans suspects this may take place alongside a capital raising to fund acquisition of a stake in the NSW government's WestConnex sell-down, if the company is successful. The transaction is likely to be timed mid 2018. The NSW government has indicated it will sell at least 51% of WestConnex.

Macquarie observes the company is taking a very conservative line regarding development, expensing bid costs as they are incurred, having highlighted expectations that costs will remain elevated, reflecting the ongoing bidding opportunities within its development pipeline.

Credit Suisse also expects corporate costs to remain at the higher level as the company bids for WestConnex and maintains a focus on customer value initiatives. Distribution guidance is expected to increase at the first half result, when clarity is provided on CityLink (Melbourne) traffic post completion of the widening, to maintain growth above 10%.

Credit Suisse forecasts FY18 distributions of $0.57 per security. The broker also notes the potential for an equity raising for the West Gate Tunnel and forecasts around $600m.

Toll Concerns

Macquarie observes Andrew Head's role has narrowed, with his sole focus on the development of the NSW opportunities. Michele Heuy has taken on operations for existing roads in NSW. The broker suggests this management change highlights how important NSW has become, along with managing stakeholders, in obtaining both government and consumer acceptance of toll roads.

The broker believes the numerous examples in the company's presentation citing value for money and the quantum of tolling versus other countries is an attempt to address a emerging backlash regarding tolls.

Meanwhile, the current opportunities are full, with around $1.6bn of committed expenditure and at least $4.4bn in pending expenditure. This should firm up in the coming 12 months. Replenishment of the pipeline potentially comes from WestConnex, and other projects in NSW and Queensland as well as another US city.

Technology

The company has highlighted investment in technology as a key theme, driving network enhancements. Such investments this year include the roll-out of Glide as well as mobile GPS trials for retail and commercial customers. The company has launched Linkt, a new tolling platform to replace some of the smaller brands.

There is still a problem in that various brands co-exist across the eastern states. Macquarie notes, Linkt, Roam and Citylink all have the same engine and there are scale benefits with integration.

Overall, the results re-affirmed the quality of the network for Citi, as well as the growth pipeline. The broker envisages further upside in the share price towards a 12-month valuation of $12.62, and additional upside on successfully achieving financial close for the West Gate Tunnel project. Valuation does not include future projects that have not yet reached financial close. Adjusting the numbers provides a total return estimate of 12.5% and Citi downgrades the stock to Neutral from Buy.

Macquarie emphasises Transurban is not a concession distribution company and judges the business to be about extending concession life through expansion and new toll roads. Valuation is centred around the internal rate of return of 8.6% rather than the dividend yield. This is expected to be the theme for the next 4-5 years as the next construction phase is managed.

There are three Buy ratings and three Holds on FNArena's database. The consensus target is $12.58, suggesting 8.4% upside to the last share price. Targets range from $11.77 (Morgans) to $13.30 (UBS). The dividend yield on FY18 and FY19 forecasts is 4.9% and 5.4% respectively.

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