Transurban Pays Up In Canada

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

Transurban will acquire the A25 toll road and bridge in Montreal, in line with its strategy to expand its North American presence.

-Opportunity to drive efficiencies, upgrades and network enhancement
-Auction success suggests constructive view of eventual revenue upside
-WestConnex likely to drive the share price in the next few months
 

By Eva Brocklehurst

Transurban ((TCL)) is venturing onto new ground with its first toll road acquisition in Canada. In keeping with a stated strategy of expanding North American operations, the company is acquiring the A25 toll road and bridge in Montreal, a city of around four million people.

The acquisition, for CAD840m and CAD18m in transaction costs from Macquarie Infrastructure Partners, is generally considered to be full. This is based on a view that the concession has only 24 years to run, the asset-level debt is expensive and revenues are being shared with the government.

The concession expires in September 2042. Montreal is heavily urbanised and congested and there are opportunities to drive value in operating efficiencies, customer product upgrades and network enhancement.

Morgans expects the acquisition to be mildly accretive. Revenue has sufficiently exceeded the original forecast such that it is now being shared with the government. Tolls escalate with the Canadian CPI and also lift when overall traffic levels exceed pre-defined thresholds.

The transaction highlights the breadth of growth opportunities, Ord Minnett believes, estimating average daily traffic grew by 4% in FY17 while toll revenue was up 8%. The revenue sharing component, above an undisclosed threshold, adds to the attraction.

Average daily traffic growth across FY16-17 was 3.4%. The asset is also taxable at a 27% tax rate. Morgans calculates the enterprise value represents around 3% of its total valuation for Transurban, so this is a relatively small entity in the company's rapidly expanding portfolio.

Macquarie considers this an incremental acquisition with an attractive tolling profile that creates a new growth front. The acquisition in a new city through an auction process is unlikely to mean the asset is undervalued, and the broker suggests the value being added is utilising the latent equity in the balance sheet.

UBS also points out that the company was successful in a contested process without any obvious cost-of-funding advantage or adjacent asset synergies. This suggests a more constructive view of the eventual revenue upside.

On the basis of an estimated 4% debt funding cost the asset is estimated to be marginally accretive to cash flow. The tolling structure is also novel versus other roads in the Transurban network as it represents a hybrid between the Australian and Washington models, including the revenue sharing arrangement with the Montreal transport authority.

The main risk, in Morgan Stanley's view, is the underperformance of traffic in winter. The company intends to use CAD-denominated debt to fund the acquisition, similar to its funding arrangements in Virginia. Morgan Stanley believes overall group gearing and credit ratings remain prudent and sustainable.

Full Price

Headline metrics suggest the valuation of the asset is high and RBC Capital Markets calculates the equity internal rate of return (IRR) is below its 8% equity IRR value for Transurban shares. The broker estimates around 2% accretion to FY19 free cash flow per security but requires further information, particularly on the tolling mechanism, to make a better assessment.

The A25 is modestly accretive to Deutsche Bank's cash flow forecasts but the acquisition cost is below its 9.1% IRR, while the EBITDA (operating earnings) multiple at 26x is high, particularly given the remaining concession is for 24 years.

CLSA agrees the acquisition price looks full, estimating the IRR to be around 7.4%, which is offering around a 5% return over the current 10-year bond yield, and this demonstrates that the stock is trading at too great a discount to fair value for the existing portfolio.

The broker suggests that while it may take some time for investors to become comfortable with the impact of higher yields versus economic reality, the discount to fair value is likely to close. CLSA, not one of the eight stockbrokers monitored daily on the FNArena database, has a Buy rating and $13.65 target.

Comparing transaction multiples is highly subjective, Ord Minnett asserts, given the variation in asset time, location, demographics and the length and terms of concessions. Still, on first appearances the price appears to be full.

Margin expansion will, therefore, be critical. Yet, the broker is confident that operating improvements, upgrades and network enhancements will drive expansion of the operating earnings margin to a forecast 75% by FY30, from 68% in FY17.

WestConnex

RBC Capital Markets does not believe the company's foray into Canada alters its probable desire to acquire WestConnex, as Montreal is not a significant deal in the context of the overall enterprise value.

The broker, not one of the eight monitored daily on the database, rates the stock a Sector Perform with a $12.50 target. The broker is reluctant to become more positive, despite recent stock and sector weakness, until there is further clarity on WestConnex.

Others, including UBS and Deutsche Bank also expect WestConnex will be the key driver of the share price over the next six months, as this will either mean the company solidifies control of the Sydney network or a new operator emerges.

The database shows six Buy ratings and one Hold (Morgan Stanley). The consensus target is $13.12, suggesting 19.1% upside to the last share price. Targets range from $12.80 (Credit Suisse, yet to comment on the acquisition) to $14.50 (Ord Minnett).

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