Slowing Growth A Challenge For Transurban

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

The challenge brokers foresee for Transurban is generating growth off an increasingly large and complex base.

-Increased reliance on heavy vehicle traffic and high-occupancy toll pricing
-Negative view from ACCC on WestConnex a potential blot on the horizon
-Will the distribution be raised if unsuccessful on WestConnex?
 

By Eva Brocklehurst

Transurban ((TCL)) has grown its portfolio of toll roads substantially, indicating at its FY18 results that the number of securities have swelled, as a result of raising capital to fund investments. As the absolute dollar value of distributions has grown, the company has signalled distributions are unlikely to grow at historical double-digit rates in future.

Transurban continues to target approximately 100% distribution of free cash flow over time. Accumulated growth projects are worth around $10bn and span several years. Network enhancements are also on offer, such as the widening of Logan, Gateway or M7 motorways.

Second half operating earnings (EBITDA) grew 9%, while traffic volumes increased 3%. Strong growth occurred in Melbourne and Sydney, which offset softness in Brisbane and a decline in North America. Queensland revenue may be soft but Macquarie anticipates costs for the Airportlink will be normalised after a jump in FY18. FY20 will also capture the benefit of the Logan enhancement.

Guidance is for distributions of $0.59 per security in FY19, which includes the successful acquisition of WestConnex and a subsequent capital raising. Management was unwilling to commit to any increase in distribution guidance should the acquisition be unsuccessful.

Macquarie finds positives in the result, including Citylink and the strength of truck traffic in the fourth quarter, which was up 8.7%. Queensland revenue was soft, although the broker anticipates costs for the Airportlink will be normalised after a jump in FY18. FY20 will also capture the benefit of the Logan enhancement.

Morgan Stanley believes investors should be prepared for further normalisation of growth rates in view of the system growth on the company's toll roads and real increases in expenditure. The broker observes free cash flow is increasingly reliant on heavy vehicle traffic, which is more cyclical, and high-occupancy toll pricing, which cannot be modelled.

Nevertheless, quality of cash flow is improving over time and the broker notes better processes for administration fees amid increases in average life of concessions and portfolio diversity.

WestConnex

A view by the ACCC that goes against the company is the main negative on the horizon, in terms of bids for future growth projects in Australia, CLSA suggests. The broker, not one of the eight monitored daily on the FNArena database, downgrades Transurban to Outperform from Buy. Its target is $13.56.

The ACCC's report on the Sydney Transport Consortium bid for WestConnex is scheduled for September 6, while the Queensland Senate inquiry into toll roads is due to report on September 13. Morgans believes the significant construction, operating and funding risk of WestConnex implies a capital raising will more than likely be required for a successful acquisition.

The consortium is natural owner of the stake in WestConnex, Ord Minnett asserts, and after a delay in the ACCC report, finds it hard to believe a final decision will be handed down by the NSW government ahead of the competition regulator.

Distribution Outlook

Citi observes FY19 will be the company's lowest growth year for distributions since FY13. That said, the broker acknowledges distributions will not change if WestConnex is acquired, and may provide scope for an upgrade if Transurban is unsuccessful. While some may view the slower growth as temporary, Citi believes headwinds are emerging, including debt amortisation on the Eastern Distributor and M5.

Moreover, the revised growth profile could result in investors demanding a higher yield which implies a de-rating of multiples. The broker also believes there is downside risk to the current pay-out ratio.

If anything, Macquarie envisages potential upside to the distribution if the bid for WestConnex is unsuccessful, as cash generation will grow through Citylink, A25, Legacy Way and Gateway road enhancements.

Free cash flow can be distorted by capital releases which makes distributions more difficult to predict, Morgans points out. While the company did not provide guidance on future capital releases, these have been pre-agreed with governments. Morgans expects capital releases from Queensland in FY19, North West Roads Group and the 95 Express Lanes.

UBS forecasts $100m of additional cash flow in FY19, generating growth of $0.03 per security and underpinning the distribution guidance. This is driven by 11% growth in operating earnings, with about half from the rebound in traffic on Citylink after the completion of government works mid 2018.

Beyond WestConnex

Meanwhile, the planning scheme for the West Gate Tunnel project has been approved by the Victorian Parliament but the Citylink concession extension and enhancements have not yet been submitted. The company has also purchased an additional 8.4% of the M5 West which takes its ownership of the asset to 58.4%. The concession expires in December 2026, upon which the road is likely to be transferred to the Sydney Motorway Corp.

NorthConnex is expected to remain within budget but this is not assured, Morgans asserts, and an additional $130m expenditure is assumed. The potential timing issue also puts at risk the capital release assumed in FY20. Debt servicing is expected to increase meaningful in FY19.

Macquarie also believes Transurban will benefit from the M5 acquisition, despite the price being undisclosed, as the incremental interest will be financed by debt. The potential for a re-configuring of the timeline for NorthConnex is a negative, the broker acknowledges, given the question over whether it will delay a capital release from the M7. The truck toll increase is already generating majority of the value in the project.

Despite the company highlighting the US and Canada as core to future growth, both regions experienced relatively flat traffic volumes. US roads had a tough fourth quarter and demonstrate to Macquarie the increased local economic risk versus Australian roads. Transurban is committed to start the construction of the I-95 Fredericksburg Express Lanes extension at the end of FY19.

The database shows six Buy ratings, one Hold (Morgan Stanley) and one Sell (Citi). The consensus target is $12.69, signalling 5.9% upside to the last share price. Targets range from $10.39 (Citi) to $14.00 (Ord Minnett). The distribution yield on FY19 and FY20 forecasts is 4.9% and 5.3% respectively.

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