Australia | Apr 06 2020
Is the withdrawal of Transurban's distribution guidance a sign of more long-term changes to distribution policy?
-Debt covenants likely to be threatened if the current lock-down lasts for six months
-Growth projects being prioritised to boost future cash flow and support employment
-Crisis may bring about a permanent change to distribution policy
By Eva Brocklehurst
The complexity of the impact of the coronavirus crisis on Transurban's ((TCL)) road network cannot be underestimated and, given the uncertainty, the company's board has elected to withdraw the second half distribution guidance.
Macquarie suggests revenue in North America is being affected the most, close to being down -90% as cities there enter full lock-down. Hence, the company's liquidity boost of $1.2bn is positive and should provide ample flexibility.
In addition, Transurban will generate $800-900m of operating cash flow. Debt covenants are manageable, in the broker's view, and will only be threatened in 2020 if the current lock-down last for six months.
UBS estimates proportional cash flow would need to fall an average of around -50% in order to breach weighted average covenants. Moreover, high-quality companies such as Transurban would be well able to obtain waivers or remedy any breach.
The investment-grade credit rating of Transurban Finance, the company's corporate debt vehicle, acts as a critical constraint because it is the source of $3.9bn of the company's $4.5bn of liquidity, Morgan Stanley points out.
The broker assesses the credit metrics thus: with a recovery in traffic by the end of 2020, credit stress is manageable. If further travel restrictions eventuate, equivalent to a -40% drop in traffic for a full year this could lead to credit stress. In this case North American roads and WestConnex M4 would be in debt lock-up and repair to the balance sheet would subsequently be required.
Ord Minnett revises forecasts, assessing the serviceability outlook has deteriorated further. This increases the likelihood that further counter-measures may be employed to defend the investment-grade rating. Hence, the broker increases the weighted average cost of capital assumption to 6.2%.
Macquarie believes Citylink (Melbourne) is a leading indicator of the of the direction of traffic, and it is down -40%. In Australia, Victoria has been faster to ramp up restrictions versus NSW. Additionally, the broker notes, Citylink is affected by airport traffic, which has disappeared, whereas in Sydney this impact is spread over multiple toll roads.
Transurban's construction work on existing projects has not been affected by shutdowns but, in the event of further restrictions, downside risk is anticipated to both timing and budget. Growth projects are being prioritised to bolster future cash flows as well as support employment.
There are limited operating levers as most of the company's expenses are fixed. Hence, Morgan Stanley looks at traffic scenarios. The most challenged roads in the portfolio, in the broker's estimates, are the 495 and I-95 in the US. Macquarie agrees, as volumes have now collapsed with the broader lock-down of Virginia until June 11.
In analysing traffic, Morgan Stanley estimates a deep and prolonged decline could mean more assets withhold distributions and slow the return to more comfortable debt coverage. Such a scenario could be helped via policy support, in highlighting the employment benefits of the company's network to the economy.
Assuming policy restrictions are the main constraint on transport, the broker envisages intra-urban toll roads will recover faster compared with inter-urban roads and air travel (which may be subject to restrictions across multiple jurisdictions).
Moreover, if social distancing persists as workplaces re-open then the company's toll roads could benefit from diversion from public transport. In the company's key markets, public transport ranges from a 5% share, as in Brisbane, to 22%, in Montreal.
UBS expects traffic should be one of the first economic activities to recover and amid lingering concerns around using public transport. The broker assumes a three-month shock to traffic, whereby Australian private vehicle traffic declines -50% and heavy vehicles -20%.
This is acknowledged as a more moderate assessment than the case for international traffic. UBS upgrades to Buy from Neutral while Credit Suisse goes the other way, downgrading to Underperform from Neutral on valuation.
Transurban has withdrawn the second half distribution guidance of $0.31 per security, and expects to pay a distribution in the second half from free cash, retaining $125m to manage liquidity. Previously payments were paid out 100% and included capital releases.
Morgans expects, at current prices, Transurban may deliver a yield of 2.2% over the next 12 months, although the distribution will grow rapidly as traffic recovers. At this stage, the broker expects a second half distribution of 14.75c. Assuming capital releases are retained for balance sheet support, the broker calculates the distribution in FY21 could decline to $0.35.
The shift to underlying cash flow does not surprise Macquarie. Also, the crisis may bring about a permanent review of policy, aligning distributions with cash flow, using only the balance sheet capacity for reinvestment opportunities and only if there are no share buybacks or capital returns. Such approaches would reduce the need for new equity, the broker suggests.
Credit Suisse agrees the board is likely to adopt a similar approach in FY21 and reduces distribution estimates by -30% for FY20 and -38% for FY21.
The broker envisages the possibility that companies and boards that get through this current crisis may become more risk averse. This could lead to more conservative capital structures and more cash being steered to the balance sheet rather than restoring dividend pay-outs to high historical levels.
The consensus target on FNArena's database is $13.09, suggesting 12.3% upside to the last share price. The distribution yield on FY20 and FY21 forecasts is 4.0% and 3.9% respectively. There are three Buy ratings, two Hold and two Sell.
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