Australia | Jul 11 2013
-Toll road traffic, earnings pick up
-Higher rates pressure bottom line
-Distribution cover intrigues JP Morgan
By Eva Brocklehurst
Toll road owner/operator Transurban ((TCL)) has finished FY13 with a flourish. Traffic growth across most assets picked up in the June quarter and momentum is continuing into FY14. Proportionate Australian revenue grew 5% in the June quarter and average daily revenue outperformed traffic growth because of toll increases and changes in traffic mix. FY14 should be a good year, in most broker opinions.
Just how good is the question, as risks and expectations are massaged. Macquarie notes the quarterly traffic growth was softer than in the March quarter but this likely reflected the timing of Easter, which was not in the school holidays this year. While not disappointing altogether, underlying growth has not continued the third quarter trend. It may be too early to measure this conclusively but the current quarter should provide more confidence about the risk to traffic forecasts, particularly that associated with Sydney's M3.
In 2013 Sydney's M2 upgrade should be completed with benefits to the broader road network. CIMB notes removal of Pocahontas in the US from earnings forecasts is offset by upgraded expectations for the M2 and Lane Cove tunnel. Traffic growth was strongest on the M2, up 7.5% in the June quarter, followed by the Westlink M7, up 5.4% and the Lane Cove tunnel, up 5.2%. Melbourne's CityLink also recorded solid growth, up 3.2%.
The timing of Easter meant that there was one extra workday in the fourth quarter of FY13 which probably boosted traffic by 0.2-0.5% in BA-Merrill Lynch's view. The broker remains particularly positive on the Sydney roads, given that extremely wet weather during June probably hampered traffic. M2 traffic growth received minor benefits from the opening of the section west of Pennant Hills Road with additional volume from the Windsor Road and Macquarie Park/Herring Road ramps.
CityLink was also strong. Here, the driver of the positive traffic growth was weekend trips, up 7.6% in the quarter. This rise in more discretionary travel suggests sentiment may have improved in Melbourne. The Eastern Distributor, traditionally a barometer for economic activity in central Sydney recovered, with traffic up 1.8% in the quarter. Weekend traffic on the M1 also picked up. Performance on the 495 Express Lanes in the US underwhelmed brokers but the company had previously stated that these lanes were unlikely to distribute cash in the first two to three years of operations. Merrills doubts shareholders are attributing much value to it currently.
The company's forward balance sheet capacity is of note. Macquarie assumes rolled debt will cost 5.5-7.5%, some 50 basis points higher. This may not have an impact on the ability to fund the M3 upgrades but would increase the challenge for the East-West link funding. Traffic may have been sound but it was not strong enough for Macquarie to revise forecasts and the M2 improvements were not quite as expected. The broker wants to see more evidence of all this but is happy to retain an Outperform rating.
JP Morgan expects the FY13 earnings growth of 4.7% will be pressured by higher interest paid, estimating this will translate to proportionate net profit that is down around 9.6% on the prior year. The broker thinks FY13 is the consolidation year and the market will now focus on the growth potential of FY14 cash flow as well as the strong operating leverage. The stock is trading above valuation and hence an Underweight rating is retained leading into the results on August 1. The stock is also trading at a 3% premium to the broker's price target of $6.56. Having said that, on a relative basis, JP Morgan still prefers the stock to the likes of Sydney Airport ((SYD)).
What will be of interest in the FY13 report is how well the expected distribution is cash-covered. The company has said it expects the 31c per share distribution to be at least 95% cash covered but this, in JP Morgan's calculations, comes up short. At 31c per share, the broker estimates the distribution may only be 91.9% cash covered.
In Merrill Lynch's view the widening of the M2 will be the driver in a step change in Transurban's distribution profile from FY14. From there the broker estimates a 22% rise in tolls and 10% rise in traffic will result in an uplift accounting for around 55% of the FY14 estimated free cash flow increase to 34.5c from 28.9c. CityLink adds another 43% of the expected increase. CIMB names Transurban as a top pick in the sector, trading on a 17.5 times FY14 forecast enterprise value/earnings.
Goldman Sachs has taken a softer line on FY14, given expectations of softer economic growth. CityLink estimates have been lowered by 2.5% in terms of traffic growth while M2 is steady at 12% for FY14, given the cycling of construction works during FY12. The broker maintains a Buy rating as Transurban offers a strong organic growth profile which is driven by completion of the M2/M5 upgrade and the ramp up of the Capital Beltway. On an absolute basis the stock is seen expensive, trading at a 7% premium to the broker's discounted cash flow valuation of $6.35.
While the distribution yield is in line with long term earnings, for Merrills it is inferior to other defensive names such as DUET ((DUE)) and Spark Infrastructure ((SKI)). On the FNArena database the stock has a 4.5% consensus distribution yield based on FY13 forecasts, and 4.9% based on FY14 forecasts. The consensus target price is $6.54, suggesting 4.8% downside to the last share price. There are two Buy ratings, four Hold and one Sell. The target price range is $5.85 to $6.94.
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