Transurban Rolls Out A Robust Outlook

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

-Development costs increasing
-But growth profile is robust
-Queries re US cash flow inclusion
 

By Eva Brocklehurst

Toll road developer and operator Transurban ((TCL)) rolled out a dividend increase and a robust growth pipeline in its first half results, demonstrating confidence in the traffic outlook. Traffic growth and earnings from the Melbourne and Sydney assets were strong. Brisbane remains the weakest of the east coast networks, because of softer economic conditions in Queensland. US road earnings are also benefiting from an improving economy.

The pipeline of projects appears full but Macquarie observes it falls short of the company’s objective to have one project in construction and one in development in every region. NSW is the market which misses those targets. The most obvious opportunity there, in Macquarie's view, is the reorganisation of the CCT/M1 and the Sydney harbour tunnel and bridge slated for around 2023.

Strategic development costs are increasing and management has signalled investment is not necessarily delivering an immediate return, although Macquarie observes the company is attempting to cater to a changing environment, flagging more details about the potential impact of technology will be available for the upcoming investor briefing.

UBS notes earnings growth of 14% lagged the 19% revenue growth, which was unusual. This stemmed from a 2.7 percentage point decline in margin to 73.7% but, excluding new projects in start-up mode, this moderates to 76.1%, a 0.3 percentage point decline. The broker expects the elevated costs of new project developments should also moderate.

Transurban has plans for $4bn in capital to be deployed over the next five years on projects for which it is in exclusive negotiations. UBS expects gearing capacity and the dividend reinvestment plan will be sufficient to fund this capital.

The 21% growth in proportional costs surprised Morgans. Several items contributed to this, with the start of the Legacy Way and ramp up of express lanes, as well as investment in growth projects.

Transurban is now factoring in the US express lanes into its calculations, with a $28 contribution for the first time to free cash flow. This surprised both Morgans and Macquarie, as the company had previously indicated it did not expect to have access to these cash flows until later in the decade.

The quality of this cash flow will be questioned further if the express lanes are still in distribution lock-up, which Morgans maintains is yet to be confirmed. Macquarie warns that counting trapped cash flow as part of a distribution measure is a very low-quality entry on the books.

Morgans reduces proportional earnings estimates by 2.0%, noting that this does not include estimates for the Victorian Western Distributor project, which if it proceeds may add 60-70c per security to valuation. The broker also notes the company has merged service and fee revenue into toll revenue, thus making the revenue result less clear on a composition basis and reducing the ability to compare with historical data.

Deutsche Bank likes the quality of the portfolio but believes the stock is relatively expensive. The company’s development pipeline to 2022 requires up to $8.2bn in capex to be invested and the broker suspects these may necessitate some additional equity funding going forward, although management maintains timing of the projects will also assist funding needs.

Nevertheless, free cash flow growth is robust, as is the development pipeline, in Morgan Stanley's view. The broker considers the amount of operating expenditure growth is acceptable at this point in time, and while debt risks are increasing, they are manageable.

Investor concerns are mainly about the debt levels and rising costs, but Morgan Stanley believes the company can service and refinance its holding company and project debts under most reasonable adverse cases. The broker endorses management's practice of optimising debt costs versus re-financing risk by pushing out the debt tenor, rather than by simply minimising costs.

The broker believes investors appreciate the strength, diversity and growth prospects of the Australian road network and are increasingly re-rating the US roads, now that the company is announcing traffic and revenue growth in that region. Morgan Stanley does not include major growth projects such as Victoria's Western Distributor in its analysis but believes that could add a further 90c per share to valuation should it proceed.

There are three Buy ratings and three Hold on FNArena's database. Macquarie remains restricted on rating and target. The consensus target is $11.04, suggesting 3.2% upside to the last share price. Targets range from $9.99 (Morgans) to $12.00 (UBS).
 

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