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Morningstar | Atlas Records Strong Cash Flow Growth in 2018 on Interest Savings; Increasing FVE to AUD 5.70

Narrow-moat-rated Atlas Arteria performed well in 2018, with EBITDA rising 5% to AUD 869 million, mainly on solid traffic and toll growth at core asset APRR in France. Distributions to securityholders increased 20% to AUD 24 cents per share, benefiting from significantly lower interest costs as expensive hedges rolled off. The full period benefit of lower interest rates and other positives will drive distributions to AUD 30 cents per share in 2019, with further strong growth likely for a couple more years. The 2018 result was close to expectations. However, we increase our fair value estimate 7% to AUD 5.70 per security on reduced interest rate expectations and after incorporating the lower Australian dollar. At current prices of around AUD 6.90, the stock is overvalued.

We think there are two key areas where our view of Atlas Arteria’s worth differs from the market: interest rates and French corporate tax rates. While we continue to expect interest rates to trend higher over the medium term, global central banks have become more dovish recently, leading us to tone down our expectations for rate rises. This is the main driver of our fair value increase. As for French corporate tax rates, we remain sceptical about government plans to cut the tax rate from 39.4% in 2017 to 25.8% in 2022. Supporting this scepticism, the French government has delayed planned tax cuts so that it has enough money to fund concessions prompted by yellow vest protests. We factor in an unchanged long-term French corporate tax rate of 30%, but really it’s anyone’s guess.

APRR, which contributes 85% of Atlas Arteria’s proportionate EBITDA, performed well with EBITDA increasing 6% to EUR 1.87 billion. The result benefited from solid CPI-linked toll increases, good cost control and solid traffic volume growth, particularly for higher toll-paying trucks. Total traffic volumes increased 2.2% as train and airline strikes forced more people and goods on to roads.

The French proclivity to protest wasn’t a complete boon for APRR though, with the yellow vest movement disrupting traffic volumes in the December quarter. We forecast traffic growth slows in 2019 as key economic drivers such as tourism numbers, manufacturing, import volumes and household disposable income lost momentum through 2018. Additionally, we assume train and airline strikes don’t reoccur.

The biggest driver of free cash flows was lower interest rates as expensive long-term interest rate hedges at APRR’s holding company Eiffarie expired on June 30, 2018. The full-year benefit of EUR 150 million pretax will flow through in 2019. APRR road upgrades are negotiated with government in return for supplemental toll increases or concession extensions. Guidance is for capital expenditure of EUR 420 million per year until 2021, which should keep tolls growing just under CPI. Without additional negotiations with government, capital expenditure will fall to base rates averaging EUR 170 million (real) per year until concessions end in 2035, and toll growth will fall to the base rate of 70% of CPI.

In the U.S., Dulles Greenway performed fairly poorly, as expected, with EBITDA falling 2% to USD 74 million. Greenway traffic volumes fell 4.5% as competing, free roads were upgraded, and on the impact of the partial government shutdown and poor weather. This investment remains in distribution lock-up because of high financial leverage but it should be able to start paying distributions to Atlas Arteria in a couple of years as traffic volumes and earnings improve. Negotiations with government to restructure tolls broke down late last year. We understand the firm was asking for long term toll price certainty in exchange for agreeing to cut tolls for motorists travelling short distances, which we think is reasonable. Tolls currently increase at the higher of CPI plus 1%, real GDP or 2.8% each year to 2020. Atlas must apply to the regulator for toll increases beyond 2020. We believe there’s a good chance the regulator will allow generous toll growth to continue for the medium term to help current poor returns at this road improve.

Management internalisation is on track to complete by May 15, 2019. In prior roles, new CEO Graeme Bevans built large infrastructure businesses for two large pension funds. We interpret his appointment to mean Atlas Arteria will look to expand its portfolio via acquisition of new infrastructure assets. If true, the firm will likely need to raise equity once acquisitions are identified.