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Morningstar | Initiating Coverage on Atlas Arteria; Overvalued Despite Attractive Distribution Outlook

We reinitiate coverage of Atlas Arteria with a fair value estimate of AUD 5.30 per security. While the firm has an excellent outlook for distribution growth, as lower interest and tax rates boost free cash flows, its main asset has a relatively short life. Taking the short life into consideration, we believe the stock is overvalued at current prices around AUD 6.80.

We believe Atlas Arteria has a narrow economic moat underpinned by efficient scale. Its most valuable investment is a 25% stake in Autoroutes Paris-Rhin-Rhone, or APRR, which owns a concession over the main tolled motorway network in eastern France. Atlas also owns the concession to the Dulles Greenway in the U.S. For toll roads, new entrants are deterred by inelastic demand and substantial upfront construction costs. A difficulty in securing land and planning permission further deter new entrants. We also believe the roads benefit from a form of switching cost due to time savings compared with non-tolled alternative roads. We estimate the time saving between Paris and Lyon is around two hours, or 30%, compared with the non-tolled alternative route. A relatively short concession life of 17 years for APRR precludes a wide moat.

APRR is a large, hard-to-replicate motorway network with relatively defensive revenue. Trade and tourism are key drivers of traffic volumes, which tend to grow slightly faster than real GDP. Toll prices follow a set path--base increases of 0.7% of CPI excluding tobacco. Upgrades to the roads such as adding extra lanes to alleviate traffic congestion are negotiated with the government in return for additional toll price increases or concession extension. Upgrades generally provide attractive risk-adjusted returns. Generally, the main risk toll road projects face is inaccurate traffic forecasts, but this is relatively low for upgrades given the roads are already established and traffic patterns well known.

Additionally, returns for upgrades are typically good given the monopoly position in negotiating upgrades to its roads. The main APRR concession ends in late 2035, while the concession over the alpine part of the network ends in 2036.

Atlas Arteria’s other key asset is the wholly-owned Dulles Greenway in the Greater Washington area. This asset has underperformed recently as non-toll competing roads were upgraded to reduce congestion, thereby detracting from Greenway’s traffic volumes. Recent agreement with the government will see lower tolls for motorists travelling short distances, hurting toll revenue further. But with a long concession to 2056, a wealthy and growing local population and plenty of room to add extra lanes, the long-term outlook is positive. Toll price growth is negotiated with the Virginia State Corporation Commission every five years, likely negating the potential to earn excess returns. The SCC considers three factors when setting toll prices: whether tolls are reasonable in relation to the benefit obtained; whether toll prices materially discourage use of the road; and will tolls provide no more than a reasonable return for the owner? Tolls increase faster than the consumer price index to 2020, helping improve current subpar returns. Thereafter, the firm will apply to the SCC for additional toll increases.