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Morningstar | No Major Revelations at Transurban’s Investor Day

Transurban Group’s investor day reiterated its focus on successfully delivering its large development pipeline and delved into some of the potential longer-term growth opportunities. We continue to believe it is a high-quality company, warranting a wide economic moat rating. But the recent rally in bond prices has pushed its security price above our unchanged AUD 11.50 fair value estimate. As such, we believe the stock is moderately overvalued. Fiscal 2019 distribution yield is just 4.3%, essentially unfranked and partly supported by capital releases a.k.a. debt.

The firm reiterated near-term priorities: deliver its current projects; maximise operating performance; and enhance customer and community experience. The firm has a huge amount of development work underway in the midst of a nationwide construction skills shortage. Fortunately, Transurban has fixed time, fixed price contracts with first and second tier construction companies to deliver its developments. Bank guarantees, which become payable to Transurban in certain circumstances, also help mitigate risk of timing delays.

Operating performance is continually improving through small road upgrades such as new on-ramps, new technologies including video tolling and artificial intelligence to improve traffic forecasting and maintenance planning, and economies of scale as many of the firm’s existing systems can be used on new roads at minimal extra cost. In terms of enhancing experiences for customers and the community, the firm is actively engaging with community concerns around its developments, providing help to hardship customers and providing motorists with travel time comparisons on its roads versus untolled roads.

With so much on its plate, we doubt Transurban will take on any major new projects for a few years. But over the longer term, management sees huge growth potential as governments, many heavily indebted, look for partners to deliver much needed road upgrades and additions.

Management also discussed how new technologies like automated vehicles could significantly increase traffic volumes on its roads without causing congestion--think automated cars whizzing around at high speed and with minimal gaps as each car communicates seamlessly with those around it and with the grid. Management forecasts mainstream adoption of this technology in the mid-2030s, which could give its mature assets a second wind.

Management provided a session on tax, explaining the firm’s tax treatment and when tax will ramp up, but leaving far too much unanswered for outsiders to calculate what tax payments will be. For Australian investors, we don’t consider this isn’t a major issue as increasing tax payments will lead to higher levels of dividend franking.

The firm also provided a session on long-term traffic forecasting. Management believes its forecasting skills are a key differentiator, allowing it to make more accurate bids on road acquisitions. Key planks to its long-term forecasts are demographics and growth of the cities, personal wealth and broader economic conditions, and major potential changes to road networks. That all sounds great, but we understand Transurban won the WestConnex auction by offering a lot more money than the next highest bidder and a lot more than the government was expecting, justified by Transurban’s significantly rosier long-term traffic forecasts.

We think Transurban could be putting too much faith in its ability to predict the distant future. One key area where management could be wrong is technology. Having spent so much time talking about how technology could benefit the business at the investment day, it was surprising that telecommuting was dismissed as a fad. Technology has improved to the point where working from home is a viable option for many.

At Morningstar Australasia, one in five work from home at least one day a week, using software such as Zoom to join meetings with video and audio and Skype to chat with team members. We think this trend will intensify as people use technology to reduce cost of living pressures, including making fewer trips to work and even moving out of major cities. In this way, Transurban could overestimate long-term traffic demand growth, though this isn’t a near-term concern.