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Morningstar | Solid 1H19 Operating Performance for Transurban Though Plenty of Noise

Wide-moat Transurban’s first-half fiscal 2019 underlying proportionate EBITDA increased 10% to AUD 1.0 billion, in line with expectations. Key drivers were solid traffic volume growth in most markets, toll increases and three acquisitions. Unchanged distribution guidance points to AUD 0.59 per security in fiscal 2019, with mid-single-digit growth in 2020. Distributions will need to be supported by debt in coming years--what management refers to as a capital release--because of equity dilution from recent raisings, but this isn’t a major concern. Free cash flows will improve as new development projects complete; Transurban has nine projects completing over the next five years. We make minor changes to earnings forecasts, mainly increasing depreciation and interest expense, which were both above expectations in the half. We maintain our AUD 11.00 per security fair value estimate and consider the stock marginally overvalued at current prices. Its security price has improved recently as global central banks tone down expectations for interest rate increases. This trend could have further to go, but we think interest rates will trend higher over the longer term and this will detract from the attractiveness of income stocks such as Transurban.

The Sydney road network saw proportionate revenue increase 8% to AUD 527 million and EBITDA increase 8% to AUD 400 million. Key drivers were 2.1% growth in traffic volumes and acquisition of the 25.5% stake in WestConnex and an additional 15.4% stake in the M5. Excluding the acquisitions, toll revenue grew 3%. WestConnex comprises several road projects, with the M4 the only operating part at present. The next project to complete will be new tunnels extending the M4 east in a few months, followed by an extension to the M5 in 18 months. Work has commenced on the M4-M5 link, which should complete in fiscal 2023, followed by a couple of smaller projects.

The slightly delayed NorthConnex tunnel, linking the M2 to the Newcastle Freeway, should open in 2020. Combined with potential new roads being considered by the state government, including a western harbour tunnel, a link between the Princes Highway and the M5, upgrades around Sydney Airport and a northern beaches link, Sydney’s road network should undergo profound change in the next 10 years.

In Melbourne, toll EBITDA grew 5.4% to AUD 362 million on 4.6% growth in traffic volumes and toll increases, partly offset by lower fee income from nonpaying motorists after changing fee arrangements in the wake of a public backlash. Traffic growth benefited from recent upgrades to state-owned feeder routes. Looking forward, growth is likely to slow before the West Gate Tunnel project completes in 2022.

Brisbane was an underperformer, with EBITDA up just 2.4% to AUD 146 million. The main negatives were subdued traffic volume growth of 0.3% because of disruption from works on Gateway and Logan motorways, as well as similar fee changes to Melbourne. Traffic volumes should rebound in coming months, leading to a better performance in fiscal 2020.

North America performed relatively well with EBITDA of AUD 96 million, up 8.5% excluding the A25 acquisition in Montreal. The 395 express lanes are 50% complete and scheduled to open in fiscal 2020. Additional extensions are likely in this congested region. The A25 has been integrated, and back office systems are being enhanced.

Transurban’s balance sheet is relatively sound, though credit metrics deteriorated over the past year. Gearing increased 60 basis points to 35.8% in December 2018, and funds from operations/debt fell 30 basis points to 8.6%. While high, gearing is reasonable considering the firm’s highly defensive and growing earnings. Risk is well managed with a long average debt maturity of around nine years, while almost all debt is hedged for interest rates and currency.