Transurban Group: taking the M5 to 100%

About the author:

Nathan Lead
Author name:
By Nathan Lead
Job title:
Senior Analyst
Date posted:
09 August 2019, 5:49 PM
Sectors Covered:
Infrastructure, Utilities

  • The 2H19 result was outweighed by a surprise capital raising of up to $700m mostly to fund the buyout of the remaining M5 West investors. 
  • The predictability of earnings is comforting, with the 2H19 result in-line with our EBITDA forecast and close to market expectations. However, quality of cashflow support of the DPS deteriorated. 
  • DPS guidance for FY20 implies 5% growth, as per expectations. 
  • Earnings forecasts are revised upwards, while our target price declines (Morgans clients can login to view detailed reports and price targets); both are due mainly to the acquisition of additional M5 interests. HOLD.
  • Next key event is September quarter traffic data release and AGM on 10 October.

The bulls will like… 

Earnings growth was solid and predictable (EBITDA +12%), albeit driven by acquisitions.

The diversity of the asset portfolio, both within and across markets, reduces earnings volatility. Development projects will come on-line over coming years and lift cash generation.

Lower market interest rates will continue to benefit debt service as debt is refinanced and as additional debt is raised.

Balance sheet management is prudent (targeting BBB+ credit rating) and capital markets are supportive.

We forecast FY20-25 DPS growth of 5% pa CAGR, which is solid in the context of a lower-for-longer world. Capital releases to support the DPS growth is a sensible way of appropriately gearing assets. Falling bond rates will continue to be supportive of defensive equities like TCL.

And the bears will dislike…

Tracking how TCL is funding its development projects, capital returns, distributions, and tax obligations is increasingly complex.

Quality of coverage of the distribution from underlying cashflow has weakened, with ~25% of the DPS in FY19 needing to be funded from additional borrowings. There are signs, maybe temporary, that weakening economic conditions are impacting traffic growth.

Low CPI will certainly slow earnings growth on those roads with CPI-linked toll escalation.

Finally, there is concern that TCL will dilute the returns from the existing asset portfolio by pursuing development and M&A opportunities that deliver relatively lower project returns in a low interest rate world. 

Forecast changes 

Proportional EBITDA lifts 4%, due mainly to the increased ownership of the M5 West.

Free CF improves 7-12% on a per share basis, due to higher EBITDA, tax deferral, and leveraging the low cost of equity via the capital raising.

DPS growth forecast beyond FY20 lifts to 5% CAGR, based on the stronger Free CF outlook. 

Investment view 

Our base case DCF valuation reduces (Morgans clients can login to view detailed reports and price targets). First-time DPS guidance for FY20 of 62 cps implies solid 5% growth on pcp and distribution yield in the low-4%. So on the face of it the potential investment return is limited.

But as we've noted previously, the risk free rate (2.5% pa) we assume in our cost of equity assumption (6.7% pa) is above current Commonwealth Government bond yields (used as a proxy for the RFR).

Instead assuming a 1% risk free rate, and holding all else constant, lifts our valuation (Morgans clients can login to view detailed reports and price targets). On that basis, TCL could be considered to be within the bounds of fair value. 

More information

Morgans clients can login to view our detailed report and share price target for Transurban Group (TCL). Alternatively, please contact your Morgans adviser or nearest Morgans office for access.

Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.

 

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