Transurban Group: Waiting for the recovery to gain momentum
About the author:
- Author name:
- By Nathan Lead
- Job title:
- Senior Analyst
- Date posted:
- 18 February 2022, 12:30 PM
- Sectors Covered:
- Infrastructure, Utilities
- There was no surprise the 1H22 result was weak, but it was better than expected.
- We retain an ADD rating, viewing TCL as a high quality toll road portfolio that provides long-dated resilient cashflows with leverage to a COVID recovery.
- 12 month target price decreases (login to view) per share.
1H22 delivered -4% decline in EBITDA (6% beat of our forecast) and -12% decline in Free CF per share (3% beat). Interim DPS of 15 cps had already been disclosed.
1H22 key result details
Flat toll revenue on pcp was stronger than we expected, with lower volumes and Express Lanes sell-down offset by price escalation, commercial traffic resilience, and new asset contributions.
Q2 traffic across the group was +3.5% above pcp, but still 9% below Q2FY19 (and that includes contributions from new assets). TCL said in 1H22 each 10% reduction in monthly average traffic resulted in a reduction of revenue vs 1H20 of c.$6-8m/month in Sydney and c.$4-5m/month in Melbourne.
EBITDA margin declined 300bps on pcp to 66%. This came from a permanent accounting change (over half of the margin decline), fixed cost leverage, workforce investment, and higher insurance premiums. Similar cost drivers are expected for 2H22. In more normal times TCL expects a margin of 73-74%.
On the face of it, FFO:Debt at 8.0% warrants caution given limited margin against S&P’s credit rating downgrade trigger. However, we expect earnings improvement to lift this key credit metric.
Forecast and valuation update
TCL provides no earnings guidance. Distribution policy is to pay in line with Free CF ex capital releases. However, TCL says capital releases from WCX may be used to offset the dilution from 2021’s capital raising over the next 1-2 years.
We are believers that traffic will recover to trend by CY23, noting that roads in Brisbane, Europe, and at times Sydney have rebounded to pre-COVID levels. We’re targeting EBITDA rising from c.$1.9bn in FY22 to c.$2.9bn by FY24, and DPS to grow from c.35 cps to >60 cps over the same period.
Our DCF valuation captures the present value of TCL’s future cashflows over the life of the remaining term of each concession. This valuation has decreased (login to view), as a result of higher costs, recovery phasing, and roll-forward.
TCL is an outstanding play on a COVID recovery given its operating and financial leverage and high EBITDA margins. TCL illustrated that its c.100% debt hedging profile and inflation-linked toll escalations (c.68% at CPI, the vast bulk of the remainder at c.4% pa fixed) would likely provide a net benefit in a rising interest rate environment over the near term.
We agree from a cashflow perspective, but the valuation debate is whether this benefit is overwhelmed by the market adjusting long-term discount rates higher.
We part-risk for this by assuming a 3% pa risk-free rate (vs 10 year bond rate at c.2.2% currently) and modelling out existing debt facilities and terms in full and apply a rising interest rate assumption to new debt.
Our ADD recommendation is not predicated on today’s result. It is based on taking the opportunity at current prices to buy a stock that in normal times frequently traded at or above NPV.
We reckon the IRR you will get for a 5 year investment period will be close to 8% pa; we understand core infrastructure assets typically price in the unlisted market on 6-7% pa IRRs. If the price sinks too low the unlisted funds will likely be circling the business a la Sydney Airport.
- Release of Q3 traffic data due in April.
Traffic risk, with heightened uncertainty from short and long-term COVID impacts.
Macro drivers (population and employment, interest rates, inflation, AUDUSD).
Capital management, including both sources and uses of capital (note potential impairment of A25).
Project cost over-runs, noting discussions with FredExt builder are underway.
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