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Transurban Group - Australian Infrastructure

Transurban is a major toll road investor with concessions to operate 14 Australian and two U.S. motorways. Concessions grant the right to operate the roads and collect tolls for predetermined amounts of time. The core Australian roads are integral parts of the motorway networks in Australia's three largest cities: Melbourne, Sydney, and Brisbane.

Granting toll-road concessions allows governments to use private capital and expertise to provide necessary improvements to road networks. Typically, concession life and toll profiles are set in negotiation prior to the road's construction, with the intention of providing a fair return for investors. Tolls increase in line with the consumer price index or at an agreed fixed rate, though some roads with meaningful competition have dynamic tolling, such as Transurban's U.S. investments. When concessions end, the company returns the roads to the government for no consideration, after repaying all related debt.

The Melbourne market represents a valuable opportunity for Transurban, in 2016, approximately 903,000 people travelled to, or were present in the City of Melbourne on an average weekday. The City of Melbourne expects this figure to grow by 55% to 1,402,000 by 2036, and double in size by 2051. Significant growth in population in the city provides an early indication as to the opportunities available for the development of further toll roads to ease anticipated congestion.

Sydney is an ever expanding city, and while its expansion has limits relating to geographic constraints, the city’s population density is also on the rise. Sydney is currently a city of 5.1 million people, expecting to increase to 5.6 million by the end of 2018, with a population density of 400 people per kilometre. Transurban already owns the majority of tollways in Sydney, including NorthConnex, the M5 South-West, the M2, the Lane Cove tunnel, the Eastern Distributor and the Cross City tunnel.

CityLink was the company's highly successful foundation asset, providing a solid earnings base to expand into Sydney via acquisitions and a development. As early pioneers, these roads generate strong returns on investment because of limited competition in the bidding process and few data points for the government in negotiating tolls and concession lives. The Brisbane assets are also of high quality, but returns are lower, as a result of their higher acquisition price. Organic expansion, such as widening Sydney's M2 and M5, generate good returns from higher traffic volumes, toll increases, and concession extensions, with flow-on benefits for traffic volumes on connecting motorways also owned by Transurban.

The NSW Government is managing a $16.8 Billion infrastructure project called WestConnex, which comprises 33km of new and upgraded roadway and tunnel, and is designed to improve connections between the city’s east and west. Last year the NSW government announced the sale of 51% of the Sydney Motorway Corporation (which is in charge of financing WestConnex) and hoped to raise $5bn from the sale of the majority share by mid-2019. The Australian Financial Review reported that Transurban was part of a consortium that also includes AustralianSuper and Abu Dhabi Investment Authority. Transurban is widely reported to be the frontrunner to win WestConnex.
The company continues to demonstrate its investment discipline, long- term investment horizon, and core skills. Post the 2018 capital raising we view TCL’s debt capacity for further investment is strong, with 10% funds from operations to total debt ratio well above the 7.5%-8.0% required by S&P for its BBB+ credit rating.

Operating cash flow increases strongly during concession lives, as solid revenue growth, driven by rising tolls and traffic volumes, is leveraged over a mostly fixed cost base. Cash flow available for distribution to investor’s increases in line with a road's operating cash flow until about 10 years before the concession life ends; thereafter, a portion of operating cash flow is used to repay debt. Cash flow stops when concessions end. Concessions on the Australian roads are set to end between 2026 and 2065, with a weighted average remaining concession of 22 years. Including the long-life U.S. assets, the weighted average is 27 years.

Transurban’s initial foray into the US toll road market was disappointing, however, their third U.S. investment, the 95 Express Lanes, is performing well. U.S. assets are located in and around Washington, D.C. Concessions in the U.S. are extremely long, at 75 years or more. Given improved performance of U.S. assets, further developments in the area are likely.

Transurban is a conservative infrastructure investment with sustainable cash flows and a reasonably attractive dividend yield at 4.6% p.a. Conservative investors looking for long term value and capital stability could benefit from including Transurban in their portfolio.

Filed under Newsletter \ Tom McBride
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