ConnectEast on a fast track

Few companies directly profit from Victoria's drought but ConnectEast, the sole-purpose toll road company created to build and operate Melbourne's 39 kilometre Eastlink project, is ahead of schedule on its November 2008 deadline thanks to the state's dry spell.

In today's video interview ConnectEast managing director, John Gardiner, goes some distance towards explaining why this mid-sized infrastructure stock is suddenly gaining price on the sharemarket: As Gardiner suggests, the "derisking" of ConnectEast is becoming a reality.

After trading below $1.00 for most of 2006 ConnectEast is currently trading at about $1.40.

With the prospect the project may open early combined with possible extensions to the original road plan '” not to mention predators such as Transurban waiting in the wings '” the stock is emerging as an attractive choice for income focussed investors.

The interview

James Kirby: Your ConnectEast group is probably one of the lesser known of the infrastructure stocks on the stockmarket, but I believe the project here on site at Melbourne [the Mitcham–Frankston tollway] is running ahead of schedule. Could you tell us a little more about that?

John Gardiner: ConnectEast is a single-purpose entity set up to build and operate Eastlink, so we don’t have interests in other toll roads as do some of the other stocks in the area; the focus is just on Eastlink. At this stage, our progress has been very good. We’re been particularly favoured by Melbourne’s drought, which doesn’t suit others but certainly suits us, and by very good industrial relations environment and by very good management team '” Thiess John Holland, who are contracted to construct the road and provide the tolling systems and control systems.

Now your project has always been due to open in November 2008. Is there a possibility you could open it earlier than that?

We’re not making any commitments about opening early at this stage. I think the response, James, would be that we’re on track to deliver this project and are very confident that we will deliver this project by November 2008.

And, of course, your stock on the ASX has also been travelling quite well, probably reflecting the progress at the site. Are we getting close to a peak on the stock price?

I think that what you’re seeing is a unit price that is reflective of the value of the stock as seen by analysts at this stage. At $1.42, we’re pretty much on average of the fairly extensive analyst coverage that we have of the stock. And by and large I think you’d say that stocks like this tend to play catch-up all the time; it’s probably de-risked to the extent that the value is even greater than where it is now, but we’re comfortable with the stock at $1.40 and some of those analyst reports are fairly out-of-date now.

We’re in a period of rising interest rates. Are interest rates rising on this project?

No, they’re fixed and I suppose other roads have looked at refinancing so that’s something that we would monitor and pay attention to. In terms of our long-term risk in relation to interest rates, our tolls are pegged to interest rates and in fact interest rates have run somewhat above our predictions so far, so they’ve been quite favourable to long-term outcomes for ConnectEast at this time.

And also, John, we’ve been through a period of rising petrol prices. What effect do petrol prices have on a project like this?

I’ve been in toll roads for about eight years now and I’ve seen a number of fuel price increases. Generally, the impact on traffic on toll roads is relatively short-term. There are factors that mitigate in favour of toll roads in relation to petrol prices and they’re clearly that if you’ve got a freer run on a toll road than you have on the more congested other routes you save petrol by using the toll roads. Generally I think the imperative with people is that they want to take advantage of the time. The other impact, of course, is a longer-term one but it’s certainly been dramatically shown in various parts of the world at present and that is the move from larger more heavily fuel-consuming vehicles to smaller vehicles and even hybrids, so we don’t expect that fuel price increases will be a major factor in the long term.

Now an intriguing possibility that has emerged in your project is the possibility that the road itself could actually extend, that you could have a 12 kilometre extension at Frankston later on. Is this true?

Not quite in the way that you’re describing it, James. The State Government has announced an environmental effects statement for Frankston Bypass, so we expect that a Frankston Bypass will be built sooner rather than later. We doubt we will be involved in it but we will certainly get some traffic uplift from that project, which we have to share in part with the state but there would be a benefit to Eastlink from that. Similarly an Eastern Freeway extension '¦ Sir Rod Eddington has been asked to look at that. That could provide us with some benefit as well.

Now beyond engineering and construction issues, on the stockmarket of course we’re in a period of intense takeover activity. Has ConnectEast been approached in any way by private equity groups of late?

No.

Well is there any possibility on the other hand that you could take over something else yourself?

Well as I said before, at this stage we’re a single-purpose entity and to change that role so that we can do more than operate Eastlink we would need to gain the permission of the state and of unit holders, so that’s something that we can’t really speculate on at this stage.

But it’s not impossible?

It’s not impossible, no.

Now ultimately, John, a group like ConnectEast '” it’s an income stock. What sort of income could investors in ConnectEast expect in the future?

Well, currently investors are being paid a dividend of 3.25¢ every six months '” 6.5¢ per annum '” and that will continue until we get through our ramp-up period, the early traffic growth period. After that the board has determined that dividends would be paid primarily using the free cash flow. So the bulk of free cash flow would be provided back to unit holders as dividends.

Now you’ve always said that your project, the Eastlink tollway, when it opens will be the cheapest tollway in Australia. Can you keep that promise?

Our tolls are fixed for ever more. Essentially they’re hedged against inflation because they’re linked directly to the consumer price index, but in 20 years’ time our tolls in real terms will be the same as they are now. And they are substantially lower than any other private toll road in Australia.