– When the group might pull back its cashflow and start reducing its debt.
Alan Kohler: Well Scott, welcome to Business Spectator. Thanks for joining us.
Scott Charlton: Thank you.
AK: Now, when you come into a new business, new company like this as the new CEO, of course you review the strategy and the team and so on, and we’ll get onto that in a moment. But I’m just wondering whether you came into Transurban and said, hello, this place pays out more than a 100 per cent of its free cashflow in dividends, what’s going on here?
SC: Well, that certainly was the case when Chris Lynch took over, but Chris had changed that, so the board in the last few years has adopted a philosophy to pay out approximately 100 per cent to a free cashflow, so we’re paying out all of our free cashflow, but not more than our free cashflow.
AK: Well, I think it was 117 per cent in 2012.
AK: And this year it’s a bit more.
SC: Ninety-five per cent. It’s 95. Last year it was 95 per cent of free… oh sorry, we’re forecasting 95 per cent of free cashflow. It will be 95 per cent covered free cashflow.
AK: That’s what I mean. It’s 95 per cent covered. It’s not fully…
SC: Not fully covered. We’re even paying out more than… sorry, less than fully covered last year, so we were just 102, 103 per cent I think.
AK: But it gets to what Transurban is. I mean, it’s kind of a shovel for tolls to go out to investors, isn’t it? That’s what your job is.
SC: Well, that’s what we like about it.
AK: Your job is to just get this pile of cash from tolls and shovel that to investors, right?
SC: Well, that’s right. My job is to increase the margin of those assets and drive the efficiency of the margin. Because there’s a lot of asset, and there’s a lot of capacity that’s there that’s not being utilised at certain times of the day and there are a lot of things we can do with technology, so my job is to try and drive that margin up so that we can get more of that cash and shovel it out to investors. And we had this interesting position with our network where if government wants to do anything going forward and they want to expand the network, we’re in a unique position to sort of leverage those assets to create those future cash opportunities.
Robert Gottliebsen: Scott, I’m afraid I can never understand your model very well.
RG: And I think that’s one of the reasons your share price hasn’t matched other income stocks. You’re a company that pays out all your free cashflow, I understand that. You’ve got $5 billion worth of projects… going or in the future. And you’ve got debt, in a parent company, of about $3 billion. And then in the various toll roads there’s debt. It’s about one or $2 billion dollars there, too. At what point do you stop paying all your cash out and start reducing your debt?
SC: Your debt profile.
RG: When does that happen?
SC: Yeah. So, if you look at… we’ve got different, obviously, concessions and the average length is similar out there, you know, at 20-plus sort of range. So if you look at some of the assets that we’ve handed over like the M4 – so we had to hand over the M4 back to the New South Wales government – so sort of ten years before the M4 was handed over we started to pay down the debt profile, so the cash coming up from the M4 was less than the free cash being distributed because it was paying down the debt. So, when you get to that last sort of 10 to 12-year period of concession arrangement, you look at sort of then how you pay down that debt when you get to the end of the period when you have no asset and you have to hand it over to the government, you know, that debt’s repaid. But we’re a long way from when...
RG: So, in Citylink when would you start getting to that situation?
SC: Well, we still have, you know, out to 2035 or ’32 on the concession, so we’re a long way from that position.
RG: Twenty years?
SC: Yeah. But the other thing to…
RG: So, in 10 years you’d start to pull back your cashflow?
SC: Potentially. But the other thing that we have with Citylink is, again, the opportunity like we’ve done on Southern Link upgrade and we’re looking at other projects with the Victorian government. It’s easier for us to develop these projects and extend the concessions as we’ve done on the M2, as we’ve done on the M5. When the government wanted an upgrade, we extended the concessions for another 10 to 15 years.
RG: But when you upgrade, you then borrow more money, so it sort of, you know…
SC: Yeah. But the assets are also in different profiles, so you’ve got assets like Citylink that are coming into maturity, that are generating quite a bit of cash, you’ve got the M7, that’s in a ramp-up phase, so it’s still in its early development. It’ll start to generate more cash. So the thing that we need to make sure is we’ve got this balanced portfolio so we can continue to grow our distributions which is what our security holders want. And then we have to make those decisions whether these upgrades or enhancements are going to add value over time or do we return that cash to our shareholders? So, distribution growth is very important to us.
Stephen Bartholomeusz: That’s a critical issue, isn’t it, Scott? Because, as Bob says, there are $5 million worth of investments and I think you’re over the hump on that, so in two or three years’ time you’ll have a big decision about whether you just keep shovelling cash even harder or whether you spend it.
SC: Yeah. Well, that’s the decision we’ve got to make and we’ve got some unique positions. Like in New South Wales we have an unsolicited proposal with the government there to do a negotiated deal. So, over the… you know, getting out into 2015, ’16, ‘17 we’ve got all these projects that we’ll have start delivering. They’ll deliver major cash. So, our decision then will be does the next generation of opportunity make more sense from an internal rate of return and future cash generation perspective, or are we better off just to return substantial cash to the shareholders? Because at some point if we continue along this path, the balance sheet will create quite a bit of capacity and the shareholders rightly will ask well why don’t you return some of that capacity, if we can’t find investments?
SB: Is there a geographic dimension to that question you got posed yourself? In Australia governments, state and federal, seem to be capacity constrained in terms of debt. Does that mean in that a two or three-year time horizon you’ve got to start to think about whether you actually want to become more global than you are, because at the moment you’ve got US operations?
SC: Yeah. No. Look, really our markets are the eastern seaboard of Australia and the north Virginia, the Washington DC area. So you know one thing that we have learned is that leveraging the existing networks and playing in your backyard adds a lot more value than global expansion or looking at new markets, so we’re very, very focused on those markets. And we think we have the opportunity to potentially add value and if we don’t, then we’ll look to return that money to the shareholders.
AK: Is this true? I mean, you talked about wanting to be more efficient and that’s your job, is to grow efficiency, but one of the ways of doing that is through scale. And the question, I guess, is can you get scale without retained earnings?
SC: We believe we can. So, the scale of what our asset businesses are doing… If you look we’ve just implemented a new system on Citylink for our tolling system, for instance. We’re looking at potentially rolling that out to all our assets in NSW, so we continue to maybe have one back office instead of having five to eight different back offices across the group. So, we think we can drive the operation efficiency and we think our scale is big enough in Australia. The interesting thing when you start moving to new markets, whether it’s different… outside Australia, the US, the UK, you have different concession arrangements. A lot of times those arrangements constrain you from how you can consolidate your businesses. Luckily in Australia now NSW and Victoria are more open to how we look at consolidating some of our businesses. So, in the case of NSW we’re able to now have an operating agreement for Lane Cove and M2 as one. Previously we had to have separate arrangements. So, there is ability through that business to create more margin efficiency and it creates more cash to return.
RG: In your business asset, Citylink, there was some excellent work done on the exit from the Melbourne City, but it was completely stuffed up on the entrance which means that the city now has to build a rail link. Whose fault was that? And would you accept some of the blame for it?
SC: Look, the original concession and the design were something that obviously was done a long time ago. We are constantly in discussion with VicRoads about how we can improve the efficiency. Right now, we have an issue with the Bolte Bridge and the West Gate Freeway…
RG: But the investment was absolutely wasted. It doesn’t work anymore.
SC: Well, I mean we tried everything we do to fix it. I can’t take personal responsibility for it, but the city can…
RG: No, no. But the company can.
SC: I think the original design and those things evolve over time, which creates an opportunity for us to help work with the Victorian government to try and fix these things. One of the things that we are trying to do in a policy sense as well is that I think in the past some of these operators have tried to act as independent pieces of infrastructure. We see ourselves as part of the network, so the whole network has to function efficiently. We actually want public transport to work well. We want the other modes of transport to work well because that frees up our capacity and our roads to function well and it also frees up in the long-term future different models. So, again for the efficiency of our roads when you’re looking at pricing at a certain time and the same price applies, eventually, hopefully if people have alternative modes of transport, public that are accessible, we can look at making these roads more efficient, then we can solve some of these problems. So, we’re willing to work with the Victorian government and have done on the upgrade of Southern Link and happy to look at other things to fix these problems.
RG: So, you won’t be claiming damages?
SC: A material adverse. Yeah. Look, it’s not in our interest to claim those. I mean it's different if they’re going to do something that I guess is going to damage our security holders without discussing it with us, but so far we’ve been working collaboratively with both governments to try and find solutions because it’s in both our interest. I mean we try to solve these problems because that frees up our network. If our network's in gridlock, we’re not making money because they’re not passing under the check points. They’re stuck.
RG: So, you must be… I know it’s not your fault, but the company itself must be very disappointed at the failure of that important part of Citylink.
SC: Well, there’s always been room for improvement. I mean I’m happy to use the word disappointment, but yeah look there’s always room for improvement.
RG: But you do agree with me it doesn’t work properly?
SC: It can always be improved, yeah, but there are sections of the whole…
RG: So, it’s true, isn’t it?
RG: Your predecessors got that wrong and the city bleeds as a result.
SC: Well, actually let’s just…
AK: Well let's talk about the fact that to some extent it’s a team. You’ve come in… Can you tell us a bit about how you found the team? Have you had to make any changes so far and do you plan to make any changes in the future?
SC: Yeah. So, we announced and the new executive team and we’ve made some announcements previously, so not big changes or wholesale changes. But a couple of things that I have done is elevated a couple of the portfolios. So the technology portfolio used to report in underneath the CFO and there are three different silos of technology, so we had road technology, the corporate technology, and then sort of customer technology. That’s now all reporting to me directly and it’s all been consolidated.
Our delivery and operations was in silos under the assets. We’ve now consolidated that, so we get the operational excellence, best practice and enables us to look at these bigger projects that might come down the road. So, it’s not a wholesale change, it’s not additional overhead, but it’s elevating a couple of the portfolios reporting directly to me.
We want to play a more active and leading role in policy and we’ve got the federal election coming up, where we can obviously provide some input on how these projects will be funded and how the private sector interacts. And we would particularly applaud the New South Wales government and the unsolicited proposal, a process where we were able to actually have a discussion with the government about what we might provide that’s sort of unique and deliver their plan. In the past you were just handed a piece of paper that says 'you must compete and deliver against this', and a lot of times we might not think it’s the most efficient design or structure, but that’s what the government has asked for, so you had to participate. Here we can sit down and have an intelligent conversation and maybe come up with some smarter ideas.
SB: Scott, the hot lanes in Virginia are open. I know it’s really, really early days and so you can’t draw any conclusions from the numbers. But looking at that dynamic pricing model, could there be an application of that here?
SC: Yeah. Look, we love the dynamic pricing model and that road is the most technologically advanced in the world and, you know, if you look in terms of addressing the issues, it addresses public transportation, it addresses optionality, it addresses choices and we think it’s…
AK: Just to explain to the viewers, what we’re talking about is differential pricing on lanes.
SC: Yeah. So, you have free lanes running aside tolled lanes and the toll lane price changes dynamically with the traffic on the free lane, so as the traffic on the free lane congests, the price rises on the toll lanes to maintain a minimum of forty-five miles per hour in the free lanes. So, the public transport that uses that for free and high occupancy vehicles which have three or more people in the car, they use that for free, so it addresses quite a few issues. We think that it would be very applicable to the Australian model. Under our existing concessions we can’t apply it because it doesn’t allow for it. It does seem to address a lot of issues, but we haven’t had a lot of luck with the politicians being brave and out on the front foot on looking at dynamic pricing, but if you talk to a lot of the bureaucrats behind the scene, they eventually see that those type of models need to bring efficiency.
SB: And does it get consumer acceptance, or are they confused by the fact the price is changing even as they drive along?
SC: I’ll have to send you the YouTube link. There is a great YouTube video of some guy driving down there, referring to everyone else in the free lanes as – I think he used the word "chumps”, because he was driving at 65 miles an hour for a dollar and they were stuck in traffic all the way home. So a free advertisement on YouTube – so good on public media!
So, the customers accept it really well. I think the issue that we’re dealing with is a huge change of traffic patterns in the Washington area, because construction has been under it for five years and some of the customer survey work that we’ve just done, they’re afraid that the price will change while they’re on the road. But as soon as you pass the gate entry you see the price. That’s the price that’s locked in and so there is some concern and we have some more education to do with our customers.
AK: Along those lines, the congestion tax in London has, as I understand it, been very successful. Do you think that could happen in Australia and if so, could Transurban be the collector?
SC: Look, we think long-term that the network, again as a whole with public transport and all those models, needs to work. So if the government wants to use [it], and New South Wales was talking about distance-based tolling, so they want to move to eventually long term under their master transport plan to a distance-based tolling. Now, that might even evolve outside of the network to even the feeder roads and if they were to move to that, we have the technology and the capability to provide that operation, if that’s something the government wants to outsource.
RG: So, you’re talking about – or they’re talking about – tolling a lot of roads that are currently free?
SC: Eventually. I think in their master plan they talk about distance-based tolling on the main roads. So the whole issue of that long-term debate between you raising revenue from fuel tax and a lot of that revenue going into general funds, do you start making the transition so it’s more transparent? The price you pay for roads is actually the price it costs to do roads, and I think eventually we’ll have to get there whether it’s in 10 years or 20 years.
AK: But that’s different from the congestion tax, which is pricing the CBD entry.
AK: But you could presumably do that as well.
SC: We could do that as well, if that’s something we proceed with. I mean, the government has so far made it pretty clear that they don’t want to do it. They do accomplish that in different ways, and obviously the charges that are charged in Sydney for parking, the taxes that are raised on parking– it kind of works as a congestion charge.
RG: Scott, around Australia, particularly on the east coast, there are a lot of road-type projects that are in the pipeline. How do you believe these will be funded? Do you think we’re going raise a lot of equity? Do you think Transurban will use its equity base to do a whole lot of them? Obviously some will be done purely by government, but let’s assume the private sector is going to be used. How is it going to work?
SC: So look, the government’s got between Sydney and Victoria… there could be fifteen billion dollars’ worth of major roads that they want the private sector to look at, and there are the other government roads as well. There’s a huge appetite out there from the unlisted global infrastructure sector. It’s a massive ball of money.
You look at still how they compete overseas for brownfields assets. So, there is a lot of capital out there. But the equation has to be structured correctly. And this greenfields traffic risk that’s scared and caused so many problems in the recent transactions has to be addressed by how government goes about the structure. So, there are different ways to look at the structure. I think there’s a lot of equity capital if it’s structured correctly… some of those capital partners are actually investors in Transurban. We have a lot of super funds who are investors in Transurban. So, we could be part of that equity equation as, you know, basically the funnel for super and infrastructure money, and there’s a lot of unlisted money and we work with them as partners.
Probably the biggest issue is more on the debt side. Because we don’t have a long-term debt capital market as we do in the US or the UK, funding them from a debt perspective actually makes it a bit more complicated. I think there’s a bigger appetite for equity.
RG: Have you ever thought of offering Transurban debt to your own shareholders?
RG: Why not?
SC: It doesn’t give us the return that we’re looking for.
RG: The rates are too low?
SC: Yeah. The rates are too low for us.
AK: But I mean the problem with the greenfields projects in recent times has been investment bankers coming out with traffic projections that were far too aggressive… You just need to come up with sensible projections of traffic.
SC: And I think what will happen is you’ll have the first couple of projects in, and somebody would say, "Look, we have our own network traffic modelling people and we have our own team internally”. One of the reasons Transurban didn’t participate in the last round of toll roads was because of that – because they had a different view on traffic.
AK: So, your view was right.
SC: Yeah, our view was right. So now we’re in the position that when everyone’s afraid to take traffic risk, it’s probably a good time to take traffic risk because you can be realistic and look at it effectively. But what we try to do is leverage off our existing network. So when we build an extension or a new ramp or an upgrade, we’re actually leveraging off the brownfields traffic and not essentially taking all greenfields risk.
SB: There are a couple of very new projects in Queensland that are in strife. Is that an opportunity?
SC: Look, for us we like the network approach. If you look at Sydney and Melbourne, we’ve got surfaced roads, very long roads with lots of optionality and lots of connections. The issue for us with RiverCity Motorway and BrisConnects –I’m assuming you’re familiar with those two roads – is that they’re both tunnels, and there’s little expansion opportunity. They’re small connections even though they’re big, capital intensive projects, so they’re expensive to operate. They’re actually not very long, and there’s not a lot of optionality. So QML is a very interesting asset in Queensland because it looks the same as a Citylink or our Sydney network, but the RiverCity and BrisConnects are not at the top of our list.
SB: One of the issues that has bedevilled Transurban throughout its history has been that the North American pension funds have had a very different view and a longer view of value than the Australian institutions. Is that changing? Given what’s happened post-GFC, are the Australian institutions getting their mind around the fact that these are CPI plus long-term cashflow streams?
SC: I think the answer is yes. I think for the big ones and, as you know, the future funds and the new supers and the QICs, I think the answer is yes because if you look at the competition overseas, those funds are competing quite aggressively against those North American, Canadian and Asian sovereign funds overseas for infrastructure assets. There’s still a massive group of super funds that isn’t participating in an unlisted way, but we’re happy for them to participate through Transurban where we can provide liquidity and the expertise.
RG: I think whatever plans you do is you use the self-managed funds.
RG: Because that’s where the money is and they want to invest in infrastructure, I don’t know how many tens of billions are available, but it’s more than you can provide. It’s all there. The big superannuation funds don’t understand it – except the ones you’ve mentioned. But that’s the market.
SC: Yeah. Well look, again they can obviously invest through a listed entity which provides them liquidity and hopefully that expertise. So we do hear a lot from government, "Oh, we want to tap the super funds to fund these,” and we sit there as Transurban and go, "Well we’re ready, you give us the project”. I mean, it still has always been more a lack of quality projects now and opportunity than not the capital.
AK: We’ll have to leave it there, Scott. Thanks very much.
SC: Thank you.
Alan Kohler holds shares in Transurban.
Follow @AlanKohler on Twitter