Transurban: Interim result 2019

Anyone who has listened in to a Transurban result call knows the deal. You sit there silently, reading colourful PowerPoint slides, until chief executive Scott Charlton delivers the punch line: 'distribution guidance is reaffirmed'. Phew.

Transurban shareholders own one of Australia's highest-quality businesses - the country's biggest toll road operator, and a regulated monopoly with a stable, growing dividend. However, because the stock tends to attract people after a steady income, any potential downgrade to the dividend causes a stir, even if operations are running smoothly.

When management got to slide 27 of the presentation, you could sense investors on the call feeling a little uneasy. First-half distributions came to $775m. Free cash flow, however, was only $668m. Were it not for a $98m capital release from NorthConnex after the company reached certain milestones, there would have been an uncomfortable shortfall in free cash flow. 

Nearly all the analyst questions following the presentation were about that one slide, with the overall theme being 'without that capital release, would the company have reduced its dividend?'.

With some caveats, management said no. The capital releases - where previously committed money for a road's construction can be withdrawn from the asset and replaced by debt - are pre-agreed for specific amounts and at specific times. That degree of certainty allows the company to build the releases into its cash flow forecasts years in advance, and so dividend payments are decided with this big picture in mind. There aren't any surprises. 

Reassuringly, Charlton explained that the company wouldn't 'refinance or do a capital release to make a [dividend payment], particularly if it doesn't make sense from a financial or value perspective'. He said that had the capital release been delayed, the board would likely have paid the dividend anyway on a 'look through' basis.  

Sunny Melbourne

Underlying toll revenue increased a hearty 9% to $1.3bn for the six months to December, while earnings before interest, tax, depreciation and amortisation (EBITDA) rose 10% to $1.0bn.

With the exception of Brisbane - which we'll get to in a moment - revenue and traffic numbers improved in all cities, including the company's North American assets. The result had three main drivers: regulated toll increases, cost-cutting, and traffic growth in Sydney and Melbourne of 3% and 5%, respectively, following the completion of road upgrades.

The Melbourne network, in particular, had a good year with revenue growth of 6% and EBITDA growth of 5% due to the uplift in traffic numbers following the completion of road upgrades. 

That said, population growth in Transurban's Melbourne catchment is only 3%, so growth in the low single digits is about as much as we can hope for over a 20-year stretch.

The company's Sydney network had a strong year too with an increased ownership stake in M5 West helping to boost revenue and EBITDA 8%. Excluding the acquisition, revenue growth was a more modest 3%, however. Management said the enormous WestConnex project is on track with new M4 tunnels due to open later this year and a new M5 tunnel due to complete next year.

Queensland letdown 

The Queensland network produced the worst performance by far, with flat traffic numbers and a paltry 2% rise in revenue and EBITDA. Management said the poor result was due to disruptions from construction work on the Logan Enhancement Project and Gateway Upgrade. On the bright side, the Inner City Bypass upgrade is now complete and commuters can expect time savings and reduced congestion, which should encourage traffic growth in future years.

Transurban's US and Canadian investments performed ahead of expectations, with 43% revenue growth and a 53% increase in EBITDA. Most of this was from the acquisition of the A25 road in Montreal; however, the company's US roads still performed admirably with a 12% increase in revenue and the new 395 Express Lanes in Washington, DC, expected to complete in the 2020 financial year. 

Management has flagged distributions of 59.0 cents for the 2019 financial year, as well as 'mid-single digit distribution growth' in 2020, for a partially franked dividend yield of 4.8%.

Transurban has a monopoly in the eastern states and inflation-protected revenue, but the company's lack of ownership of its roads - and 30-year average concession life - means it deserves a discount relative to similar infrastructure assets that have a longer life (see Why Sydney Airport beats Transurban). This was a good interim result but Transurban's share price is trading well above what we consider its intrinsic value and we continue to recommend you AVOID it.