Transurban: Interim result 2014

Transurban announced a solid first-half result, though the company’s US assets continue to be a drag. Underlying toll revenue increased a healthy 13% to $556m compared to the prior corresponding period, largely due to excellent traffic and toll revenue growth throughout the Sydney Orbital Network. Operating profit increased 11% to $463m, and an interim distribution of 17 cents was declared (21% franked, ex date already passed) for a forecast full year distribution of 35 cents and current yield of 5.1%.

Free cash flow was up 25% to $240m. Such impressive growth is testament to the power of incentives. The CEO’s remuneration package was changed in 2012 to include a new long-term incentive framework that is 50% based on shareholder returns relative to a group of comparable companies, and 50% based on the three-year compound growth rate of, you guessed it, free cash flow per security. We think the current structure does a good job of aligning management’s interest with that of the shareholders.

Melbourne’s 22km CityLink, which accounts for 49% of Transurban’s revenue, had reasonable traffic growth of 2.1%, especially given there were several closures to resurface the tunnels. Toll revenue was strong at $269m, up 8.6%, while earnings before interest, tax, depreciation and amortisation (EBITDA) increased 11.3% to $243m.

Sydney shifts gear

Performance of Transurban’s Sydney portfolio was far above our expectations. A major upgrade of the M2 was completed mid last year and, since then, traffic in the northwest corridor has been booming thanks to the flow-on effects of a highly integrated road network.

Traffic on the M2 increased 12.6% which, together with toll increases, lifted revenue by a whopping 32.3% to $97m. The M7 had a 7.5% increase in traffic and 9.5% increase in revenue to $117m. Traffic through the Lane Cove Tunnel was 8.7% higher, boosting revenue by 11.5% to $36m. There was, however, a 2.6% decline in traffic on Sydney’s M5 South West, which is 50% owned by Transurban, due to extensive works to widen the motorway (thankfully now more than 60% complete). Revenue fell 3.2% to $102m for the M5.

US still in gridlock

Transurban’s Virginia based 495 Express Lanes have been a disappointment from the day they opened in 2012. Traffic numbers have never lived up to expectations and EBITDA is still in the red with a loss of $4m for the period.

Transurban is now seeking to restructure the asset by injecting more cash to pay off some of the debt and reduce the interest burden. Management ‘remain committed to the Northern Virginia market’ and still believe there’s long-term value in the project. We’d prefer management focus its time and energy (not to mention shareholders’ money) firmly on Australia.

Growth Pipeline

Transurban still has plenty of room to grow. As we explained in Transurban's roadmap for Cross City Tunnel on 12 Nov 13 (Hold – $7.11), the company has acquired the senior secured debt of Sydney’s Cross City Tunnel for $475m. Transurban is now the lead contender to purchase the asset, which would link directly to the company’s Eastern Distributor.

There are also ongoing talks with the NSW Government to build an 8km toll road connecting Sydney's M2 and the M1 Pacific (formerly the F3, and the main route to Newcastle). Furthermore, Transurban is part of a consortium bidding on the $5bn privatisation of Queensland Motorways. While this would be a significant addition, it’s still too early to tell whether it will eventuate or even be approved by the Australian Competition and Consumer Commission which has raised some concerns.

Transurban owns many high-quality assets, produces steady cash flow and still has some reasonable growth prospects. But all this doesn’t come cheap. Its share price is flat since 12 Nov 13 (Hold – $7.11) and we continue to recommend you HOLD.