Transurban: Result 2016

If, on the way to work, you've noticed a few extra people driving, you're not the only one. Transurban has had an excellent year of growth due to strong traffic on all its roads. Underlying toll revenue increased an impressive 18% to $1.9bn due to growth in traffic and the addition of Legacy Way, AirportLinkM7 and the US-based 95 Express Lanes.

Earnings before interest, tax, depreciation and amortisation (EBITDA) rose 15%, while free cash flow rose 21% to $926m. Even after excluding the contribution from the newly added roads mentioned above, EBITDA rose 12% for the existing network.

The Sydney network, which accounts for 41% of revenue, had strong traffic growth of 7% following the recently completed upgrade to the M5. Toll price increases, including a higher truck multiplier, led to 14% growth in revenue. Work is now underway to develop the NorthConnex project and management said it is so far on time and within budget. 

Melbourne's Citylink (34% of revenue) only managed to increase revenue by 1%, though toll price increases meant that revenue for the network grew 7%. A road widening project is currently underway to improve traffic flow at points of congestion and Transurban is negotiating with the Victorian Government to build the $5.5bn Western Distributor. Management expects to close the deal by late 2017.

Up north

Queensland Motorways (16% of revenue) saw traffic rise 27%, although this includes the newly acquired Legacy Way and AirportLinkM7. Management said the new roads were performing ‘at the upper end of expectations'.

Transurban's 95 Express Lanes in North Virginia, USA are also ticking along nicely, with traffic increasing 14% and EBITDA more than doubling with the roads now fully operational. Transurban has reached an agreement with local authorities to extend the 95 Express Lanes by 3km and is negotiating for a further 14km extension. Longer toll roads tend to be more attractive to motorists from a value standpoint so, if the extensions go through, we expect traffic to continue to ramp up. 

EBITDA margins improved slightly or were unchanged for all roads, though the overall margin for the company shrunk from 74.7% to 73.8% due to a higher proportion of earnings coming from the lower-margin Brisbane and US-based roads.

This was a great result for all of Transurban's assets but, as we explained in Why Sydney Airport beats Transurban, the company doesn't actually own them. At the end of their lease concession periods, the roads will be handed back to the Government, which means that in around 34 years Transurban will cease to exist in its current form. That may sound like a long time, but it knocks a huge chunk off our valuation; assets held under a 34-year lease are around 30% less valuable compared to their freehold equivalents depending on your interest rate assumptions (for more on ‘leasehold relativity', click here).

As a near monopoly, Transurban has many competitive advantages and its inflation-protected revenue is a nice bonus. Management expects to make total distributions of 50.5 cents in 2017 (up 11%) and we're increasing our price guide to account for underlying business growth. But with an enterprise value to EBITDA ratio of 25, there's still far better value on our Buy list. SELL.