Unravelling Hills Motorway

The value of infrastructure assets is also evident in the growth of Hills Motorway Group's share price. Cars first started roaring down Sydney's M2 - owned by Hills - in 1997. Back then the share price touched a low of $1.28.

We climbed aboard, belatedly we'll admit, in issue 53/May 00 (Accumulate - $3.29) and have enjoyed a handy 44% share price rise since then. It makes the point - cash collecting monopolies deserve to trade at a premium.

Protected monopoly

In our last recommendation in issue 85/Aug 01 (Long Term Buy - $5.21) we made exactly this case. Hills will be collecting tolls for the next 40 years and the payment of interest from the debt used to build the road is the only significant cash expense.

Over that 40-year period traffic flows and revenue should increase, as will the tolls. The company is also protected by NSW Government legislation. Amazingly, if future public transport takes traffic away from the motorway, Hills will be compensated.

In other words, this is a glorious, competition-proof concrete monopoly in a city where the public transport system gets ever more parlous.

As evidence, consider that between January and June, vehicle numbers on the M2 increased every month on last year. The average traffic growth for the period was 3.3%.

This was the justification for our previous positive recommendation, although the price has fallen a little since.

That prompted us to apply the methodology we've used to assess Macquarie Infrastructure Group, another toll road operator, to Hills.

We've been suggesting you sell Macquarie Infrastructure since issue 100/Apr 02 (Sell/Switch to MBL - $3.36) for the following reasons: quite simply, a toll road's value is determined by the amount of future cash flow it can generate, which is then discounted back to today's dollars. This approach has two significant risks.

First, no one really knows how many vehicles will be using the motorway in the future – an educated guess is all we can make.

Forecasting

Second, it's hard to predict where interest rates will be in six months time, let alone in ten years, which makes forecasting the discount rate equally difficult. Again, it's an educated guess, usually based on the 10-year bond rate.

But, having made some conservative assumptions, even with the expected benefits to flow from the Western Sydney orbital link, due for completion in 2007, Hills isn't cheap. It's priced at 29 times 2001 cash flows and more than two times book value.

That is not to say it's time to sell. With potential revenue to come from billboard advertising, greater toll efficiency from E-tags and growing traffic usage, there's a good case to be made to HOLD FOR THE UPSIDE.

This remains a good long-term investment but the valuation isn't sufficiently compelling to warrant a buy recommendation.