Transurban Group: Finding a source of additional value

About the author:

Nathan Lead
Author name:
By Nathan Lead
Job title:
Senior Analyst
Date posted:
18 October 2021, 9:30 AM
Sectors Covered:
Infrastructure, Utilities

  • Adjusting our valuation approach has unearthed an additional source of incremental value.
  • We upgrade from HOLD to ADD. We view the current price as an attractive entry point following completion of the retail entitlement offer.   

Event

We adjust our DCF valuation approach to concession-based assets.  

Analysis

Previously we had assumed a constant 0.7 equity beta in our cost of equity estimate applied to the DCF valuation of TCL’s assets. The equity beta reflects the sensitivity of geared cashflows to broader macroeconomic/market conditions.

However, this did not adjust for differences in NPV gearing across assets or time. 

Our change is to adjust the equity beta for an asset’s NPV gearing, by assuming a constant asset beta (0.47 based on delevering our estimate of TCL’s historical statistical beta) and relevering this based on the NPV gearing of each road concession. Hence, this captures differences in the cost of equity due to gearing. 

For instance, we estimate debt vs NPV for Transurban Qld at 38% and thus 7.6% pa cost of equity (assuming 3% pa risk free rate and 6% pa market risk premium). The Hills M2 has 13% NPV gearing and we apply a 6.3% pa cost of equity.

Under our previous approach we applied a consistent 7.2% pa cost of equity to both assets. Also note that the discount rate we apply to Citylink is 6.5% pa, because although it carries TCL’s corporate debt it is also supported by the equity value of TCL’s non-Citylink ownership stakes.

Given revenues continue to grow in the later years of a concession period while project debt is amortised to zero, we think NPV gearing and thus cost of equity typically declines in the later years of an asset’s concession.

In the period from full debt repayment to concession expiry (typically 12-18 months using the M5W as an example), NPV gearing falls to zero and the unlevered cost of equity is 5.8% pa.

This valuation approach means capital releases have minimal impact on valuation, as the time value benefit of bringing forward distributions through early release of capital is offset by a higher cost of equity to reflect the increased gearing.

Forecast and valuation update

No change to forecasts.

June 2022 valuation lifts from (login to view) as a result of the change in valuation approach, with the largest value improvements in relatively under-geared assets (M2, North West Roads, Citylink corporate group).

Six-month valuation roll-forward to December 2022 lifts the valuation to (login to view).

Investment view

Upgrade from HOLD to ADD. At current prices, we estimate a 12-month potential TSR of c.11%, comprised of c.8% upside and c.2.8% yield.

FY22 will be impacted by WCX equity issuance and depressed traffic levels. Nonetheless, we expect TCL’s DPS to lift 5% in FY22 to 38.5 cps (1H22 DPS guidance is 15.0 cps). Over the following 4 years to FY26F, we expect the DPS to lift to c.80 cps, implying a CAGR of c.20% pa. Traffic recovery, toll escalation, and new asset contributions will be the key drivers, as will low interest rates.

On a 5-year IRR basis, we estimate TCL is trading on 8.6% pa, or a c.6.9% pa premium over the 10-year risk free rate. This takes into account the rapid growth in DPS over the time period, as well as capital growth from DCF valuation roll-forward towards the asset portfolio’s peak value in late 2029. We view the risk premium as an attractive entry point into the stock.

Price catalysts

1Q22 traffic data to be released on 21 October.

Risks

Traffic risk, with heightened uncertainty from short and long-term COVID impacts.

Macro drivers (population and employment, interest rates, inflation, AUDUSD).

Size of the “meaningful financial contribution” required to complete the West Gate Tunnel Project (we assume an additional $1.1bn above the original project budget).

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Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.

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