Transurban Group (ASX: TCL) is probably the best listed toll road portfolio in the world. The market is already aware of Transurban's solid and growing dividend profile – you currently get a 4.4% yield which is expected to grow at double-digit levels over the next two years with significant potential beyond that.
Quality Earnings Growth
It is however, worth looking through the headline numbers to fully appreciate the quality of the growth. Three of its major roads which represent over 55% of revenue and 77% of EBITDA have minimum toll increases above the rate of inflation (4.5% for Citylink and 4.1% for M1 & M2), while the other Australian roads provide a minimum of CPI.
This means that all else equal, revenue and EBITDA should grow well above inflation. But all else isn't equal – through leveraging their position in the Sydney and Melbourne markets, they have been able to negotiate greater increases in truck tolls on four of their roads, including their largest, as compensation for works done.
Further, the work being done is largely to increase the capacity of the network – construction of the Northconnex in Sydney and widenings on Citylink and the M5 which should also lead to traffic growth.
Unappreciated Option Value
All this is known, and if you believe markets are efficient, mostly priced in. Where I think the market is getting it wrong, is it is failing to properly appreciate the option value inherent in the roads.
Management is highly capable, and has shown itself adept at leveraging the position of its existing road network to put together deals that no-one else could do – such as funding Northconnex though concession extensions and truck toll increases on other roads they own (M7, M2 and LCT).
They are likely to look to do something similar on the Western Distributor project in Melbourne; and there will be ample opportunities in Sydney with the Westconnex as parts of that project come to market over the next few years.
They are also in the box seat for the Brisbane Airport Link bid, being the only party who could effectively integrate the road with their Queensland network, saving on back office and potentially maintenance costs.
Transurban also owns two roads in the US that are often ignored. They shouldn't be. While the current contribution is small (less than 1% of EBITDA last year) the US roads have significant potential to become meaningful over time. Both roads have long concessions which run till 2087 and both work on dynamic pricing – that is the toll goes up as traffic increases and falls as traffic decreases.
Open your Google Earth and have a look at these roads (I95 and I495 express lanes) on a map. They run through some of the richest counties in the US, and feed traffic into and around the Washington DC area. While initial traffic was weaker than expected, road space is a limited resource. With growing populations, as competing roads become more congested, demand and toll revenue should increase handsomely in the medium to longer term.
So what are the risks?
The two key risks are poor acquisitions and rising interest rates. In my view, in the short term, both of these are relatively limited. The CEO Scott Charlton has shown considerable discipline so far in acquisitions, and seems focused on existing markets and on doing deals, the Queensland Motorways acquisition aside, where they can bring something to the table that no one else has. This avoids a price shootout, and defrays much of the risk by seeking compensation on other parts of the network.
While a significant rise in real interest rates is a risk to the valuation, a soft Australian economy and continued weakness in the mining sector make this unlikely in the near term, with most people expecting interest rates to fall.
Foolish takeaway
With low risk growth, option value and a good and growing dividend yield, Transurban is one stock that investors with a long horizon can buy and hold for the long term.
