Security price: $10.62
Industry: Toll roads
FY17 forecast distribution: 50.5 cents per share
Infrastructure has long been a staple of income-focused equities portfolios. Many are viewed as bond proxies given they are priced on yield and have attractive defensive characteristics. As interest rates fell over the last few years, yields demanded from bonds (and hence infrastructure) fell, which allowed such securities to trade on higher valuations. Looking at it from another perspective, with investors unable to find viable yields in cash and bonds, many flocked to infrastructure, happy to pay higher prices (and hence receive lower yields). However, with US rates having bottomed and ostensibly moving higher as early as this December, there may be some reversal in this effect. How pronounced this is will largely depend on movements in domestic interest rates and may indeed offset whatever rises occur in the US.
In the meantime, investors may be able to use any volatility stemming from interest rate uncertainty to find attractive entry points into high quality infrastructure with solid yields. In our view, Transurban (TCL) remains chief amongst such stocks. Its recent strong results were a timely reminder of TCL’s enviable position in the market. Its assets – some of the busiest toll roads in Australia and the US, are unique and largely inimitable. It’s pricing – pre-set and loosely regulated, is guaranteed to grow at levels exceeding consumer price inflation (CPI). Its market share – bordering on monopolistic, continues to solidify, as TCL is recognised more and more as the premier operator in the country.
In years past, such qualities may have been overlooked. TCL offered yield and unspectacular, long-dated growth but so then did the miners and the banks. In the yield-starved world of today where interest rates creep towards 1%, a defensive, 4.8% yield and the prospect of predictable long-dated growth are highly attractive. This has been reflected in the stellar price performance of TCL, but as stated earlier, interest rate uncertainty may provide volatility for an attractive entry price. That being said, TCL currently trades at a discount to our FY17 valuation of $11.45 having fallen from recent highs above $12.00.
Our valuation places TCL at a premium to the rest of the sector in line with its superior growth prospects. With its project pipeline clearly mapped out, TCL should be able to sustain strong dividend growth over the medium term with the forecast 11% increase in FY17 likely to be indicative. Investors should however be aware that TCL’s capital investment over the next five years is likely to cost $6.2 billion, with a strong possibility of capital raisings in FY18-FY20. There is also a risk of significant project delays and/or capex blowouts during the period though TCL does have a strong track record in this regard.
Though infrastructure prices may have peaked, TCL remains one of the highest quality yield stocks on the market, having built a dependable, growing yield on the back of some of Australia’s busiest toll roads.