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A tale of 2 infrastructure-linked stocks

Glenn Freeman  |  14 Feb 2018Text size  Decrease  Increase  |  
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Transurban (ASX: TCL) more than tripled its first-half net profit to $331 million, following strong growth in toll revenue, particularly in the US and Melbourne, according to AAP reports.

The toll road developer and operator booked a $331 million net profit for the six months to December 31, up from $88 million the previous corresponding period.

Revenue was up 21.9 per cent to $1.6 billion, with toll revenue jumping 9.6 per cent to $1.1 billion.

Transurban has toll roads in Sydney, Melbourne, Brisbane, and the Greater Washington Area in the US.

Transurban will pay a fully franked total interim distribution of 28 cents per share, up 3 cents from the previous corresponding period.

Following the result, Morningstar maintained its fair value estimate for the wide-moat-rated company. Revenue is growing "broadly in line" with expectations, but operating costs increased faster than expected, up 8 per cent for the half, according to Morningstar senior equity analyst, Adrian Atkins.

"Some cost increases were non-recurring while others support growth, but we nonetheless downgrade our fiscal 2018 earnings before interest, taxes, depreciation and amortisation forecast 2 per cent to $1.8 billion," Atkins says.

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"Regardless, the overall impact is too minor to alter our valuation."

Atkins believes at its current price Transurban is fairly valued, and notes the stock price is down 13 per cent from its peak, "and the firm's distribution yield is back to reasonable levels around 5 per cent, growing at high-single digits".

"However, we still highlight two main risks," Atkins says.

The first of these is rising bond yields, "which could increase Transurban's largest cost--interest expense--and reduce the attractiveness of its yield".

"Second, ongoing expansion late in the cycle amid increasing competition for projects could threaten return on capital," he says.

Atkins views these risks in the context of Transurban's strong pipeline of projects in Australia and Washington D.C., in addition to its ongoing investigation of further upgrades and new roads in its core market of Australia.

He also notes the US government's focus on improving ageing infrastructure, with a strong reliance on private capital, adds further growth opportunities in the US, where Transurban's "good track record on new expansion opportunities provides comfort".

However, he notes the above risks reduce the attractiveness of entering new markets, because of less ability to leverage existing operations and relationships.

Freight trains

Rail freight operator Aurizon Holdings (ASX: AZJ) on Tuesday announced a first-half profit increase of 52 per cent from the previous corresponding period, when its accounts were weighed down by impairments and one-off items.

The rail freight operator's profit for the six months to December was $281.5 million, up from $185.8 million a year ago, according to AAP. However, underlying earnings before interest and tax were down five per cent at $485.3 million.

Excluding the "true-ups" from the regulated Queensland rail network, that were a feature of the previous corresponding period, "earnings would have been up marginally, which we consider to be a reasonable result," says Morningstar's Atkins.

He says first half underlying earnings before interest and taxes (EBIT), and underlying net profit declines of 3 per cent and 5 per cent, respectively, were broadly in line with expectations.

"We reduce our fiscal 2018 EBIT forecast slightly to $922 million. However, we make more material reductions to our longer-term forecasts, factoring in price pressure for coal haulage, the loss of Cliffs iron ore haulage earnings earlier than previously expected, and less favourable regulated returns," Atkins says.

In response, Morningstar's FVE is reduced 9 per cent to $4 a share--Aurizon was trading at $4.64 as of the publication date.

"While customer demand has improved because of the strong coal price rally, heightened competition is putting downward pressure on prices and leading to more flexible haulage volumes under contracts, which is a bad thing from Aurizon's perspective," Atkins says.

Operating costs were up 5 per cent, thought Atkins expects earnings to improve as revenue on new contracts starts.

Regulatory changes have had an impact on Aurizon's coal haulage operations in Queensland.

"Management was scathing of the Queensland Competition Authority's recent draft regulatory ruling. One of the main issues is an allowed return on capital well below recent regulatory decisions elsewhere in the country, despite the much higher risk to Aurizon's network due to the volatile coal price and very high customer concentration," Atkins says.

He notes a failure of regulatory maintenance allowances to keep pace with Aurizon's larger network and higher volumes "will cause volumes across to network to fall by up to 20 million tonnes per year, or around 9 per cent".

"This means maintenance cost savings in the network business will likely be offset by reduced earnings in Aurizon's coal haulage business," he says.

According to Atkins: "It seems Aurizon is trying to get customers and the government to side with it against the regulator ... Even if the regulator relents on this matter, it's clear the regulatory environment is tough and will only get worse if the coal industry undergoes another painful downturn."

Despite the challenges, Aurizon is regarded by Morningstar as holding a narrow moat, with its "rail operations holding significant cost advantages over other forms of bulk commodity transportation".

"Size and long-term government ownership, while dominating rail haulage in Queensland, have allowed Aurizon to establish large-scale businesses with significant positions in three strategically important transportation markets," Atkins says.

"The coal-haulage market is highly concentrated, with few competitors and a few large customers, providing reasonable scope for enhanced future financial returns."

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Glenn Freeman is a senior editor at Morningstar.

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