In a recent announcement, Citi analysts said, "Transurban Group (ASX: TCL), which has a portfolio of 11 roads in Australia including Melbourne's CityLink, Brisbane's Gateway Motorway and Sydney's Eastern Distributor, is one of the world's top listed 'cash cows'."
Sounds great!
There's also lots of discussion around Transurban being a great income play, with dividends per share rising by 10.1% per annum during the last five years and forecast to increase by 12.2% per annum during the next two years.
More good news!
But as an individual investor, I question this type of investment strategy.
I've always avoided buying shares in businesses that never make any money, have significant amounts of debt, pay dividends despite earning nothing and whose return on equity (ROE) is low.
I'm even more fearful when I find a company that displays all these characteristics at the same time. But I have found them all in Transurban.
Let's look at the last financial year as a typical example.
The company reported revenues of $1.1 billion, and net profit of $282 million. Its cash flow from operations was $521 million, meaning it had a cash flow ratio of around 1.8.
This all sound good so far.
Here's where the problem starts. Its cash flows from investing, that is, the money it spends on upgrades, maintenance, replacement of plant and equipment and the like, is $903 million. This leaves it with cash flow after investing of negative $382 million.
But it gets worse! Transurban then decides to pay dividends of $418 million. Its other financing cash flows are $9 million, and foreign exchange effects are $2 million.
So, the cash flows after investing of $382 million have now become negative $811 million.
How does Transurban fund this shortfall?
It raises equity capital of $2.7 billion, takes on additional debt of $735 million, and the cycle continues until next year.
This is what I call the revolving door method of cash management. The company pays dividend distributions, which obviously must be funded by borrowings or capital raisings. The first funding source increases risk and the second dilutes your ownership. And I haven't even discussed what it does to ROE, which last year was a pitiful 4.7%.
Poor track record in the United States
In addition to its revolving door method of cash management, Transurban's expansion into the United States has also been disappointing. It lost its first U.S. investment, Pocahontas Parkway, because of weak traffic numbers and excessive debt. The second investment, the recently opened 495 Express Lanes, was also struggling before Transurban injected substantial new equity. But the third U.S. investment, the 95 Express Lanes development, appears to be performing better. U.S. assets are located in and around Washington, D.C. Concessions in the U.S. are extremely long at 75 years or more.
Price performance and valuation
In the past 12 months, Transurban's share price is up nearly 28%, which has outperformed the S&P/ASX 200 (Index: ^AXJO)(ASX: XJO), up just 2% in the same time. This rise is clearly driven by income-hungry investors chasing dividend yields.
The price-to-earnings ratio for Transurban is around 35, and the price-to-book ratio is 3.18. I think Transurban is one of the most overvalued shares on the ASX at its current price around $10. This is why the time to sell is now.
