Toll road operator Transurban Group (ASX: TCL) has often been referred to as one of the top picks for income investors, given its solid and growing dividends over the years, stable, long life and defensive assets (toll roads) and the tailwinds associated with increasing traffic on its roads.
As Charlie Aitken of Aitken Asset Management notes, Warren Buffett once said that his dream investment would be a monopoly toll bridge. That pretty much sums up Transurban's assets – mostly toll roads (one toll bridge included). Sure, motorists could decide not to use the toll road and go around, but that usually entails a much longer route and take more time too.
Toll roads also have other benefits. There are high barriers to entry – who's going to build another motorway alongside an existing one – which also makes the toll road a monopoly asset. Tolls can also increase – usually linked to the level of inflation.
Expenses each year are minimal, mainly maintenance of the roads, much less costly than the initial capital required to build the road in the first place. That it one reason why the company can report EBITDA margins of more than 80% on some toll roads.
Occasionally, Transurban will commit to spending significant amounts to improve its toll roads. But that is good news. If a company can generate higher rates of return on its capital, shareholders should want the company to continue investing in its assets.
And Transurban doesn't just own one toll road but has an interest in fifteen. Here's a list of all their assets and the company's ownership interest.
|Location||Toll Road||Distance||Ownership||Opened||Concession End|
|Sydney, NSW||Hills M2||21km||100%||1997||2048|
|Lane Cove Tunnel||3.6km||100%||2007||2048|
|Cross City Tunnel||2.1km||100%||2005||2035|
|M5 South West||22km||50%||1992||2026|
|Brisbane, Queensland||Gateway Motorway||23.1km||62.5%||1986||2051|
|Go Between Bridge||0.3km||62.5%||2010||2063|
|Virginia, USA||495 Express Lanes||22km||100%||2012||2087|
|95 Express Lanes||46km||100%||2014||2087|
In the last half, Transurban reported 19.3% growth in revenues, with average daily traffic (ADT) increasing on all its roads, particularly in the US (up by 139.6%) which resulted in toll revenues rising 216%.
After declaring a 22.5 cent dividend in the first half, Transurban is forecasting to pay 23 cents in dividends in the second half for a total of 45.5 cents in the 2016 financial year. Dividends have grown at a compound rate of more than 10% each year since 2009. At the current price of $11.01, shares are yielding 4.1% (partly franked), which might not seem like much, but investors also need to consider the lifetime value of these assets they will become part-owners in.
There is one issue that investors do need to be wary of, and that's the company's debt levels. Buying the contract to operate toll roads or building them are hugely expensive. Transurban and its partners paid just over $7 billion for its Queensland Motorways in early 2014 (excluding AirportLinkM7, which the company bought for $1.9 billion in 2015).
At the end of December 2015, Transurban had $12.2 billion worth of group debt. While interest rates around the world are currently low, they are increasing in the US, and obviously rising interest rates would mean the company will need to pay more in interest, resulting in less free cash flow and operating profits.
It's also important to note that $6.6bn of that debt is non-recourse to Transurban and linked to the underlying asset – should anything unexpected occur.
Don't be misled by Transurban's P/E ratio either. Due to accounting rules, the company has to take relatively large depreciation and amortisation charges (non-cash) that reduce net profit. If you want solid and growing dividends, investors might want to take a closer look at Transurban.