This morning Transurban Group (ASX: TCL) reported its half-year results for the period ending December 31 2018. The toll road operator posted a profit from ordinary activities of $145 million (down 56%) on revenue of $1,286 million, which is up 30.2%.
The company reported that on a proportional basis EBITDA (operating income) increased 9.9% to $1,001 million, which translated into free cash flow of $715 million left over to feed investors' hunger for dividends.
A total interim dividend of 29 cents per share was declared, compared to 28 cents per share in the prior corresponding half. The company also maintained guidance for a final dividend of 30 cents per share to take full year dividends to 59 cents per share.
This places the stock on a yield of 4.7%, although it has already gone without the rights to the 29 cents per share payout. The group has previously stated it aims to grow fiscal 2020's dividends at a mid-single-digit rate.
The net profit was dragged down despite toll road revenue growth by ballooning costs across a number of line items on its profit and loss statement including interest on debt costs, depreciation, construction costs, and employee expenses.
The rising costs reflect a debt-driven expansion push by the group with it undertaking nine new toll road development projects over the next 5 years including the major WestConnex development in Sydney that is estimated to have a total cost of $16.8 billion, excluding airport gateway costs.
Its being funded largely by public sector debt collateralised against future toll road revenues, with Transurban recently raising $4.8 billion to take its share of the giant project.
Fortunately for investors Transurban has a good relationship with governments as shown by its sky-high gross profit margins (EBITDA of $1,001 million on proportional revenue of $1,286 million) and pricing power, as it's able to lift tolls for drivers who commonly have no choice but to pay if they want to travel to their destination.
Should you buy?
This monopoly like status gives it some defensive cash flows, but debt remains a key risk for investors with gearing (proportional debt to EV) at 35.8%.
Group debt stands at $18,445 million at a weighted average cost for capital markets debt of 4.5% and average term to maturity of 9.1 years. '
The question for investors is whether Transurban's 4.7% yield is enough to compensate for the risk in owning equity given risk-free and benchmark lending rates in the U.S. are expected to rise further in 2019.
I expect the share price will come under pressure today and I'd want a yield closer to 5.5% before becoming an interested buyer.
This means a big valuation drop.
