Is the Transurban share price too expensive?

Transurban Group (ASX: TCL) shares are up close to 30% over the past year alone as the yield hunt intensifies on the back of falling Australian cash rates. Based on today’s $14.64 share price and guidance for 62 cents per share in distributions over FY 2020 the stock offers an estimated 4.23% yield. This is low compared to historical standards, but still attractive compared to the pathetic returns available on cash savings rates. 

Today it announced it has refinanced $1,650 million worth of syndicated bank debt into two separate tranches of $825 million with terms to maturity of 3 to 5 years respectively.

Transurban reported the refinancing completed on “favourable” terms, although no specific financials or benefits were reported.

The debt is to help finance the group’s major Melbourne West Gate Tunnel project, among other expensive construction projects it’s undertaking in Victoria, Sydney and the US. 

Should you buy?

Given debt is so cheap today it makes sense to invest for Transurban, although the key risks for investors remain too much leverage or a change in the interest rate cycle. The latter could prove a double whammy for Transurban as the interest on its gross debt rises, while its free cash flows used to pay dividends become less attractive to investors. These scenarios would likely equal a lower valuation and share price. 

Overall though it’s a quality business model with the sky high group EBITDA margins of 75.4% usually at levels reserved for sexy software businesses.

The margins are so strong because once a toll road is built it requires little ongoing maintenance or staff support, as it’s just a question of sitting back and collecting the toll revenue. 

In fact building toll roads by issuing debt is one of the oldest business models in the world first employed by the Romans who built straight toll roads and tolled bridges to get travellers around.

Some Roman roads are still toll roads today. This is a business model likely to last the test of time then as is reflected by the impressive long-terms for Transurban returns. 

Overall, Transurban has a solid business model on paper, but it’s not immune from risks around leverage or equity investors demanding a greater yield in compensation for the balance sheet and operational risks around the business.

I’d probably sit on the fence with a ‘hold’ rating today. 

Another monopoly-style business unsurprisingly popular with investors is Sydney Airport Ltd (ASX: SYD). It could also be worth some more research.