company valuation report

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2011

Company Valuation Report

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Table of Contents

1. EXECUTIVE SUMMARY ........................................................................................................ 5

2. INTRODUCTION TO TRANSURBAN GROUP ................................................................... 9

2.1 Overview ................................................................................................................................ 9

2.2 History .................................................................................................................................. 10

2.3 Share Price Performance ...................................................................................................... 12

2.4 Products and Services ........................................................................................................... 14

2.5 Toll Roads ............................................................................................................................ 15

2.5.1 CityLink ......................................................................................................................... 15

2.5.2 M2 Hills ......................................................................................................................... 15

2.5.3 Lane Cove Tunnel .......................................................................................................... 15

2.5.4 M1 Eastern Distributor .................................................................................................. 15

2.5.5 M7 Westlink .................................................................................................................. 16

2.5.6 M5 Motorway ................................................................................................................ 16

2.5.7 Pocahontas 895 .............................................................................................................. 16

2.5.8 Capital Beltway HOT Lanes .......................................................................................... 16

2.6 Corporate Strategy and Objectives ....................................................................................... 16

2.7 Sources of Competitive Advantage ...................................................................................... 18

2.8 Ownership Structure ............................................................................................................. 19

2.9 Capital Structure ................................................................................................................... 20

2.10 Management Structure ....................................................................................................... 21

3. INDUSTRY ANALYSIS .......................................................................................................... 23

3.1 Overview .............................................................................................................................. 23

3.2 Industry External Drivers ..................................................................................................... 23

3.3 Market Segmentation: .......................................................................................................... 25

3.4 Products and Services Segmentation: ................................................................................... 25

3.5 Major Market Segmentation ................................................................................................. 26

3.6 Industry Participants/Competitors ........................................................................................ 27

3.7 Porter Analysis ..................................................................................................................... 29

3.8 SWOT Analysis .................................................................................................................... 31

3.9 Industry Outlook ................................................................................................................... 34

4. ECONOMIC ENVIRONMENT ............................................................................................. 36

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4.1 Overview .............................................................................................................................. 36

4.2 Macroeconomic Indicators ................................................................................................... 36

4.2.1 Oil Prices........................................................................................................................ 36

4.2.2 Inflation .......................................................................................................................... 38

4.2.3 Interest Rates.................................................................................................................. 41

4.2.4 Exchange rates ............................................................................................................... 42

4.3 Economic outlook ................................................................................................................. 44

4.3.1 Estimated Market Return ............................................................................................... 44

5. CURRENT ISSUES ................................................................................................................. 46

5.1 Macroeconomic Factors ....................................................................................................... 46

5.1.1 Increase in Oil Price ....................................................................................................... 46

5.1.2 Increase Level of Debt to Disposable Income ............................................................... 46

5.1.3 Availability of Public Transport .................................................................................... 46

5.1.4 Government ................................................................................................................... 47

5.2 Microeconomic Factors ........................................................................................................ 47

5.2.1 Potential Investments ..................................................................................................... 47

5.2.2 Competitors .................................................................................................................... 47

6. FINANCIAL ANALYSIS ........................................................................................................ 49

6.1 Dupont Analysis ................................................................................................................... 51

6.1.1 EBIT/Sales ..................................................................................................................... 53

6.1.2 Sales/Total Assets .......................................................................................................... 53

6.1.3 EBIT/Total Assets.......................................................................................................... 54

6.1.4 Interest Expense/Total Assets ........................................................................................ 54

6.1.5 Net Before Tax/Total Assets.......................................................................................... 55

6.1.6 Total Assets/Common Equity ........................................................................................ 55

6.1.7 Net Before Tax/Common Equity ................................................................................... 55

6.1.8 Tax Retention Ratio ....................................................................................................... 56

6.1.9 Return on Equity ............................................................................................................ 56

7. VALUATION ASSUMPTIONS ............................................................................................. 58

7.1 Required Rate of Return (CAPM) ........................................................................................ 58

8. VALUATION ANALYSIS ...................................................................................................... 60

8.1 Dividend Discount Model (DDM) ....................................................................................... 60

8.1.1 Dividend Forecast .......................................................................................................... 61

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8.1.2 Intrinsic Share Price ....................................................................................................... 63

8.1.3 Sensitivity Analysis ....................................................................................................... 63

8.2 Free Cash Flow to Equity Model (FCFE Model) ................................................................. 65

8.2.1 Cash Flow Forecast ........................................................................................................ 66

8.2.2 Intrinsic Share Price ....................................................................................................... 67


8.3 Pricing Earning Ratio ........................................................................................................... 69


8.4 Price/Book Value Ratio (P/B) .............................................................................................. 73


8.5 Net Tangible Asset Backing Model (NTA) ......................................................................... 75

9. VALUATION DISCUSSION .................................................................................................. 78

9.1 Dividend Discount Model (DDM) ....................................................................................... 78

9.2 Free Cash flow to Equtiy Model (FCFE Model) .................................................................. 78

9.3 Price / Earnings Ratio Model (P/E) .................................................................................. 79

9.4 Price/ Book Value Ratio (P/B) ............................................................................................. 80

9.5 Net Tangible Asset Backing Model (NTA) ......................................................................... 81

9.6 Preferred Valuation Method ................................................................................................. 82

10. CONCLUSION & RECOMMENDATIONS ...................................................................... 83

11. APPENDIX ............................................................................................................................. 84

11.1 Appendix 1: Excel Raw Beta and Adjusted Beta Calculations .......................................... 84

12. REFERENCES ....................................................................................................................... 85

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1. EXECUTIVE SUMMARY

Transurban Group (TCL) is an Australian based company that and was first listed on the

Australian Stock Exchange (ASX) on the 14th

March 1996. The industry that it is in is industrials

and the sector is transportation on the ASX. It specialises in the operation and management of toll

roads. TCL main headquarters are in Australia however their operations extend to North America.

TCL also continues to search for other opportunities abroad to add to its portfolio of investments

in toll roads.

The share price movements of TCL have been extremely volatile in recent years the period from

March 2006 through to March 2011; TCL was trading at prices ranging from a monthly high of

$8.299 to a monthly low $3.996. In more recent times preceding August 2010 TCL share price

has been experiencing an upwards trend which can be seen as a positive sign. At the start date of

writing this report TCL share price was trading at $5.19 (as of 23/3/2011) and at the conclusion

of this report TCL share price is trading now at 5.44 (as of 13/5/2011).

Transurban operates and owns tolls, its operations provides specific products and services. Its

main product is the electronic tagging devices used for toll roads. The electronic tagging devices

that are known as e-TAG and e-PASS, the tagging device that is sold to commuters in Melbourne

for use on CityLink is known as the e-TAG. The CityLink is Transurban flagship toll road.

Transurban is also involved in the business of consulting and are experts in their industry. Their

consulting clients are from the public sector such as councils and governments domestic and

abroad. Their expertise is in the development and management of electronic toll roads, traffic

projection and modelling.

Transurban is a company that is highly leveraged and this is explored through examining their

capital structure. The five years history of the company demonstrated that the company had a

high net gearing ratio. This also indicated that Transurban Group had been heavily financed by

the outside parties. A company should have a well balance net gearing percentage as debt is

always a cheaper source of financing compared to equity financing but a highly geared company

would be risky to the company as the interest repayment would be very high. On the other hand,

the interest cover ratio of Transurban Group was relatively low for the past five years. Interest

cover ratio is vital as it measures the amount of profit available to cover the interest expenses of

the company. Therefore, the higher the ratio the less risks the company is bearing.

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The Toll Road Operators industry has been growing steadily over the last decade as governments

seek to lower the cost of transport infrastructure through Public Private Partnerships (PPPs). And

as the main supporting partner, Transurban contributes most to the growth by the enhancement

projects of new toll roads and increased traffic on existing toll roads. The company holds the

greatest market share in Australian toll road industry at around 33.6%.

In the coming years, the industry revenue is expected to be pushed higher as the increasing

opening of new toll road and tunnel. The strong Australia economy as well as increasing

population density will see higher demand for toll road as a result of boosting road freight activity.

However, any increase in the fuel price as a result of Carbon Pollution Reductions Scheme

(CPRS) will infer users to switch from using toll road to using to public transportation.

The porter’s 5 forces tool is a powerful tool helps to better understand the strength of the

industry’s current competitive position as well as the strength of a position that the toll road

operators are considering moving into. There are five important forces that determine competitive

power in Australian toll road, but the most valuable force determining industry attractiveness is

competitive rivalry. The competition in this industry is increasing and operators will face

competition with price, customer service levels and product differentiation.

The company’s major strengths include its leading position, holding dominant assets enable to

maintain its market share in the industry. The enhancement of existing road assets not only

deliver more value to the community but will also boost profit to TCL. However, TCL also

suffers from outstanding debt problem which will affect shareholders’ dividends payments. Apart

from that, the proposition of CPRS along with traffic congestion adds to the threats to Transurban

with travel reduction.

Transurban Group’s future potential growth can be affected by the economic environment such as

macroeconomic and microeconomic factors. Examples of macroeconomic factors that will affect

Transurban Group are oil price, level of debt to disposable income, inflation and government

regulation. As the oil price increase, there will be less people using their cars as transportation

and thus fewer consumers using the toll road. When the level of debt increases, the level

consumer’s disposable income will decrease and consequently consumers have to reduce their

level of expenditure by avoiding high petrol costs and toll costs. Inflation will cost the level of

expenditure to rise, as the prices of the consumer goods increase. Thus, travelling with own

transport will incur a higher cost. Government regulation such as increase in taxes and upgrading

the public transports will also affect the company’s profitability level.

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Microeconomic factors are factors that affect individual economy choices as well as individual

decision makers. Examples of the microeconomic factors that will affect the company are

potential investments and competitors. It is imperative for the company to be consistent in

discovering the potential investments which can bring in more revenue to the company. Potential

investments for Transurban Group can be the acquisition of potential growth assets and

upgrading the existing assets. Competitors play a vital role in affecting the decisions that will be

made by Transurban. When the rivals are performing well, the company will need to resolve with

alternative ways to boost up the company’s performance level as well as to outperform them.

EBIT is used to measure the amount of profit that the company can generate irrespective of other

external factors such as how the business if financed and government regulations. The five years

historical data demonstrated that average growth of Transurban Group was 187%. On the other

hand, EPS had been incurring negative figures from 2006 to 2009 and had a large increase in

2010 which overturned the figure into positive value. This also portrayed that the company’s

profits generating ability was very high. The ROE of Transurban Group had been relatively low

for the past five years. However, looking at the big increase in ROE in 2010 and upon the

completion of the future upgrading projects, it is very likely that the ROE will increase in future.

The preferred valuation method was the dividend discount model. This was the preferred model

over the other models because Transurban historically consistently paid dividends and we expect

would expect this to continue in the future. It was preferred over the discounted FCFE model

because the FCFE future growth rates would be more difficult to predict and it was also preferred

over the ratio relative valuation techniques since it was difficult to find companies that were

similar to Transurban and its structure.

The DDM and the FCFE models suggest that the share value of Transurban is underpriced and is

currently trading at a discount of 3.1%, FCFE model suggests that TCL share is trading at a

discount of 2.5688%. The relative valuation techniques used also suggests that the stock is worth

buying with exception to the P/E ratio which suggest we should avoid holding the stock or even

sell the stock. The five valuation methods used, four of our valuations conclude that Transurban

stock is worth buying or holding, while only one of the method used would lead to the conclusion

that investors should sell or avoid TCL stock.

Based on this information we recommend a buy-hold recommendation on TCL stocks, since TCL

shares are trading at a discount. TCL shares is trading at a discount of 3.1%, based on the market

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price of $5.31 as of the 15/4/2011 from the intrinsic value of $5.48 calculated from the dividend

discount model.

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2. INTRODUCTION TO TRANSURBAN GROUP

Transurban Group Company Details:

ASX Listing Code TCL

Official Listing Date 14 March, 1996

GICS Sector Industrials

GICS Industry Group Transportation

GICS Industry Transportation Infrastructure

Internet Address http://www.transurban.com.au

Registered Office: Level 3, 505 Little Collins St, MELB, VIC, AUSTRALIA, 3000

Market Cap $7,478,000,000.00

Total Shares Quoted 1,443,500,000

Last Close $5.18 (as of 23/3/2011)

*Source: Australian stock exchange (2011) & Morningstar DatAnalysis (2011)

2.1 Overview

Transurban Group (TCL) is an Australian based company with its headquarters located in

Australia, TCL has offices in Melbourne and Sydney. They also have vested interests in North

America so they have offices in America; their American offices are located in New York,

Washington DC and Atlanta. The Group is currently in the top fifty companies listed on the

Australian Stock Exchange.

Transurban Group is in the industry of transportation and infrastructure. It’s a toll road owner,

operator and they are involved in the development and management of electronic toll roads. The

company started out as a single purpose business which was for the purpose of CityLink in

Melbourne (Transurban 2011). They currently have interests in eight toll roads and have

approximately 5 million customers around the globe. TCL interests can be seen in table 1.

Table 1: Transurban Group Interests in Toll Roads

ROAD INTEREST

AUSTRALIA

CityLink (Melb) 100%

Hills M2 (Syd) 100%

Lane Cove Tunnel (Syd) 100%

Eastern Distributor M1 (Syd) 75.1

Westlink M7 (Syd) 50%

Motorway M5 (Syd) 50%

Virgina, USA

Pocahontas 895 75%

Capital Beltway HOT lanes (under construction) 67.5%

*Source: Transurban (2011)

http://www.transurban.com.au/

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2.2 History

Transurban group was formed in 1992, it started out as a joint venture between two engineering

firms. The two firms in the joint venture at the time were Australian company Transfield

Construction Pty Ltd and a Japanese company Obayashi Corporation. The joint venture was for a

submission with the Government of Victoria to build, own, maintain and operate Melbourne City

Link (Morningstar DatAnalysis 2011). In 1995 the Victorian Government accepted their

submission and TCL was listed on the Australian Stock Exchange in 1996.

The CityLink project consisted of two major sections, the Westlink which connects the

Tullermarine and Westgate Freeways and the Southern Link which connects the Monash and

Westgate freeways (TCL Annual Report 2000). The project involved financing design,

construction, marketing, operation and maintenance of the toll roads. CityLink was first open to

traffic in August 1999, the development of the electronics tolling system on City Link which is a

cashless tolling system was a world first (InvestSMART 2011). The City Link project endured

numerous setbacks. There was the late delivery of the Central Toll Computer System; this

prevented the tolling of the Western Link until eight months after contracted completion date and

four and a half months after the section opened to traffic. The Western Link operated without

tolling on the 15th

August 1999 and commenced tolling on the 3rd

January 2000. Between the

financial period of 30th

June 1999 and 3rd

January 2000 TCL derived no net revenue from the

City Link project (TCL Annual report 2000).

On the 19th

February 2001, the Burnley Tunnel suffered a structural failure in an arch of its

structure. As a result of the structural failure the tunnel was closed for nine days. Transurban lost

approximately $1.9 million dollars in toll revenue and incurred $0.6 million dollars in consulting

fees (TCL Annual Report 2001). In 2001 in an out of court settlement the Transfield Obayashi

Joint Venture agreed to pay Transurban $157 million in damages (Millar R, & Moynihan, S

2007).

In 2001-02 it was a big year for Transurban, it was a year of transformation. In August 2001

Transurban negotiates its release as a single-purpose entity with the Victorian government. Being

a single-purpose entity the company was legally restricted to the business of operating and

developing Melbourne CityLink (TCL Annual Report 2002). In April of that year the group filed

an expression of interest for Lane Cove Tunnel in Sydney and in February 2002 and the

management team makes a major trip overseas to find new business opportunities. Towards the

end of the 2002 financial year Transurban group finalised a debt refinancing package worth $1.7

billion, this increased the company’s ability to raise capital and invest in other projects

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domestically and internationally. During the period CityLink also launches a cost reduction

program to save $1 million per month on customer service and marketing costs, in July 2002

CityLink achieves that target and reduces cost down from $3.5 million to $2.5 million. Revenue

from tolls and fees for traffic in 2002 financial year was up 41.8% from the previous year.

TCL had another great year 2002-03; CityLink Revenue topped $230 million demonstrating

higher growth than what was initially forecast. In that period revenue was 10.7% higher than the

previous year. In the month of October Transurban’s consortium wins the $2.23 billion Westlink

M7 project in Sydney at the time it held a 40% share in the Westlink M7 project. It was the first

of many projects in Sydney; TCL financed the project by raising $430 million in equity (TCL

Annual Report 2003). Over this period the company was prospering, the future looked bright and

there was plenty of optimism about TCL.

In 2003-04 financial year traffic on Melbourne increased by 6% that saw revenue grow by 10.1%,

this was another positive year for TCL. Over the year they introduced other programs designed to

increase revenue and cut costs. In July they introduced a new video tolling product which

attracted more than 34,000 new accounts and generate over $1.5 million in revenue (TCL Annual

Report 2004). CityLink continued to develop further programs to cut operating costs and increase

revenue. In December 2003, Transurban and Macquarie Infrastructure Group agreed to set up a

tolling venture as New South Wales (NSW) six tolling roads would eventually move from

manual toll roads to electronic tolling, they already have a current joint venture in Westlink M7.

Transurban continued to increase its stake in NSW roads when it purchased 8.1% share in Hills

Motor way on 19th

April. TCL was entering in further bids for business opportunities. Transurban

was bidding to develop and operate the Mitcham-Frankston project and entered a tender in

Sweden. The tender in Sweden was TCL first tender outside of Australia and the tender was

unsuccessful (TCL Annual Report 2004). During this period it was one where TCL was actively

seeking new projects domestically and overseas to increase returns to its stakeholders.

The financial year for 2004-05 was an excellent year for investors, company securities grew from

the start of the 2004-05 financial year from $4.87 a year and trading at a high of $7.45 (TCL

Annual report 2005). That year Transurban was listed as one of the top fifty companies on the

ASX. Transurban were also successful in a takeover bid for Hills Motorway (M2) where it would

become 100% owner of the M2. The 100% ownership of the M2 and 40% ownership of the M7

made TCL a major stakeholder of around half of Sydney’s motorway. In early 2005 Transurban

reached an agreement on the upgrade of the Tullermarine/Calder interchange, however they were

unsuccessful in the bid for Mitcham-Frankston Freeway. TCL however continued its interest in

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international opportunities. In the US they were targeting potential projects in the State of

Virginia, whilst also setting up an office in the United Kingdom building relationship with

potential partners and monitoring potential opportunities. Revenue on the CityLink was also up

during the period it was up 8% during the 2004-05 period (TCL Annual Report 2005).

Transurban had its first international toll road in June 2006, it was the Pocahontas Parkway in

Richmond, Virginia in the United States. The Company’s portfolio of toll roads now consisted of

four toll roads. TCL and its partners also opened Sydney’s Westlink M7 eight months early while

TCL had the full electronic tolling system working ten months early earning a performance bonus

of $8.3 million (TCL Annual Report 2006).

The company continued enhancing its portfolio of toll roads by adding more toll roads to its

portfolio. TCL takeover of Sydney Roads Group (SRG) increases TCL stake in five out of the

nine motorways in Sydney (TCL Security holder review 2007). The Security holder review of

Transurban (2007) states that on December 2007, TCL construction partner Fluor and the

Commonwealth of Virginia reached a financial close on the Capital Beltway Hot Lanes project in

Virginia. The joint agreement will allow TCL to operate the lanes for 75 years (TCL Security

holder review 2007).

On August 2008 TCL further increased its stake in its toll roads it already has interests in. It

further increase an addition 2.5% in Westlink M7 taking its interest to a total of 50%. While in

September 2007 TCL acquired an additional 3.8% in Airport Motorway Group, taking its

invested interest in Eastern Distributor to 75.1% (TCL Security holder review 2008).

During the 2009-10 financial year TCL posted an annual net profit turnaround. It posted a profit

turnaround of $59.605 million which was up from the $16.134 million loss from the previous

financial year (Herald Sun 2010). The profit turnaround for 2009-2010 financial year was the first

profit made in ten years. TCL continued to increase its portfolio in toll roads it announced on the

10th

of May 2010 that it had reached agreements to acquire the Lane Cove Tunnel, in August the

group assumed operational control (Morningstar 2011). The 2011 results will be released in the

near future.

2.3 Share Price Performance

The following chart (figure 1) compares the five year historical performance of TCL share price

against the All Ordinaries Index from the period of March 2006 through to March 2011. During

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that period TCL was trading at prices ranging from a monthly high of $8.299 to a monthly low

$3.996. When TCL was trading at an all time high on May 2007 the share price rapidly declined

from then. The All Ordinaries Index also declined in close proximity. This would suggest the

share price of TCL is correlated to movements in market indices. It can be seen from figure 1

TCL share price has depreciated further than the market (relative to the All Ordinaries Index)

through periods prior to March 2009 where it was trading at all time low. The 20 month moving

average of TCL share price would suggest that there is a downwards trend however early 2010

the trend started to flatten out and the share price was improving, possibly even changing trends.

Figure 1: TCL Share Prices vs. All Ordinaries Index (5 Years Closing Monthly Prices)

*Source: ASX (2011)

The next chart (figure 2) compares the past six months of the daily share price of TCL with the

six month daily change of the All Ordinaries Index. The pricing movements seen in figure 2 show

that from periods preceding August 2010 TCL share price was experiencing an upwards trend

following the trend of the All Ordinaries Index. This would also further clarify that TCL and the

All Ordinaries are closely correlated. The upwards trend can also be seen from the twenty day

moving average of TCL share price. The upwards trend slowly steadied from early November to

present. During the six month period it can be said that the price of TCL stock price was

extremely volatile as during the period there was a fluctuation in share price of around 19%,

However TCL share price has improved which is a more positive sign.

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Figure 2: Share Prices vs. All Ordinaries Index (6 month Closing Daily Prices)

*Source: ASX (2011)

Transurban’s stock price was last trading at $5.30 at the close of trade (25th

March 2011),

although it is still trading below its previous high it has recovered from trading at its five year low

in early to mid 2009.

2.4 Products and Services

Transurban operates and owns tolls in Australia and North America and through these operations

it provides specific products and services. Its main product for what it’s known for is the

electronic tagging devices used for toll roads. The electronic tagging devices that are used in

Australia are known as e-TAG and e-PASS.

The main tagging device that is sold to commuters in Melbourne for use on CityLink is known as

the e-TAG, with e-TAG account commuters can travel through toll roads in Melbourne and

Sydney. The e-PASS account is for commuters that only occasionally use toll roads and can only

be used for travel on Sydney’s Westlink M7 tolls. The two accounts allow up to four vehicles to

be registered on the one account. They also offer commercial e-TAG for businesses which

require account holders to have at least five vehicles registered on the one account. Visitors that

are in Sydney they can purchase the visitor’s e-PASS which allows visitors to travel on all

Sydney toll roads for up to 30 days (Roam 2011).

Transurban is also involved in the business of consulting they are experts in their industry and

offer consulting services. Their consulting clients are from the public sector such as councils and

governments domestic and abroad. Their expertise is in the development and management of

electronic toll roads, traffic projection and modelling.

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2.5 Toll Roads

Transurban has interests in eight toll roads, six of the eight toll roads are in Australia and two are

in America. The six toll roads in Australia are the CityLink, M2 Hills, Lane Cove Tunnel, M1

Eastern Distributor, M7 Westlink and M5 Motorway. The two toll roads in America are the

Pocahontas 895 and Capital Beltway HOT lanes.

2.5.1 CityLink

The company flagship asset is CityLink which is 100% owned and managed by TCL. It connects

to three major freeways, the West Gate, Tullermarine and Monash. The freeways link to

Melbourne manufacturing hubs, city, port and airport with around 22 kilometres of motorway.

Melbourne’s CityLink was one of the world’s first fully electronic toll roads with currently more

than 1.8 million vehicles registered to use the toll roads. CityLink was first opened to traffic in

August 1999 and the company has a concession to operate the road until 2034 (Transurban 2011).

2.5.2 M2 Hills

Sydney’s M2 motorway was first open to traffic in 1997 and was acquired by Transurban in June

2005. The M2 in Sydney has 21 kilometres of motorway, it links the lower north shore of the city

with the northwest regions and connects to the Westlink M7 and the Lane Cove Tunnel. The M2

is a combination of electronic toll and cash toll connections, there are certain lanes for each. The

company has 100% interest in the M2 and currently has a concession to operate the road until

2042 (Transurban 2011).

2.5.3 Lane Cove Tunnel

Lane Cove Tunnel has about 3.6 kilometre of motorway it connects to the M2 and has a fully

electronic tolling system. The tunnel is located in Sydney it was opened to traffic in 2007 and was

acquired by Transurban in August 2010. It is 100% owned by the company and they have a

concession to operate the road until 2037 (Transurban 2011).

2.5.4 M1 Eastern Distributor

The M1 is 6 kilometres of motorway that links Sydney’s City Centre, Harbour Bridge and Tunnel,

southern suburbs and Sydney’s airport. The road contains a combination of electronic and cash

tolling and includes a 1.7 kilometre tunnel. The road was first opened to traffic in 1999 and was

acquired by the company in 2007 with a concession to operate the road until 2048. TCL has a

75.15% interest in this asset (Transurban 2011).

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2.5.5 M7 Westlink

The M7 Westlink consists of 40 kilometres of motorway in Sydney and links to M2, M4 and the

M5. The road is a full electronic toll operated road and improves access to Western Sydney by

helping motorist avoid traffic lights. The M7 was opened to motorist in 2005 and was acquired by

the company also in 2005. They currently have 50% interest and a concession to operate the M7

until 2037 (Transurban 2011).

2.5.6 M5 Motorway

Transurban’s sixth asset in Australia is the M5 in Sydney, the M5 is 22 kilometres of road and

connects the F5, M5 East and M7 Westlink motorway. The motorway contains a combination of

electronic and cash tolling system. It was first open to traffic in 1992 and was acquired by TCL in

2007. The company has a 50% interest and a concession to operate the toll road until 2023

(Transurban 2011).

2.5.7 Pocahontas 895

The Pocahontas 895 was the first international toll road added to Transurban toll road portfolio.

TCL acquired the asset in 2006 with a 75% stake and has a contract to operate the road until 2105.

The Pocahontas 895 is a 14 kilometres stretch of road in Richmond, Virginia, USA and is a

combination of cash and electronic tolls (Transurban 2011).

2.5.8 Capital Beltway HOT Lanes

The Capital Beltway HOT Lanes is a project that Transurban is currently completing, the

construction began in early 2008 and is expected to open in 2013. The construction consist of 22

kilometres of electronically tolled HOT lanes with an additional two lanes added to each direction

bring the total to twelve lanes. TCL has a 67.5% interest in this asset which is still currently under

construction (Transurban 2011).

2.6 Corporate Strategy and Objectives

According to the Transurban annual report (2010) the chairman of Transurban Group, Mr

Lindsay Maxsted, year 2010 was a great year in term of growth in revenue on all the Australian

assets and 13% of increment in EBITDA. These results had facilitated the generation of 31.8%

growth in underlying free cash to $347.5 million. Since year 2008, objective to reduce cost had

been delivered successfully this will save the corporation $45.3 million, twice as much as what

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was expected from the original cost cutting target. The following highlights the projects that will

be carried out by Transurban Group as part of their development strategy and objectives to be

achieved in the coming future:

1. MI-Citylink upgrade in Melbourne

Extra lanes and freeway management system will be constructed to improve the traffic

flow and reduce congestion on M1 which includes CityLink’s southern section. The cost

is estimated to be $1.39 billion. The upgrading of M1 is forecasted to increase the traffic

level to additional 7% on CityLink within 5 years and improving the safety level when

travelling on the busy road corridors.

2. Hills M2 upgrade in Sydney

Additional lanes will be built in both directions along 14.5km of the motorway and

widening the tunnel as well as installing new tolled ramps to improve the access to the

motorway and alleviate congestion. The cost is approximately $550 million. Upon the

completion of the upgrade, it is expected to drive in more traffic by approximately 17,300

average daily trips by year 2016.

3. M5 widening in Sydney (Interlink Road Project)

Expanding the 21km motorway which is the main route for freight, passenger and

commercial between Port Botany and Sydney airport and South West Sydney to three

lanes in each direction to reduce traffic jams. The cost of the project is approximately

from $350-$450 million. The project is estimated to increase the traffic and boast up the

revenue. In terms of economy benefits, M5 widening will enhance the network connection

between the airports, industrial hubs and ports. The overall outcome is it will reduce the

travelling time for road users.

4. Building 58 new bridges and two electronic tolled Hot Lanes in Washington DC (US)

On a 22km section of the 1-495 ring road, two new electronically tolled Hot Lanes will be

built in each direction which increase the total number of lanes from 8 to 12.In term of

replacing the old infrastructure, 58 new bridges and overpasses will be constructed. The

project will cost approximately $US2 billion. In terms of economic benefits, over the year

of 2008 to 2013, the massive project opens up 11,800 jobs for the public and $2.7 billion

in the economic for the Washington metropolitan area.

5. 1-95/395 Hot Lanes Project

Collaborating with Fluor-Lane, both are working with the Virginia Department of

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Transportation in reviewing and finalising the financial plan, scope and timeline for the 1-

95/395 Hot Lanes Project

Transurban Group is very optimistic about the future where the projects are to be carried out will

boost the corporation’s cashflows in long term, driving the returns and creating value for the

shareholders.

2.7 Sources of Competitive Advantage

Transurban Group has been actively carrying out massive multi millionaire dollars projects as

part of their development plan to expand their territory in Australia as well as in United States.

Several factors that make Transurban Group being competent in the market are:

1. Technology advancement enables the Transurban Group to appear as the world leader in

electronic tolling and providing excellent customer service with more than one million

fully interoperable e-Tag devices.

2. High barriers to entry into the market due to the government regulation and high cost of

establishment make Transurban Group one of the dominant players in the road tolling

market.

3. Transurban’s traffic forecasting is highly regarded which strengthen the asset acquisitions

and projects enhancement.

4. Efficiency of the operation and management teams in ensuring all the massive projects are

constructed effectively according to the timeline.

5. Diversification of capital funding options.

6. Good relationship with the lenders, stakeholders and governments which creates more

business and development opportunities in future. (TCL Annual Report 2006)

The definition of competitive advantage is an advantage that the company has over its

competitors which allow the company to perform better in the market. Examples of competitive

advantage are customer service, company’s cost structure, product and facilities offered, network

distribution and the company’s management (Investopedia 2011).

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2.8 Ownership Structure

Table 2: Transurban Substantial Shareholders as at Last Notice 01/09/2010

Capital Partners Pty Ltd Canadian Pension Plan Investment Board

Shareholding 187,139,384 182,552,346

Share Held (%) 13.50 12.90

*Source: Transurban Group Annual Report (2010)

The two largest shareholders of the Transurban Group since 2009 were Capital Partners and

Canadian Pension Plan Investment Board. From year 2009 to 2010, there was a declination of

total shares held by Capital Partners which was 2.09% and CPPIB was 0.51%. Ontario Teachers’

Pension Plan Board was in the list of the substantial shareholders in year 2009 withholding 12.22%

of the securities and was dropped out in 2010. Other companies that were substantial sold over

the past 12 months were National Australia Bank, BlackRock Investment Management Limited,

Capital Partners and Ontario Teachers’ Pension Plan Board (MorningStar 2011).

Table 3: Distribution of Shareholders of Stapled Securities

Ordinary Shares Number of shareholders Number of Shares

1-1,000 24,717 9,743,880

1,001-5,000 31,107 78,306,126

5,001-10,000 7,109 50,916,469

10,001-100,000 3,845 81,493,545

100,001 > 225 1,220,830,613

Total 67,003 1,441,290,633


The total numbers of individual shareholders were 67,003 and the total numbers of shares held

were 1,441,290,633. Ordinary shareholders have voting rights and each share represents one vote.

Besides that, there were 5,687 holders of less than a marketable parcel of shares.

Table 4: List of the Top Twenty Shareholders as at 01/09/2010

Shareholder Shares Acquired Shares

(%)

AMP Life Ltd 11,785,190 0.82

ANZ Nominees Ltd 10,029,735 0.70

ANZ Nominees Ltd (i) 5,175,821 0.35

Argo Investments Ltd 3,405,099 0.24

Australian Foundation Investment Co. Ltd 14,825,726 1.03

Australian Reward Investment Alliance 8,776,444 0.61

Bond Street Custodians Ltd 3,266,846 0.23

Citicorp Nominees Pty Ltd 33,402,284 2.32

Cogent Nominees Pty Ltd 17,403,961 1.21

CS Third Nominees Pty Ltd 5,055,376 0.35

Djerriwarrh Investments Ltd 3,895,156 0.27

HSBC Custody Nominees (Australia) Ltd 479,852,426 33.29

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J P Morgan Nominees Australia Ltd 145,496,316 10.09

National Nominees Ltd 349,974,664 24.28

Queensland Investment Corporation 7,156,613 0.5

RBC Dexia Investor Services Australia Nominees Pty Ltd 9,404,426 0.65

RBC Dexia Investor Services Australia Nominees Pty Ltd (i) 4,880,206 0.34

RBC Dexia Investor Services Australia Nominees Pty Ltd (ii) 2,867,732 0.20

UBS Nominees Pty Ltd 12,389,880 0.86

UBS Wealth Management Australia Nominees Pty Ltd 10,422,999 0.72

Total 1,139,466,900 79.06


The total shares held by these top twenty shareholders were 1,139,466,900 which was equivalent

to 79.06%.

2.9 Capital Structure

Table 5: TCL Net Gearing Ratios

Year 2006 2007 2008 2009 2010

Net Gearing (%) 150.51 87.97 83.62 100.04 80.43

*Source: Morningstar DatAnalysis (2010)

Net gearing ratio is measured by (total liabilities– cash) divided by shareholders equity. It gives

the measurement of the contribution of long term lenders to the long term capital structure of the

business taken into consideration of how much cash received by the company. The level of

gearing is vital in assessing the risks where it represents the extent where the company is financed

by outside parties (Atrill et al.2008). A high net gearing means that the company is heavily

financed by outside parties therefore it is vital for a company to have a well balance net gearing

percentage. From 2006 to 2008, the gearing ratio dropped significantly by 66.9% and remained at

80.43% in 2010. This is positive change as a decrease in gearing ratio means that the company

reducing its risk as debt represents a financial obligation. As compared to 2006, the net gearing

was very high, which indicated that the company went into negative gearing where the company

geared more than it should. However, the net gearing percentage was still very high in 2010.

Gearing is often necessary to finance the business and it increases the return on equity provided it

is justified by the returns generated from the assets.

Table 6: TCL Interest Cover Ratio

Year 2006 2007 2008 2009 2010

Net Interest Cover Ratio 0.08 0.31 -0.11 0.68 1.14


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Interest cover ratio demonstrates the measurement of the amount profit available to cover the

interest expenses of the company. Interest Cover Ratio is profit before interest and tax divided by

interest expenses (Atrill et al.2008). For 2006, the interest cover ratio was relatively low, 0.08

which mean that the level of profit to cover the interest payments was low and therefore higher

risk. For 2008, the ratio was -0.11 indicating that the business performance was bad because the

level of profit was insufficient to cover the interest payments and as a result the corporation

needed to come out with a solution to maximise the level of profit. There was an improvement in

ratio from 2009 to 2010 which was partly due to the cost reduction plan successfully being

carried out in 2008 which save the company $45.3million. Hence, the higher the interest cover

ratio, the lower the risk and vice versa.

2.10 Management Structure

Figure 3: TCL Management Structure

The board of directors of Transurban Group comprises of eight non executive directors, one

chairman and a chief executive director. The board is being structured where each of the

members of the board has different experience, qualifications and skills to ensure effective

discussion as well as efficient decision making. The main role of the board is to provide strategic

guidance and effective management for the company. Non executive directors do not get

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involved in running the day to day business, therefore they are considered as independent from

the management. They only monitor the executive activities and play an important role when

there is conflict of interest. On the other hand, executive director get involved in the day to day

business management and is normally a full time employee. There are three committees being

established to assist the board in discharging the responsibilities which are Remuneration

Committee, Nomination Committee and Audit and Risk Committee. These committees comprise

of only non executive directors. Remuneration Committee is accountable of integrates financial

report, audit functions of external and internal and deal with risk management systems whereas

Nomination Committee is to deal with appointing new board members and performance of the

committee and board. Audit and Risk Committee focuses on directors’ remuneration as well as

incentives and remuneration packages for CEO and other senior executives.

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3. INDUSTRY ANALYSIS

3.1 Overview

The industry which the Transurban group primarily operates within is Australia’s Toll Road

Operators industry. The primary activities of this industry include the terminal facilities provision

as well as the operation of toll bridge, toll road, weighbridge, and vehicular ferry or punt. For

TCL Ltd, it mainly involved in the development and management of toll roads in Australia and

the USA.

According to IBISWORLD (2010), The Toll Road Operators industry has been growing steadily

over the last decade as governments seek to lower the cost of transport infrastructure through

Public Private Partnerships (PPPs). As a result, industry revenue has grown by an average of 3.8%

per annum to be worth an estimated $2.6 billion in 2010-11. Growth has been supported by new

toll roads and increased traffic on existing toll roads. And the increasing opening of new toll

roads is bound to have a large effect on the industry, providing a large source of growth.

Despite the internal factor of the high demand for toll bridge and road operations, the key success

of the industry also results from the external factors, such as: Optimum capacity utilization,

Long-term site tenure and location to provide stability, provision of a related range of

goods/services ("one stop shop") and advanced technology to reduce costs and increase

efficiencies (IBISWORLD 2010).

3.2 Industry External Drivers

The Key External Drivers section mainly looks at the key factors outside the control of an

individual business that determine the industry's performance. For Australian’s toll road

operator, there would be four dominant factors boosting the development of the industry in

accordance with 2010 industry report.

The first factor of the demand for passenger travel is caused by the rapid growth of vehicle

ownership. The industry is sensitive to motor vehicle usage in the cities, both private and

commercial vehicles. Our research report predicts the number of motor vehicles will tend to

increase significantly in the following years, and by 2014 the number of vehicle owners will

reach to around 17million (Figure 4). These rising amount will to a large extent support the stable

income of the industry.

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Figure 4: Expected Number of Motor Vehicles in Recent Years

*Source: IBISWORLD (2010)

Apart from the rising number of vehicle, real household disposable income contributes

proportionally towards the operation of the industry. The greater the disposable income of

households the greater the expected demand for use of toll roads. Toll roads provide convenient

travel routes but toll fees can be costly especially when a free alternative route available

(IBISWORLD, 2010). Figure5 shows that the disposable income fluctuates dramatically from

2007 to 2012.

Figure 5: Expected Household Disposable Income In Recent Years


Moreover, legislative compliance requirements for services to road transport and the demand for

road freight transportation will provide sustained momentum for the steady growth for the

industry as well.

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3.3 Market Segmentation:

Market segmentation is the process of splitting customers, or potential customers, in a market into

different groups, or segments.

3.4 Products and Services Segmentation:

Toll road operators are the most profitable segment of the products and services in the industry

(figure 6), contributing 79% of industry value in 2011 (IBISWORLD 2011). Beyond the

operations of toll roads, the market also includes the provision of support and maintenance

services. Industry revenue is expected to boost over the next five year with the opening of the

Clem Jones tunnel and Hale Street Link in Brisbane. The Brisbane Airport link is due to be

completed in 2012.

Container parking, handling, equipment and refurbishment facilities make up the second main

resource of income for toll road provider. The industry report states that this segment is closely

linked to the port and international trade activity. And it will be hit by the looming Australian

recession as trade activity freezes.

Besides, the segment of weigh bridges it is closely related to the transportation industry and plays

a considerable role in the industry (8%). However, as economic activity grow slowly in Australia;

the amount of freight being transported falls significantly which to some extent drives down the

revenue from this segment.

Vehicle ferries which provide ferry and punt services for vehicles only takes up 1% according to

the figure 6. This segment provides services to locals and tourists, as the economic condition

improves; demand is expected to recover in the following years.

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Figure 6: Products and Services Segmentation


3.5 Major Market Segmentation

The major market of this industry is primarily made up of three segments: private motoring

(44%), commercial motoring (36%) and trade activity (20%) (IBISWORLD 2010). Private

motoring the main resource of revenue, demand from private motorists is negatively related to the

price of oil. Due to the soaring price of oil, many motorists simply choose to use public transport

than pay the high price for fuel in addition to tolls, parking fees and a congestion levy on inner

city car parks. However statistics from IBISWORLD shows the lower price of fuel, and public

transport systems that are stretched to capacity will cause some motorists to shift back to the use

of toll roads in 2009-10. On the other hand, the use of commercial vehicles is influenced by the

economic condition. For example, demand from commercial uses fell in 2008-09 as slower

economic conditions decreased freight volumes in Australia. However it rebounded in 2010-11 as

Australian consumers increase spending, and retailers and manufacturers rebuild inventory levels.

The trade activity segment involves import/export and wharf-related logistics operations, which

are subject to movements in trade volumes (IBISWORLD 2010).Since imports and exports in this

industry are low and steady, domestic demand will equal to revenue in the absence of imports and

exports.

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Figure 7: Major Market Segmentation


3.6 Industry Participants/Competitors

The dominant competitors in the Australian toll group are Transurban Group, ConnectEast Group

and Queensland Motorways Limited and other companies. The followings are the snapshot of

major participants in the industry.

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3.7 Porter Analysis

Porter's 5 Forces analysis deals with factors outside the toll road operator industry that influence

the nature of competition within it, the forces inside the industry (microenvironment) that

influence the way in which firms compete, and so the industry’s likely profitability is conducted

in Porter’s five forces model. Porter defined the forces which drive competition, contending that

the competitive environment is created by the interaction of five different forces acting on a

business. In addition to rivalry among existing firms and the threat of new entrants into the

market, there are also the forces of supplier power, the power of the buyers, and the threat of

substitute products or services. Porter suggested that the intensity of competition is determined by

the relative strengths of these forces.

These five forces can be neatly brought together in a diagram like the one below:

Figure 8: Porter’s Five Forces

*Source: Mind Tools (2011)

1. Supplier Power: The analysis of supplier power typically focuses first on the relative size and

concentration of suppliers relative to industry participants and second on the degree of

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differentiation in the inputs supplied. The ability to charge customers different prices in line

with differences in the value created for each of those buyers usually indicates that the market

is characterized by high supplier power and at the same time by low buyer power. The key

selling industries to the toll road operator make up of metal container manufacturing, lifting

and material handling equipment manufacturing and road and bridge construction. Supplier

power is high in this case. The technology applies to those specialized manufacture as well as

construction is unique and patent. This means there are mere substitutes to replace suppliers in

this industry.

2. Buyer Power: The most important determinants of buyer power are the size and the

concentration of customers. Other factors are the extent to which the buyers are informed and

the concentration or differentiation of the competitors. This force is relatively high where there

are few large players in the market. However, as the toll road operator industry is marketed

directly to private vehicle users and different commercial transportation industries in various

areas, therefore the relative buying power is relatively low.

3. Competitive Rivalry: The intensity of rivalry, which is the most obvious of the five forces in

an industry, helps determine the extent to which the value created by an industry will be

dissipated through head-to-head competition. The most valuable contribution of Porter's ―five

forces‖ framework in this issue may be its suggestion that rivalry, while important, is only one

of several forces that determine industry attractiveness. Competition in this industry

is medium and the trend is increasing and competition for toll roads are public roads that act as

substitutes (IBISWORLD, 2010). While with a large number of operators, competition in the

container services industry is fierce. Operators compete on price, customer service levels and

product differentiation.

4. Threat of Substitution: A threat from substitutes exists if there are alternative products with

lower prices of better performance parameters for the same purpose. They could potentially

attract a significant proportion of market volume and hence reduce the potential sales volume

for existing players. Threat of substitution is considerable high, public road and transportation

acts as substitutes for commercial traffic along with transport of freight. The high price of fuel

will result in a significant number of commuters abandon their cars in favour of public

transport. Beyond the high price of fuel, the tough economic conditions will keep pressure on

toll roads as many Australians cut spending and use public transport.

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5. Threat of New Entry: The threat of new entrants is usually based on the market entry barriers.

They can take diverse forms and are used to prevent an influx of firms into an industry

whenever profits, adjusted for the cost of capital, rise above zero. In contrast, entry barriers

exist whenever it is difficult or not economically feasible for an outsider to replicate the

incumbents’ position. Barriers to entry in this industry are high and are steady; the ability to

demonstrate to governments the benefits associated with Build-Own-Operate-Transfer (BOOT)

and Public Private Partnerships (PPP) schemes is the main barrier by entering in this industry.

Besides, the incredibly high cost of building transport infrastructure prevents new firms who

intending to get involved in.

3.8 SWOT Analysis

SWOT Analysis is a useful technique for understanding a company’s external and internal

environment which is an important part of strategic planning process. Internal factors to the firm

usually can be classified as strengths(S) or weaknesses (W), while external factors are defined as

opportunities (O) or threats (T) (QuickMBA 2010).

The SWOT analysis provides information that is helpful in matching the firm’s resources and

capabilities to the competitive environment in which it operates. The company Transurban will be

analyzed by this four aspects as follows:

Strengths:

Leading player in the market

Holding dominant toll road assets in Australia

Asset enhancements

Good road performance and safety

Innovative transport solutions

Transurban, a major player in the marketplace holds approximately 33.6% market share in

Australian toll roads industry. Its assets include CityLink (Melbourne), Westlink M7 and Hills

M2 (both in Sydney). Apart from that, Transurban also acquired Sydney Roads Group (SRG),

which had interests in three major toll roads – Eastern Distributor M1 (75.15%), M4 (50.61%)

and M5 (50%) (IBISWORLD,2010). These advanced electronic toll road assets play dominate

roles in Australian toll road market and it also represent the main income for TCL. According to

IBSIWORLD 2010, there were approximately 3.2 million customers using all Transurban roads

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in 2006, and the number of toll road users as well as revenue increase due to the increasing

activity of Australia’s economy.

On the other hand, Transurban always devotes to upgrade their existing road assets - projects

such as enhancing CityLink's corridor in Melbourne and the Hills M2 motorway in Sydney –

which will deliver more value to the community. The enhancement improves congestion, safety,

driver experience, and travel times. The benefits are moving towards a substantial growth profile.

TCL considers ―Safety‖ as the first priority and insists that safe workplace for their employees

and safe roads for the customers. The company undertakes a number of routine safety initiatives

on roads where they have management control including routine road safety inspections, incident

inspections, and independent road safety audit etc. In some extent, these series of conducts will

minimize the probability of road accident as well as establish a reputation for its safety.

TCL is a provider of Innovative solutions; Transurban always looks at new pieces of

infrastructure and develops new ways to improve their transport networks. Transurban has the

expertise and experience to play a strategic role in addressing different challenges which make

their existing infrastructure work better and create a more sustainable future.

Weaknesses:

Outstanding High Debt Levels

Given the massive investment and enhancement required, without doubt, Transurban need a large

amount of fund to finance its projects. However, statistics from Crude Oil Peak shows the

company has accumulated a debt mountain of around $4billion. Up to now, most of the previous

debt has not been paid back, but refinanced. The refinancing is done for longer periods to avoid

early capital repayments and the repayment problem is pushed into the future. This rolling over of

debt has continued recently, when Transurban obtained a bank loan of $740 million for the M2

widening in Sydney.

Shareholders might also suffer from the debt problem in that interest payments reduce the

dividends they receive, not to mention that the share value drops with higher debts. There does

not appear to be any intention to pay back debt in the foreseeable future. The next debt for the M5

widening is already around the corner.

Opportunities:

Potential Future Transactions

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Transurban continue to look for further opportunities in the US and Australia that fit their strict

investment criteria. In the US, they are actively monitoring significant long-term opportunities,

with a focus on Virginia and Georgia (Transurban 2011). For example, the company is

developing HOT lanes on the Capital Beltway (I-495)–one of the most congested roadways in

Washington,DC. The project will maximize capacity and adding value to existing infrastructure

corridors.

On-going Population Growth

The On-going population growth in Australia indicates the generation of higher traffic Volumes.

Transurban knows their current toll way assets can’t satisfy the increasing needs and that is the

reason why TCL undertakes project upgrades. The recent CityLink upgrade is starting to deliver

higher traffic flows and enhancements to the M2 & M5 in Sydney should be completed in 2012.

As a result, TCL revenues are expected to continue to grow steadily as toll road users increase.

The Purchase of Lane Cove Tunnel

In May 2010 Transurban brokered a deal to purchase the Lane Cove Tunnel for an estimated

$630.5 million (IBISWORLD, 2010). Transurban said that the acquisition of the Lane Cove

Tunnel, a 3.6 kilometre roadway in Sydney's north, would increase Transurban's exposure to

Sydney's north-west corridor, one of the city's fastest growing business and residential areas. And

the Lane Cove Tunnel toll-road concession arrangement will incrementally benefit Transurban's

strong business profile by providing some further cash flow diversity to the group.

Threats:

The Proposition of Carbon Pollution Reductions Scheme (CPRS):

Toll roads generate revenue through motor vehicle use and that travel produces greenhouse gas

(GHG) emissions. Public policies and community action designed to cut emissions. The

Australian Federal Government’s proposed emissions trading scheme-the Carbon Pollution

Reduction Scheme (CPRS) is one of the action aimed for GHC, which is scheduled to commence

in July 2011. Transurban may be exposed to indirect impacts from the introduction of the CPRS

in the form of higher energy prices (like fuel price), higher construction materials costs and a

potential impact on traffic numbers (Transurban, 2009). In the case of transport fuels, that is the

oil refineries. The increased costs will be passed to consumers of fuel. The carrying out of the

scheme will have the potential to reduce travel and revenue on toll roads.

Urban Congestion and Traffic Management

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In Australia, the Bureau of Infrastructure, Transport and Regional Economics estimate that,

without reform, urban road congestion could cost the national economy $20 billion by 2020 –

nearly double today’s estimates. High traffic volumes have resulted in low speeds, slow travel,

and significant delays in peak periods. Given the challenges posed by climate change, simply

building more roads and allowing cities to continue to sprawl is not the answer. How to develop

new ways in addressing the challenges posted by urban congestion is another problem that

Transurban faces.

3.9 Industry Outlook

According to IBISWORLD’s prediction, the next five years Australian toll road operator will be

dominated by the opening of the Clem Jones Tunnel and Hale Street Link in 2010 and the

Brisbane Airport Link in 2012. Increased capacity will push industry revenue higher, up by an

average of 3.4% per year over the five years through 2015-16 to be worth $3.1 billion.

The strong development of Australia’s economy, the numbers of trucks as well as commercial

vehicles will increases. This will combine with the opening of opening new toll roads in Brisbane

and the completion of upgrades to CityLink in Melbourne to boost industry revenue. Besides, as

the economy recovers, real household disposable income are expected to increase and Australian

customers are deemed to spend their higher disposable income. Therefore, the demand for toll

road will be boosted which is supported by higher road freight activity. In 2010-11, road freight

revenue is forecast to grow by an average of 4.4% per year over the next five years after growing

by a strong 6.6 % (IBISWORLD 2010).

The proposition of the Carbon Pollution Reductions Scheme (CPRS) will impose a carbon cost

on the upstream producers of carbon emissions. In the case of transport fuels, the increased costs

will be passed on to consumers of the fuel. Any increase in the price of fuel as a result of a carbon

price will see a small percentage of private motorists move from the use of cars to public

transport while others will seek to reduce their transport costs by using public roads and avoiding

toll roads. However, this scheme has been delayed until 2013 and the delay in implementation

and possible changes and amendments means it is unclear what, if any effect a carbon price will

have on the industry.

Secondly, in the past couple of years, the fuel prices have been experienced extraordinary

fluctuation and are not expected to return. As global economies begin to recover from 2010-2011,

the price of oil is expected to cool down and demand will increase. For many Australian, vehicles

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become an essential transport tool and the stable fuel price encourages the extensive use of

vehicles (IBISWORLD 2010). This will support an increase in the number of vehicle journeys on

toll roads over the period through 2015-16.

Road congestion Australia is expected to increase significantly over the next 20 years with the

Bureau of Infrastructure, Transport and Regional Economic forecasting that road congestion will

cost the Australian economy $20.4 billion per year by 2020. Apart from that, due to an increasing

population density in cities across the country it is likely that any new major road projects will

include significant land acquisitions costs or require the building of tunnels (IBISWORLD 2010).

It is impossible that governments alone can fund the required investment in new roads, bridges

and tunnels. Therefore, government is likely to seek assistance from private operators to fund

such projects, creating new toll roads and this would boost industry revenue.

New traffic projections of North-South tunnel (a new toll road) in Brisbane indicate that the

potential number of vehicles using the tunnel could be higher. The 6.8 kilometre tunnel running

from Woolloongabba in Brisbane's south underneath the Brisbane River and Story Bridge to

Bowens Hills in the city's inner-north opened in 2010 and the project of the airport link is

expected to be completed and opened to traffic in 2012 (IBISWORLD 2010). The new road and

tunnel will boost the industry revenue.

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4. ECONOMIC ENVIRONMENT

4.1 Overview

After a sharp, broad and synchronized global downturn in late 2008 and early 2009, an increasing

number of countries have registered positive quarterly growth of gross domestic production

(GDP), along with a notable recovery in international trade in 2010 and 2011 ( World Economic

Outlook 2011). The world economy is expected to grow at about 4.5 percent a year in both 2011

and 2012, with advanced economies growing at only 2.5 percent and emerging developing

economies growing at a higher 6.5 percent (World Economic Outlook, 2011). Emerging Asian

economics are leading the world recovery; particularly China while advanced economies Europe

and United States lag behind International Monetary Fund 2011). The world economic is on the

mend. However, the recovery is expected to remain sluggish and uneven. The conditions for

sustained growth remain fragile (IMF 2011).

Transurban Group is a toll road owner and operator with interests in Australia and North America.

Its business comes from the Australian market and American markets, thus future earnings are

leveraged primarily from the outlook of these economies. Thus we will focus on Australian and

American economies for the macroeconomics analysis.

4.2 Macroeconomic Indicators

It is important to look at a range of macroeconomic indicators to evaluate the state of the current

economy and forecast the future outlook. In this report, oil prices, inflation, interest rates and

exchange rates will be discussed.

4.2.1 Oil Prices

Crude oil prices behave much as any other commodity with volatile price swings in times of

shortage or excess supply. The crude oil price cycle may extend over several years responding to

changes in demand as well as OPEC and non-OPEC supply (WTRG Economics 2009). Oil prices

have surged to about $110 a barrel April 2011, as precautionary demand and risk premiums have

increased in response to the oil supply shock triggered by events in the MENA (Middle East and

North Africa) region. The key cyclical factor was stronger-than- expected growth in demand for

commodities during the second half of 2010, which drove up oil prices for 2011 to about $90 a

barrel by early January2011, up from the $83 a barrel expected in April 2010.

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Figure 9: Global Oil Demand and Production by Region (Millions)

*Source: International Monetary Fund (2011)

The run-up in oil prices preceding the onset of the oil supply shock reflected a number of factors.

Annual growth in oil demand in 2010 was 3.4 percent, the highest rate since 2004.Oil supply

responded to the unexpected increase in oil demand, but not to the full extent possible. Global oil

production is estimated to have increased by 3.2 percent in 2010 (World Economic Outlook

2011).

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Figure 10: OPEC and Non-OPEC production

*Sources: IMF Primary Commodity Price System (2011)

OPEC crude oil production, which is subject to production quotas, rose by 1.8 percent,

contributing one-quarter to the increase in global supply (Left panel and figure 10).

Global oil production is estimated to have increased by 3.2 percent in 2010. Higher-than-

expected non-OPEC production contributed about half of the surprise increase in supply.

Declines in the North Sea were more than offset by higher production elsewhere, notably in

Brazil, China, Russia, and the United States, reflecting incentives for investment and field decline

management embodied in rising oil prices and, in the case of Russia, changes to the tax regime to

cover high production and development costs (Right panel and figure 10).

Owing to the raising crude oil price, consumer may choose other transportation instead of

Transurban Group’s toll roads, it would be expected that families will be cutting back on

expenses for family budgets. Consequently, Transurban Group’s trading in South America and

Australia will be influenced.

4.2.2 Inflation

In mainstream economics, the word ―inflation‖ refers to a general rise in prices measured against

a standard level of purchasing power. Previously the term was used to refer to an increase in the

money supply, which is referred to as expansionary monetary policy or monetary inflation

(Trading Economic 2011).

The inflation rate in Australia was last reported at 2.7 percent in the fourth quarter of 2010. The

most well known measures of Inflation are the CPI which measures consumer prices, and the

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GDP deflator, which measures inflation in the whole of the domestic economy (Trading

economic 2010).

Figure 11: Australia Inflation Rates (2008 -2010)

*Source: Trading economics of Australia (2011)

Figure 12: Australia Long Run Inflation (1960-2010)

*Source: Reserve Bank of Australia (2011)

The Governor and the Treasurer have agreed that the appropriate target for monetary policy in

Australia is to achieve an inflation rate of 2–3 per cent, on average, over the cycle. Seeking to

achieve this rate, on average, provides discipline for monetary policy decision-making, and

serves as an anchor for private-sector inflation expectations. Inflation in Australia is moderate

due to slow wage growth, exchange rate appreciation and easing demand (Inflating Target RBA

2011).

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Treasurer Wayne Swan believes inflation is expected to rise a quarter of a percentage point in the

March quarter of 2011, as a result of Australia's devastating floods (Herald Sun 2011). As

inflation rises, the price of oil and the price of consumer goods are expected to rise, this will

result in a decrease of the demand which in result an expected fall in consumption. Consumers

will take the cheaper alternatives of transportation, Transurban Group will possible face a

decrease in revenue in Australia.

Figure 13: US Inflation Rates (2005-2010)

*Source: Trading Economic (2011)

As we can see from the chart, the inflation starts to increase at the beginning of 2010. The

inflation rate in United States was last reported at 1.6 and 2.1percent in January and February of

2011 and at 2.7 % in March of 2011. US Consumer Price Index for All Urban Consumers (CPI-U)

increased 2.1 percent before seasonal adjustment over the last 12 months, the Bureau of Labour

Statistics reported on March 17. For the month, the index increased 0.5 percent prior to seasonal

adjustment in 2010 (Trading Economic 2011). However, in the US oil prices played a lead role in

the rise of inflation during 2010 — the current level of inflation (Dec 2009- Nov 2010) is 1.1%,

and energy prices increased in the U.S. by 3.9%. (Bureau of Labour Statistics (BLS) 2011)

Because of increasing inflation, the price of oil and consumer goods will rise; this will lead to

decrease in demand and consumption. Consumer may choose the cheapest way to travel (e.g:

public transaction) instead of toll road.

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4.2.3 Interest Rates

Figure 14: Australia Interest Rates (2004-2010)

*Source: Trading Economic (2011)

From 2004 to 2010, Australia's average interest rate was 5.81 percent reaching a record high of

7.50 percent in 2008 and a record low of 3.00 percent in April of 2009. Interest rates are

controlled by the central bank (Reserve Bank of Australia). The official interest rate is the cash

rate. The cash rate is the rate charged on overnight loans between financial intermediaries, this is

determined in the money market as a result of the interaction of demand and supply of overnight

funds (Trading Economic 2011).

Since the global financial crisis, the RBA has reduced the cash rate to record lows in order to help

stimulate the economic. The cash rate in Australia was last reported at 4.75 percent. Reserve

Bank of Australia decided on the 1st March 2011, to keep interest rate unchanged at 4.75% (RBA

2011). Westpac Economist Bill Evans predicts that the next interest rate rise will come in April

2011, and this will be the first of three for that year (Tom Reid 2011).

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Figure 15: US Interest Rates (2002-2010)

*Source: Trading economic (2011)

US Interest rate (2002-2010) shows that the interest rate in US has increased by 4.28% from 1.02%

in May 2006 to 5.3% in October 2007 and has decreases to 0.25% in January 2009, this can be

seen in figure 15.

In the United States, interest rate decisions are divided between the Board of Governors of the

Federal Reserve (Board) and the Federal Open Market Committee (FOMC). The Board decides

on changes in interest rates after recommendations submitted by one or more of the regional

Federal Reserve Banks. The FOMC decides on open market operations, including the desired

levels of central bank money or the desired federal funds market rate.

According to Trading Economics 2010, the Federal Reserve has kept interest rates unchanged at

0.25% from January 2009 to August 2010 (Trading economic 2011). The low interest rates would

make it attractive for business spending as it would be cheaper for Transurban to fund new

projects and also reduce current debt. Less interest expenses will result in increase in net profit.

4.2.4 Exchange rates

The behaviour of currencies in the foreign exchange market is hard to forecast because there are

many factors to consider across many countries.

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Figure 16: Australian Dollars vs US Dollars (2010-2011)

*Source: RBA (2011)

Australia’s real exchange rate has appreciated over the last years, driven largely by an increase in

the term of trade and bringing with it benefits and challenges for the broader economy. Many

variables have been identified as correlating with the real exchange rate, including productivity,

inflation and investor perceptions (RBA Economic Competition 2010).

The rise of interest rate has had positive effect on the AUD in the last month. Inflation has

increased as a result of a decrease in money supply (i.e. currency), this means an increase in

inflation rates will cause increase in the price of Australian products. This will create less demand

for Australian product (decrease Australian export) which leads to a depreciation in AUD

(appreciation in USD).

The stronger currency is likely to negate higher earnings from the growing commodity exports

and may result is cautious business sentiment for sometimes. For example, Australia dollar

appreciation will affect business in America and the profit in America will decline. Thus, there

will be a higher risk of exchange between the countries.

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4.3 Economic outlook

Figure 17: World Economic Growth Rate (2004-2010)

*Source: World Economic Situation and Prospect (2010)

Overall, the world’s GDP is expected to climb in the future since economic recovery is on the

mend. In 2010 it was a year of recovery, it was sputtering and many questioned whether the

recovery was real and if it could be sustained. In 2011 things are looking brighter following a

booming stock market up 13%, a new 2011 Tax Stimulus package, and housing markets

stabilizing around the country. But the one major area of concern is unemployment, which is

high around 10% despite improving corporate and small business profits (Today’s Economic

2011). As a result of the positive economic outlook consumer and business confidents is expected

to be strong as the world economy is experiencing the expansionary phase of the business cycle.

4.3.1 Estimated Market Return

Since Gross Domestic Product (GDP) growth serves as an indication of the level of economic

activity, we assume expected market returns are driven by the changes in GDP growth. If GDP

growth is high, then it indicates that the level of economic activity in the economy is high and

consequently investors are optimistic and confident about the current economic condition as they

are expecting a higher return for their investments. As seen in the table below, if change GDP is

over 5%, then estimated market return will be 25% and the assumed probability that it will occur

is 15%, there will be a weighted expect market return of 3.75%. Inversely, if GDP declines, then

it indicates that the economic activity is slowing down and investors may not expect as high of a

market return. The table below shows that if the change in GDP declines is in the range of 3% -

4%, then estimated market return will be 15% and the probability of that occurring is 40% there

will be a weighted 6% expect market return. We expected that there will be a strong to weak

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growth in RGDP hence we have weighted the probability heavily in those periods (75%). The

table below shows the inputs that have been used to calculate the expected market return for the

current period. The expected market return for the period is expected to be 11%.

Table 7: Estimated Market Return

Macroeconomic

Performance

Estimated Market Return Probability Expected Market Return

(% Change in Real GDP

Very Strong (>5%) 25% 15% 3.75%

Strong (3% - 4%) 15% 40% 6.00%

Weak (1% - 3%) 5% 35% 1.75%

Very Weak (<-1%) -5% 10% -0.50%

E(Rm) 11%

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5. CURRENT ISSUES

Transurban Group like many of peers also faces external factors that affect its future and potential

growth. Macroeconomic and microeconomic factors will now be discussed to examine the

current issues that the company may face during a time of rising prices and in a recovering world

economy.

5.1 Macroeconomic Factors

5.1.1 Increase in Oil Price

The increase in world oil price since 2009 has reflected the combination of expectations of the

recovery of world economy which lead to a higher consumption in oil. Investment and

speculative demand are also among the factors that contributed to the rise in world oil prices.

From 2009 to 2010, Australia’s crude oil and condensate production is forecasted to drop by 2.3%

from 2008. Thus, due to the lower production in year 2009, Australia’s crude oil and condensate

exports are forecasted to drop by 2.4% and consequently causes the prices of oil to increase by

3.5% to 9.1billion. As a result, the increase in oil prices has a major impact of declination in

consumption of petrol. Consumers decrease their petrol consumption level by travelling with

public transport instead of driving their own vehicles. This will cause the total revenue of

Transurban Group to decrease due to the diminishing level of traffics (ABARE, 2011).

5.1.2 Increase Level of Debt to Disposable Income

Among the other countries in the world, Australia has the highest household debt to disposable

income ratio. This has a negative indication as in average Australia household has bigger debts

(Denning D 2010). According to RBA, debt to disposable income ratio had increased from 92.4

in 2009 to 97.4 in 2010. The latest RBA report showed that interest rates had increased which

overall increases the interest payments as a share of disposable income have increased from 10.6%

in 2009 to 12.1% for 2010 due to the monetary policy taken by RBA to control the inflation rate

(RBA 2011). As Australians are engaging in the higher level of debts, therefore they need to cut

down on their daily expenditure in order to sustain the debt repayments. It is a bad sign for the

growth of revenue for Transurban Group as people cut down on their travel cost by consuming

less petrol or avoid paying toll by using public transports.

5.1.3 Availability of Public Transport

Depending on the location of the areas, public transports can be a threat to Transurban Group.

Due to technology advancement, public transports such as buses, trains and trams are built

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connected to most of the areas especially in big cities like Melbourne and Sydney. Statistics

showed that yarra trams and metro trains have been delivering average of 80% in their

performance achieved (Yarra Trams 2011). The efficiency of public transports had been

consistently increased which boost the confidence of passengers in taking public transports.

Hence, more people will start to take public transports as it is more convenient and save costs.

5.1.4 Government

Few massive projects carried out by the Transport Victoria Government such as regional railway

stations upgrade and Westlink will have negative impact on the traffic growth of Transurban

Group. The upgrade of regional railway stations enhances the connectivity with bus and coach

services and better access to rail services. Improvement of passenger amenities promotes the

numbers of people taking public transports (Victoria Department of Transport 2011). NSW

government’s strategy to speed up the plan and construction of the 23 km North West rail link

will have negative impact on Transurban’s profit level. The North West rail link will connect the

passengers from areas including Castle Hill and Rouse Hill to the city making the travelling to

and from city a cheaper and easier way (NSW Department of Transport 2011). Upon the

completion of all these projects, the number of passengers using the tollway will decline as more

passengers are using public transports.

5.2 Microeconomic Factors

5.2.1 Potential Investments

Transurban Group’s growth was attributed a lot to acquisitions on strong assets and investments

into new information technology systems. According to the latest half yearly report, Westlink M7

had great potential of maximising the revenue return as southern section of the road in Sydney

had high industrial development which would continue to deliver more traffic. Western Sydney

continued to deliver high population growth and high employment which would drive in more

traffic along M7. Besides that, according to the half yearly report of Transurban Group, there was

10.3% in the growth of revenue which indicated that the growth rate had been strong (Transurban

Half Yearly Report 2011). Therefore, Transurban Group should invest in upgrading the Westlink

M7 as one of the project in future to sustain more traffic along M7.

5.2.2 Competitors

Due to high cost of establishment and extensive government regulations, the entry of new

competitors to the markets is tough. Nevertheless competitions within the industry still exist.

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Connect East and Queensland Motorways are the two largest competitors to Transurban Group.

There are few major projects such as Eastern recreation precinct, Eastlink service centre,

Somerfield, The key industrial park and Peninsula Link along the Eastlink tollway will be

completed in 2011 and 2013 are forecasted to generate more traffics towards the eastern surburbs

(CEU Annual Report 2010). As for Queensland Motorways, there are two major projects being

commenced by them which are Gateway upgrade project and free flow tolling on Gateway and

Logan motorways. The completion of these two projects will bring positive outcomes to the

public as it provides better connections for business, tourism and industry and reduces traffic

congestion (Queensland Motorways 2009). It can be seen that the eastern freeway is dominated

by Connect East and upon the completion of the projects along the Eastlink, traffics will be

diverted from the North suburbs towards the Eastern suburbs. On the other hand, Queensland

Motorway is on the move to dominate the toll roads in Queensland which restrict the expansion

of Transurban to that particular state. The impact is estimated will decrease traffic growth of

Transurban Group.

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6. FINANCIAL ANALYSIS

Transurban Group’s financial statements are complied consistent with the Australian accounting

standards and has been audited by the PriceWaterHouseCoopers accounting firm.

Figure 18: Historical Income Summary (5 years)


Transurban Group had been experiencing strong increase in operating revenue. There was a total

increase of 344 million which equivalent to 84.52% from year 2006 to year 2010. There was a

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big increase which was 136 million in operating revenue from year 2007 to 2008. The large

increase in the operating revenue was due to the successful acquisition asset of Eastern

Distributor (ownership of 75.15%) and M5 Motorway (ownership of 50%). Eastern Distributor

generated total revenue of 73.7 million while M5 Motorway managed to generate total revenue of

163.6 million which contribute to the increase in the Transurban’s operating revenue (Security

review 2008). Overall the strong level of growth in Transurban Group had indicated that

acquisition and upgrading of assets managed to drive in more traffic and capture a larger

consumer group.

Table 8: EPS Growth Compared to EBIT Growth

Year EPS (Cents) Growth (%) Growth EBIT (%)

2006 -7.6 - -

2007 -17.2 -126.31 370

2008 -13.1 23.83 -144.68

2009 -1.9 85.49 633.33

2010 4.6 342.11 80.36

*Source: FinAnalysis (2011)

EBIT (Earnings before interest and tax) is used to measure the profitability level of the firm

which capture the businesses’ ability to generate profit on its sales irrespective of other factors

such as government taxation policy of incorporation or how the business is financed.

Transurban’s EBIT margin had increase of 370% from 2006 to 2007 and had decreased of 144%

in 2008. The decrease in EBIT margin for 2008 was due to the acquisition of new assets, Eastern

Distributor and M5 Motorway where the depreciation charged on new assets employed were

larger. There was a massive increase in EBIT from 2008 to 2010 which was 1061.9%. Other

factors such as increase in toll fees on heavily populated urban areas had contributed to the

increase in operating revenue hence higher EBIT and massive cost reduction since 2008 which

save the company of total $45.3 million reduced the operating expenses eventually contributed to

the increase in EBIT (TCL annual report 2009).

EPS (Earnings per share) had been showing negative figures since 2006 to 2009 which indicate

that Transurban Group had been heavily financed by debt due to the company been actively

acquiring new assets in year 2007 to generate more revenue. It showed improvement in EPS after

2007 but still remained negative figures because the new assets had not been generating sufficient

revenue to cover the financing costs of the company. However, the dividends were still being

paid out to meet the investors’ expectations and also the company was very optimistic to turn

around the negative EPS into positive EPS once the assets started to generate sufficient revenue

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in future. There was strong growth in EPS in 2010 which was 342.11% which turn around the

negative EPS into positive value which had proven the company’s ability to generate profits for

the investors.

6.1 Dupont Analysis

Dupont Analysis provides a detailed analysis in evaluating the return on equity for the company.

The extended Dupont system captures the evaluation of the company’s profit margin, total asset

turnover, the effect of financial leverage on the company as well as the effect of income taxes on

ROE.

Figure 19: Dupont ROE Analysis Framework

*Source: Merck & Company, A comprehensive Equity Valuation Analysis

To conduct the analysis of Dupont ROE, Transurban Group’s financial performance have been

compared relative to its peers which are CTI Logistics Limited (CLX) and Toll Holdings Limited

(TOL).

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Table 9: Summary of Extended Dupont Analysis


6.1.1 EBIT/Sales

EBIT or can be considered as reported earnings before interest and tax and it attempts to measure

the profitability of the firm. Through this ratio, the investors can compare the efficiency of the

company in generating profit with the peers and gain a broader view in making investment

decision.

The EBIT margin for Transurban Group had increased from year 2006 to 2007 but had

deteriorated in 2008 and experienced an increase again from 2009 to 2010. Comparing to

all the peers, Transurban Group had not been performing well in 2006 and 2008 but

managed to outperform all the peers in 2010.

Toll Holdings had been experiencing decrease in EBIT ratio and CTI Logistics on the

other hand had been consistently maintaining the EBIT ratio on the average of 0.12.

Transurban Group had the highest EBIT ratio in 2010 as the previous assets acquisition

managed to bring in higher revenue to the company.

Therefore, it is very optimistic that Transurban Group will continue to experience positive

marginal growth as the company begin to benefit from the assets acquisition as well as massive

upgrading projects that will drive in more revenue.

6.1.2 Sales/Total Assets

Total asset turnover ratio is to measure the effectiveness of a firm’s use of its total asset base.

Therefore the higher is the ratio; the higher is the volume of sales thus higher the profitability of

the firm.

Transurban Group had the lowest total asset turnover ratio comparing to the other peers.

According to the ratio, Transurban Group had not been able to maximise the usage of the

asset in generating more income. The latter is due to Transurban Group had been carry

major fix assets that caused the ratio to be low.

However, Transurban Group had been showing consistent increase in the ratio until 2009

and remained unchanged in 2010. This showed that the company was trying to improve

the management of the assets and became more efficient in handling the assets.

It is most likely that Transurban Group total asset turnover ratio will remain low due to the

company carry a higher fix asset base comparing to the rest of the companies.

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6.1.3 EBIT/Total Assets

The return on asset ratio (ROA) measures the efficiency of the firm in delivering profits from the

assets regardless the size of the firm. A high ROA indicates that the company has a good

financial and operational performance and vice versa.

Transurban Group had the lowest ROA ratio comparing to the competitors. Transurban

Group had been massively expanding and acquiring new assets which caused the

company went into heavy financing.

In year 2008, Transurban Group had a negative ROA ratio as the new acquired assets

were not ready to generate more revenue as well as massive upgrading projects been

carried out had caused the ratio to decline. However, there was an improvement in the

ratio after 2008.

CTI Logistics had the highest ROA ratio comparing to the rest which indicated that the

company had the best financial and operational performance comparing to Toll Holdings

and Transurban Group.

It is expected that the ROA for Transurban Group will increase in future upon the completion of

the massive upgrading projects such as MI-Citylink, Hills M2 and M5 in Sydney.

6.1.4 Interest Expense/Total Assets

The interest expense to total debt ratio reflects the interest rate that the company has to pay on its

total debt. A high interest expense ratio is not a good indication for the company because the

company is paying a high interest rate on the debt and thus will increase the total expenditure of

the company.

Transurban Group’s interest expense ratio had been consistently remaining on the average

of 1.6% which was low. This was due to the offset of interest revenue. It also came to

show that although the company incurred a high interest expense but the company had

been managing the repayment of interest effectively.

It is very optimistic that the company will continue to maintain the low interest expense ratio in

the future.

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6.1.5 Net Before Tax/Total Assets

This ratio attempts to measure the level of return on the company’s asset base before tax. The

ratio is quite similar to EBIT/Total asset except it takes into consideration of the effects of

interest payments.

The ratio had been showing negative figures from 2006 to 2009 which clearly indicated

that the level of return on the company’s asset before tax was bad and came to prove that

the company was not making enough profit to cover the expenditures.

However, there was a big increase about 150% in the ratio from 2009 to 2010, which

showed significance improvement in the profitability level and where the company had

access to more funds before tax.

It is very likely that Transurban Group will continue to have increase in the ratio as the expansion

of the operations will bring in more profits in future.

6.1.6 Total Assets/Common Equity

This ratio is to examine how a company uses debt to finance its assets. It is also known as

financial leverage multiplier. The higher the ratio, the higher the financial leverage and this

indicates that the company is relying heavily on debt to finance its assets.

Transurban Group had the highest financial leverage ratio comparing to the competitors

and this came to prove that the company had been heavily financed by debts because of

the company’s expansion strategy.

The ratio overall decreased from 312% in 2006 to 260% in 2010 which demonstrated that

the company had reduced amount of debts as more revenue were generated to cover the

expenditures.

Transurban Group’s ratio is likely to remain relatively high depending on the company’s future

strategies in expanding the business as it might need extra funds to finance the massive projects.

6.1.7 Net Before Tax/Common Equity

This ratio indicates the return to equity holders before payment of tax.

Transurban Group had been showing negative ratio from 2006 to 2009 which

demonstrated that the return to the equity holders were poor. Comparing to the other peers,

CTI Logistics had the highest return to the equity holders.

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As Transurban Group had weak performance for the past 4 years, it showed a huge

improvement in 2010 where the ratio had increased about 144% from -1.49% to 0.65%.

Looking at the improvement in the ratio, it is very likely that the ratio will continue to increase in

future as the company is very optimistic in bringing in more profits to the shareholders with their

current strategy plans.

6.1.8 Tax Retention Ratio

This ratio measures the proportion of net income before tax that is not paid in the form of taxes.

The higher the ratio, the lower the rate of the tax paid.

The tax retention ratio for the Transurban Group had been inconsistent as it experience

low rate in 2006, 2008 and 2009 and relatively high in 2007 and had the highest in 2010

which was 233%.

Transurban Group had been paying the lowest rate of tax in 2010 comparing to the other

competitors.

6.1.9 Return on Equity

ROE measures the company’s profitability by demonstrating how much profit the company is

generating using the money that is invested by the shareholders.

Figure 20: Five Year Average Return (2006-2010)


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Transurban Group was the weakest performer comparing to its peers as it had the lowest

average ROE for the past 5 years.

CTI Logistics was the strongest performer as it had the highest average ROE which was

above the average benchmark. Toll Holdings on the other hands had been performing well

and managed to achieve ROE slightly higher than the average benchmark.

However, comparing to the ROE of Transurban Group from 2006 to 2010, there was a big

increase from -2.5% to 1.5%.

Transurban Group is very heavily relying on the consumers using the service of the toll road;

therefore the profits as well rely heavily on the traffics. Taken into considerations of the few

massive upgrading projects, upon the completion of the projects, there will be higher level of

traffics and the company is very likely to boost up the ROE in the coming future.

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7. VALUATION ASSUMPTIONS

The valuation that will be conducted on Transurban will be on its intrinsic share price value,

certain valuations models and techniques are used. The data that will be used for the purpose of

this analysis will be based on the firm’s and the S&P 200 historical data, as well the analysis on

the economic outlook.

7.1 Required Rate of Return (CAPM)

The required rate of return for Transurban must be derived in order to use the valuation models,

as it will give the discount factor relevant for use in valuation models throughout this report. To

calculate the required rate of return the capital asset pricing model (CAPM) is utilised. The

CAPM is made up of three components the risk-free rate ( ), market risk premium ( )

and Beta ( ). The CAPM is based on the idea that investors must be compensated for taking on

an investment. The two forms of compensation is the time value of money which is represented

by the risk-free rate and the second form of compensation is for taking on additional risks which

is represented by the product of the asset’s beta and market risk premium (Investopedia 2011).

The CAPM equation required to calculate the relevant discount factor used in the valuation

models is presented below:

Risk-free rate ( )

The risk-free rate is the return that the investors can expect with no risk associated to it. The risk-

free rate that will be used for the purpose of the valuation models will be the current 10 year

Australian Treasury bond yield. The yield for the 10 year government bond is currently 5.575

percent as of the 15th

April 2011 (Reserve Bank of Australia 2011).

Market return ( )

The market return is based on the analysis that was performed on the economic outlook. It was

calculated that based on the current economic environment the expected market return would be

11 percent. (The full calculation for the expected market return can be seen in section 4.3.1, table

7).

Market risk premium ( )

The market risk premium is the difference between the expected return of a risky asset that

exceeds the risk less asset. The market risk premium is derived from the difference between the

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expected market return (11%) and the risk-free rate (5.575%). The market risk premium that was

calculated is 5.425 percent.

Beta ( )

The beta coefficient is a measure of systematic risk, also known as non-diversifiable or market

risk. It measures the systematic risk of a particular risky asset relative to that of a fully diversified

market portfolio. The market portfolio for valuation purposes will be based on the S&P200.

To calculate the beta the five year monthly total returns indices between 1/1/2006 – 1/3/2011 for

S&P200 were used as the market return and the total return indices for Transurban Group were

used for the same period.

The equation for the raw beta is as follows:

The equation for adjusted beta is as follows:

The raw beta calculated is 0.6132 and from converting it to an adjusted beta figure it was

calculated to be 0.7408. Since the Beta is less than one this indicates that Transurban group

inherits less systematic risk than the market. The adjusted beta will be used in the calculation of

required rate of return since the beta of individual assets tends to move towards the mean market

beta in the long-run. (Refer to appendix 1 for excel beta calculations).

Required Rate of Return (CAPM) Calculation

By inputting the variables in the CAPM formula investors required rate of return can be derived.

The required rate of return for Transurban stock is calculated to be 9.5939%. This is the investor

required rate of return that will be used in the valuations models.

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8. VALUATION ANALYSIS

8.1 Dividend Discount Model (DDM)

The dividend discount model is used to evaluate the intrinsic value of a company’s share price.

This model is useful for valuation purposes where it can be seen that a company pays dividends.

The theory of the model is to determine all the present values of a company’s expected future

dividends payables to shareholders (Reilly & Brown 2009). To forecast a company’s future

dividends the appropriate assumptions for dividend growth rates must be used.

There are two evaluations models for the DDM that need to be taken into consideration. One of

the models that need to be taken into consideration is the stable growth rate model also known as

the constant growth rate model. This model is used for when the dividend growth is constant

generally in where dividend growth is stable. The requirement in order to use this model is that

the required return ( ) must be greater than the dividend growth rate (g). If it is not this violates

the assumptions of this model.

The equation for the stable growth DDM model is shown below:

The second model is the multi-stage dividend growth rate model. In this model the dividend

growth rate can be greater than the required rate of return in the short-run. In this model it takes

into account different stages of dividend growth which depend primarily on the attributes of the

company, the stages of the business cycle and on the economy’s future economic outlook.

The equation for the multi-stage growth DDM is shown below:

Where:

Since our future expectation of Transurban is for it to experience several growth phases before

the company enters into the mature growth phase, both models will be utilised to calculate the

intrinsic value of Transurban Group’s share price. In calculating the intrinsic value the company’s

future dividend growth rates must be forecasted.

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8.1.1 Dividend Forecast

The dividend for 2010 that was used was $0.24 per share. This is the sum of the interim dividend

for 2010 and the final dividend for 2010 (TCL Annual Report 2010). The full dividend for 2011

was not able to be used since the final dividend for 2011 has not been paid.

Firstly we will examine the historical dividend growth rates which can be seen in the table below.

Table 10: Transurban Historical Growth Rates

*Source: company data (Fin Analysis) (2011)

Over the past four years from 2007 to 2010, Transurban’s ordinary dividend payment has

experienced significantly fluctuation during this period especially the dramatically drop of DPS

from 57c to 22c between 2008 and 2009. In addition to the decrease freight volumes from the

slower economic conditions, the level of dividends was under further pressure.

According to Theage (2009), in 2008 Transurban captured headlines as it raised almost $1 billion

capital and shifted from its debt-funded model towards paying distributions out of cash flow. As a

result, Transurban's dividend for the half-year has been cut from 28c to 11c (57c to 22c for whole

year) and Transurban's net profit follows a $16.1 million loss in 2008/09.

After the sharp fall, TCL gained a gradually increase in its dividend payment. For the full year

2009/2010, it was reported that the company’s net profit had reached $59.418 million which is up

342% on the prior year (Theweat 2010). Transurban declared a final distribution of 12 cents per

security unfranked, bringing total distributions for 2009/10 to 24 cents unfranked. Besides that,

Transurban said it expected to pay a higher total distribution in 2010/11 of at least 26 cents, based

on the positive outlook for Transurban in the year.

Also, despite of the economic cycle, a cost reduction program conducted by Transurban had

delivered total savings of $45.3 million since June 2008. This is more than double the original

cost reduction target announced at that time. Transurban chief executive officer defined the

results and growth in EBITDA was the outcome of continued efforts in pursuing value for the

security holders. And the continuing rising distributions of dividends for shareholders

demonstrates confidence in the firm’s capacity to continue to add value.

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Currently, the interim dividend is declared to be 13c per share in the first half year of 2011, but

TCL group affirms the expectation to pay distribution in the whole financial year of at least 26c

per security. This is supported a strong pipeline of growth projects that would deliver a

significant increase to group cash flows and drive returns for security holders over the long term.

Although Transurban has provided no guidance to dividend price in the following several years,

however we maintain an optimistic attitude towards the steadily revenue growth as well as DPS

growth for the firm with the following reason:

On-going population growth which should generate higher traffic volumes;

The recent CityLink upgrade starting to deliver higher traffic flows

The tolls that Transurban charges road users are usually indexed to inflation which

suggests toll growth of around 3% per annum given the current inflation rate.

We expect to see a stable to mid strength dividend growth rate of 8% in the following three years

(2011- 2013) as the enhancements to the M2 & M5 in Sydney will be completed in late 2012.

The Hills M2 upgrade is a clear demonstration of attractive enhancement projects that can be

undertaken on Transurban’s mature toll roads (BusinessSpectator, 2009). These projects unlock

capacity for the benefit of Transurban security holders and road users alike.

Transurban is forecasted to enter a high dividend growth stage with the growth rates of 14% for

about three years. Chris Lynch, the chief executive of TCL, said "We are forecasting 7% uplift in

traffic across CityLink by 2015 - over and above regular growth - as a result of the upgrade

project." Increasing the dividend signals that directors are confident in the future ability of the

company to maintain cash flow. However, we consider the firm will get into a stable stage in the

long run with low dividend growth rate which is estimated to be 3% from 2017 onwards.

We develop the following timeline according to the assumption we’ve made:

Table 11: Forecasted Dividend Growth Rates

PHASE 1: Slow - Moderate

Growth Stage

PHASE 2: High Growth Stage PHASE 3: Stable Growth Stage

2011 - 2013 2014 - 2016 2017 - Onwards

-Dividend growth rate of 8% -Dividend growth rate of 14% -Dividend growth rate of 3%

-The accomplishment of M2 & M5

enhancement

-The commencing use of the

upgrade projects

-Stable economy

-Construction on the Capital

Beltway (I-495) High Occupancy

Toll (HOT) lane project with its

first tolls expected in early 2013

-Traffic volume is expected to be

17,300 average daily trips by 2016

-Dividend growth rate close to the

level of macro-eco long term

growth

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8.1.2 Intrinsic Share Price

Transurban Group’s intrinsic share price was calculated to be $5.48, the calculations for the

intrinsic values can be seen below in table 12. The calculations were based on the three growth

phase that we have made in our assumptions and also based on our required rate of return that we

have calculated using the capital asset pricing model. To calculate the intrinsic value of

Transurban share price we have used the multi-stage dividend growth model and the stable stage

growth model. Comparing our intrinsic value of $5.48 and the market price of $5.31 as of the

15/4/2011, it would suggest that Transurban shares are trading at a discount of 3.1%.

Table 12: Transurban Group Intrinsic Share Price (DDM Excel Calculation)

8.1.3 Sensitivity Analysis

The outcome and accuracy of the intrinsic value in DDM valuation is dependent on variables that

have been forecasted in the model, therefore it is necessary to test the significance of these

variables. The variables that need to be considered are the growth phases and the required rate of

return.

Transurban required rate of return is dependent on its market risk premium and the beta. In table

12 we compare the sensitivity of the required rate of return based on different market risk

premiums and beta values to measure the outcome of Transurban intrinsic share price.

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Table 13: DDM Beta and Risk Premium Sensitivity (Discount Sensitivity)

It can be seen from the above table that as the company’s beta and risk premium increase the

intrinsic share price of TCL decreases and vice-versa. It can be seen from the CAPM equation in

section 7.1 that as market risk premium or if beta increases the required rate of return required by

investors would increase; since the investors are taking on more risk. Based on the current

dividend growth rates, for investors to take on more risk reflected by the increase in the required

rate of return, investors would want to pay a lower price for the share. Hence increasing betas and

market risk premiums would cause the intrinsic share price to decrease and vice-versa.

Dividend growth rate sensitivity and its influence on the intrinsic value using the dividend

discount model should also be considered. Table 14 below shows the intrinsic price based on the

sensitivities of the different growth phases.

Table 14: Dividend Growth Rate Sensitivity

The table above shows that as growth rates increase the intrinsic share price will increase and

vice-versa, holding the required rate of return constant. This is also logical, if investors required

rate of return remains the same and as dividend growth rates increase investors will be paid a

greater return. If investors’ returns are increasing relative to their required rate of return they will

be willing to pay more for the stock.

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The sensitivity analysis completed for the DDM model shows that the variables forecasted and

calculated are sensitive to the calculation of the intrinsic value of its share value. This suggests

that the accuracy of the intrinsic value derived is highly dependent on the accuracy of the

forecasted growth rates and required rate of return calculated.

8.2 Free Cash Flow to Equity Model (FCFE Model)

The discounted free cash flow to equity model like the dividend discount model is used to

calculate the intrinsic value of a company’s share price. This model is useful for evaluation

purposes where a company does not pay a continuous dividend or any dividends at all. The

theory of the model is to determine all the present values of a company’s expected future free

cash flow to equity available to shareholders (Reilly & Brown 2009). There are also two discount

models that need to be considered for valuation of the company’s intrinsic value, the stable

growth FCFE model and the multi-stage FCFE growth model.

The first model to be considered is the FCFE stable growth model; in this model the growth rate

is constant as the company’s free cash flow to equity is increasing at a constant rate. The

requirement is that the required rate of return ( ) must be greater than the FCFE growth rate

( ). If it is not this violates the assumptions of this model.

The equation for the FCFE stable growth model can be seen below:

The second model that needs to be considered is the FCFE multi-growth rate model in this model

the FCFE growth rate can be greater than the required rate of return in the short-run. This model

takes into account different stages of dividend growth which depend primarily on the attributes of

the company, stages of business cycle and on the economy’s future economic outlook.

The equation for the FCFE multi-stage growth model can be seen below:

Where:

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Both of the models will be used in conjunction to one another for our valuation of Transurban’s

intrinsic share value. Both models will be used as we have forecasted for several different growth

phases before the company enters into its mature growth phase. The growth rates for the FCFE

must be forecasted in order to use these models.

8.2.1 Cash Flow Forecast

The free cash flow to equity for 2010 that was used is $0.0763 per share. The values used to

calculate the free cash flow to equity is obtain from the company’s financials from Fin Analysis.

The FCFE is calculated from the following equation below:

Assumptions for FCFE calculations:

Net Earnings are represented by net profit after tax (NPAT)

Debt ratio is calculated from Total Liabilities / Total Assets

The rest of the values are taken as is from Fin Analysis

The calculations for FCFE is then converted to a per share figure. In order to convert this to a per

share figure we divided the FCFE by number of shares outstanding. The number of shares

outstanding is calculated by the market capitalization of Transurban divided by the market price

at the end of the corresponding period. Table 15 shows the historical figures of FCFE of

Transurban between 2006-2010.

Table 15: Historical FCFE Growth Rates

*Source: company data (Fin Analysis) (2011)

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The historical FCFE shows that its growth rate of FCFE is extremely volatile the extremes are

from 109.07% growth from one year to -108.05% in another year. This indicates that the forecast

for future expectations on Transurban’s FCFE is subject to certain extremes. However the

negative growth rate experienced in 2008 could be explained by the global financial crisis (GFC)

which we would expect to have a negative impact on the company’s cash flow.

The future FCFE growth rates have been forecasted based on the analysis detailed in section 8.1.1

of this report. Our analysis expects that Transurban will experience three phases of growth in the

coming future. However it is expected that the growth rate phase for FCFE will greater than the

growth rate phase from the dividend discount model. Our analysis expects this to be the case

since we expect that for the future periods for all the current financing projects that Transurban

has undertaken will be in near completion and they will not undertake new projects in the coming

future. We expect there to be an increase in cash inflow as the cash outflow is expected to

decrease because of the completion on their current projects in the next coming years. Our

analysis of the FCFE growth rates has concluded that Transurban will experience several phases

of growth, the slow growth stage, high growth stage and stable growth stage. The FCFE growth

rate forecast can be seen in table 16 below.

Table 16: Forecasted FCFE Growth Rates

PHASE 1: Slow - Moderate

Growth Stage

PHASE 2: High Growth Stage PHASE 3: Stable Growth Stage

2011 - 2013 2014 - 2016 2017 - Onwards

- FCFE growth rate of 32% -FCFE growth rate of 41% -FCFE growth rate of 3%

-The accomplishment of M2 & M5

enhancement

-The commencing use of the

upgrade projects

-Stable economy

-Construction on the Capital

Beltway (I-495) High Occupancy

Toll (HOT) lane project with its

first tolls expected in early 2013

-Traffic volume is expected to be

17,300 average daily trips by 2016

-FCFE growth rate close to the

level of macro-eco long term

growth

It can be seen from table 16 that the first phase (slow growth stage) will be from periods 2011-

2013 growing at a rate of 32% and phase 2 (high growth stage) will be from periods 2014-2016

growing at a rate of 41%. Phase 3 (stable growth stage) it is expected that Transurban will grow

at a constant rate of 3% as company enter into the mature stage of growth, which is expected to

grow at the level of macro-economic growth.

8.2.2 Intrinsic Share Price

Based on the forecasted growth rate for FCFE in section 8.2.2 the intrinsic value of Transurban

share is $5.45 which would suggest that its share price is trading at a discount of 2.5688% when

compared to the market price of $5.31 as of the 15/4/2011. The calculations and inputs for the

discounted FCFE model are shown in table 17.

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Table 17: Transurban Group Intrinsic Share Price (FCFE Model Excel Calculation)


The outcome and accuracy of the intrinsic value of the discounted FCFE model like the DDM

valuation is dependent on variables that have been forecasted in the model. Since they will have

an effect of the model it is necessary to test the significance of these variables. The variables that

will be tested are the growth phases and the required rate of return.

The inputs that effect Transurban required rate of return is the market risk premium and the beta.

In table 18 comparisons on the sensitivity of the required rate of return based on different market

risk premiums and beta values to measure the outcome of Transurban intrinsic share price.

Table 18: Discounted FCFE Model Beta and Risk Premium Sensitivity (Discount Sensitivity)

Table 18 shows an inverse relationship between Transurban intrinsic value based on the FCFE

model with Transurban’s beta and the market risk premium. As the market risk premium or

Transurban beta increases the intrinsic value of Transurban share value decrease and vice-versa.

This is also consistent with the sensitivity of dividend discount model computed earlier in section

8.1.3 of this report.

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The growth rate sensitivity in certain growth phases and its influence on the intrinsic value using

is also considered. Table 19 represents the intrinsic price based on the sensitivities of the different

growth phases.

Table 19: FCFE Growth Rate Sensitivity

The growth rate phase of Transurban has a positive relationship with the intrinsic value of its

share derived from the discount FCFE model. If either growth from the first or second growth

phase increases the intrinsic value of a share will also increase and vice-versa. Holding the

required rate of return constant and increasing the growth rate input from what was previously

forecasted investors will be receiving a return greater, hence investors would be prepared to pay

more for the stock. The opposite effect will occur when the growth rate forecasted is lower.

The sensitivity analysis done for the discount FCFE model shows that the intrinsic value is

sensitive to the growth rate forecast and the calculated required rate of return. This suggests that

accuracy of the intrinsic values using this model is highly dependent on the forecasted growth

rates and calculations of the required rate of return. The sensitivity of the discounted free cash

flow model is just as sensitivity as the dividend discount model.

8.3 Pricing Earning Ratio

The P/E Ratio is the relative valuation ratios that compare the companies with similar attributes

on the basis of several relative ratios, say, comparing companies with similar risk and industry

life cycle. This model attempts to compare the current share price with the company’s earnings

per share. The P/E ratio model (Earning Multiplier Model) is used by investors to estimate the

value of common stock. For example, if investors are willing to pay 10 times expected or ―normal‖

earnings, they would value a stock they expect to earn $2 a share during the following year at $20.

The earning multiplier can be computed as follows:

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Price/Earnings Ratio= Earnings Multiplier:

However, the infinite period dividend discount model (DDM) can be used to indicate the

variables that should determine the value of the P/E ratio as follows:

Now if we divide both sides of the equation (earning per share), the result is:

Therefore earnings multiplier can be ultimately simplified as:

Thus, this model implies that P/E ratio is determined by:

The expected dividend payout ratio (dividends divided by earnings)

The estimated required rate of return on the stock ( )

The expected growth rate of dividends for the stock (g)

However, this formula cannot be used for the company (TCL), for EPS does not growth at a

constant rate. Thus, in this report, we will use the earnings multiplier model formula to calculate

the P/E ratio.

Given the above formulas and information, we can now calculate the P/E ratio for Transurban:

Table 20: P/E Ratio forecast 2011

2010 2011f

Current market price 5.31

Dividend/EPS Growth rate 0.08

Earnings per share 0.046 0.04968

Estimated P/E ratio 106.88

*Market Price as of the 15/4/2011

Here we expect the growth of the earning derived from per share to be in line with dividend

growth rate in this slow growth stage as the enhancement projects of M2 and M5 are nearly

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reaching completion. Our computed P/E ratio of 106.88 suggests that investors are willing to pay

$106.88 for every $1 of earnings that the company generates.

We will now then use this ratio and compare it to other benchmarks. In evaluating Transurban’s

P/E ratio to determine whether it is over / underpriced in the transportation sector, we can use

TCL's P/E ratio and EPS growth rate to compare it to its industry sector as well as the selected

company- Toll Holdings (TOL) in the same sector.

Table 21: TCL VS. The Transportation Industry Sector:

Industry F/cast year1-EPS Growth (%) Current Price/Earnings

Transportation 35.78 45.31

*Source: FinAnalysis Industry data (2011)

Transurban has a P/E (106.88) that higher than the market or industry average (45.31), this means

that the toll road industry is expecting big things in the coming future. For example, the company

will increase its influence on the industry, and probably has some comparative advantage to its

competitors operating in the same industry or market. A higher P/E ratio usually reflects a higher

expectation of future company growth (ThisMatter 2010), which means along with its larger

market value, Transurban’s investors expect the company to experience high growth in near

future.

Compared to the industry statistics, TCL has a considerable high P/E ratio and low earning

growth rate, this indicates the firm has to live up to the high rating by substantially increasing its

earnings, or the stock price will need to drop. Based on the P/E ratio and its growth rate the stock

is overpriced by the market when comparing it to the transportation industry.

TCL VS. TOL:

We also compare Transurban to other competitors in the same industry sector, we picked Toll

Holdings Limited (TOL).

According to the data from Fin Analysis, we are given 0.76 as the beta for TOL. Therefore the

required rate of return ( ) for TOL can be computed based on the previous outcome of CAPM as

shown below:

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Recall that ( ) for Transurban is 0.0959, which is slightly less than that of TOL.

From the formulas:

We see the inverse relationship between re and stock price, which indicates that as re increases,

the price of stock will decrease. In table 22 TCL’s and TOL’s required rate of return ( ), EPS

growth rate and P/E ratio are presented to compare and make a relative valuation assessment.

Table 22: TCL VS. TOL:

Company Required rate of return(Re) in (%) Earnings growth rate (%) P/E ratio

TOL 9.698 11.31 13.82

TCL 9.59 8 106.88

*Source: FinAnalysis Industry data (2011)

It’s commonly understood that higher earnings growth rates translate to higher P/Es, because

investors are expecting higher earnings growth in the future compared to companies with a lower

P/E. Holding other things being equal, higher growth firms (TOL) should have higher P/E ratios

than lower growth firms (TCL).Since TOL has more than 3% higher EPS growth rate than TCL,

but a lower P/E ratio than that of Transurban. This means investors of TCL are hoping to get

substantial high growth in their earning but in fact it is not. Therefore, the share of Transurban

could be overvalued by the market in some extent.

On the other hand, a higher required rate of return indicates higher risk for the company, that is,

the investment in TOL would be more risky than TCL. Holding other things being equal, higher

risk firm is supposed to have lower P/E ratios than lower risk firms. As the risk of two firms is

similar, they should have similar P/E ratio but in fact there is a big difference of their value of P/E.

Again, TCL’s share price must be overpriced.


The result obtained by the P/E model will be influenced by the changes in dividend growth rate

assumption as we have assumed the EPS growth rate is in line with dividend growth rate.

Therefore, when dividend growth rate increases, the value of EPS will rise. However, due to the

inverse relationship with earnings per share and P/E ratio, the higher growth rates will generate

lower value of P/E ratio.

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Table 23: P/E Growth Rate Sensitivity

This also indicates that our twelve month forecast will have a small influence on our calculated

P/E ratio and on our conclusion of our valuations. If our forecast were slightly off it would make

an insignificant influence on the outcome of our evaluation as the P/E ratio is still over 100 and

well above the industry’s and TOL’s P/E ratio.

8.4 Price/Book Value Ratio (P/B)

This model attempts to measure and allows the investors to compare the company’s market value

of equity to book value of equity. Thus, this model is effective for investors to identify those

stocks that are currently undervalued. A stock where the market value is lower compared to the

expected book value ratio is definitely worth buying. Before calculating the Price/book value

ratio, there are few steps needed to be completed such as the calculating expected book value of

the company and the expected book value per share.

Expected book value is computed as:

After computing the expected book value, expected book value per share can be calculated by

EBV/No. outstanding shares. The balance sheet for Transurban Group in 2010 demonstrated the

number of shares outstanding which manage to make the calculation proceed further.

Current share price as at (15th

April 2011): $ 5.31

Number of outstanding shares: 1414.29 million

Therefore,

The formula that is used to calculate the price/book value ratio is:

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Using the forecasted growth rate which was 8%, the ratio indicated that at the financial year end,

Transurban Group’s share will be trading at 1.66 times its expected book value of 3.19 per share.

The purpose of the ratio is to serve as a reference for the investors in seeking for share’s value

before it is discovered by other potential investors which cause the price to bid up subsequently.

A more effective way of analysing the P/B ratio is to compare the ratio with the past years

performance.

Table 24: Transurban Book Share Value 2006-2010

Year 2006 2007 2008 2009 2010

Book Equity (‘000 in $) 2462200 4016900 4074600 3841100 4176500

Shares Outstanding (‘000) 816630 1068380 1218260 1281360 1414290

Book Value ($ per share) 3.02 3.39 3.07 2.74 3.19

Current Market Price ($) 6.95 8.01 4.23 4.18 4.24

P/B Ratio 2.31 2.13 1.26 1.39 1.44

*Source: FinAnalysis(2011)

The table above (table 24), shows P/B ratio was decreasing from 2006 to 2008 and had increased

again from 2008 to 2010. A relatively high P/B ratio would be the preference of value investors

while a relatively low P/B ratio would be the preference of growth investors. According to the

table 24, the P/B ratio for the 5 consequent years did not go below 1 which indicated that the

company did not trade below its book value. Comparisons of the P/B ratio with the direct

competitor will portrait a better view in term of the equity value of the company.

Table 25: Comparison of P/B ratio of Transurban Group with Competitor

Year 2006 2007 2008 2009 2010

TCL 2.31 2.13 1.26 1.39 1.44

TOL 1.46 2.57 1.86 1.67 1.41

*Source: FinAnalysis(2011)

The table showed that Transurban Group P/B ratio was lower compared to Toll Holdings from

2007 to 2009. The latter showed that the Toll Holdings’ equity was more of value compared to

Transurban Group. Nevertheless, Toll Holdings had been experiencing decline in P/B ratio from

2008 until 2010 and Transurban Group was experiencing an increase in the ratio. In 2010,

Transurban Group’s P/B ratio was higher compared to its competitor indicated that the value of

the company had increase. Therefore for 2010, the equity for Transurban Group has more value

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compared to Toll Holdings. Hence, looking at the upward trend of Transurban Group in the P/B

ratio, investors are willing to pay more per dollar of book value of shareholders equity of

Transurban than Toll Holdings. Therefore evaluating the P/B ratio and also enforced by the

calculation of the forecasted growth rate, in future the share price is expected to increase and thus

it is attractive at the moment for the investors to buy. Furthermore, compared to year 2006 and

2007, the P/B ratio is relatively higher than 2010, and thus ratio of 1.44 seems to be a fair

valuation for the investors.


As to examine the relationship between the growth rate and the P/B ratio, different value of

growth rates had been computed.

Table 26: P/B ratio over Growth Rate Sensitivity

Growth Rate (%) 5 6 7 8 9 10 11

EBV ($ in millions) 4385.33 4427.09 4468.86 4510.62 4552.39 4594.15 4635.92

EBVPS ($) 3.10 3.13 3.16 3.19 3.22 3.25 3.28

P/B 1.71 1.7 1.68 1.66 1.65 1.63 1.62


According to the table, there was an inverse relationship between the growth rate and the P/B

ratio. As the value of the growth rate increased, the value of the P/B ratio decreased and vice

versa. The objective of the table is to measure the accuracy and the sensitivity of how the

different value of growth rate will affect the P/B ratio. The table also demonstrated direct

relationship with the expected book value per share. As the growth rate was larger, the EBVPS

was larger. If the growth rate was forecasted inaccurately, it would cause the inaccuracy in the

calculation of P/B ratio. Therefore, it is imperative to use an accurate growth rate or it would

cause discrepancies in the calculation of P/B ratio.

8.5 Net Tangible Asset Backing Model (NTA)

The net tangible assets per share ratio demonstrate how much per share investors would receive if

the company is to be liquidated immediately. Investor’s capital loss would be represented by the

difference between the purchase price of the share and ratio. Thus, this model is to provide the

insight to the investors the level of security that the company will be provided when the company

is liquidated.

Net tangible asset per share ratio is to be calculated as followed:

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Transurban Group 2010 balance sheet demonstrated the following values:

Net Assets: $4176.5 million

Intangible Assets: $7678.59 million

Number of Shares: 1414.29 million

Therefore, NTA= (4176.5-7678.59)/1414.29 = -2.48

The negative value indicated that when the company went into liquidation, the investors would

not be getting any value for the shares. Due to the limited liability investors will not have to pay

for the share but lose all the shares if the company went into liquidation.

To provide a thorough analysis on the NTA per share ratio, comparison of the company’s current

share price to its NTA per share by dividing the current share price by NTA can be made as

follows:

Current Share Price / NTAB= 5.31/2.48 = 2.14x

The value demonstrated that the investors are currently paying 2.14 times higher than the value of

one unit of its NTA. To make a precise interpretation regarding the NTA value, it is always better

to make comparison with its direct competitor.

Table 27: NTA Backing Model Comparison

Year 2006 2007 2008 2009 2010

TCL 2.03 0.38 0.8 -3.39 -2.48

TOL 3.56 -1.52 2.17 1.23 1.52


From the table, it indicated that Transurban Group had been weak in providing insurance to the

investors if the company went into liquidation. For year 2009 and 2008, Transurban Group’s

NTA ratio had been negative showing bad indication to the investors when the company goes

into liquidation.

Table 28: Current Share Price Per NTA

Year 2006 2007 2008 2009 2010

TCL 3.42 21.1 5.29 -1.23 -1.71

TOL 3.95 -9.53 2.77 5.08 3.61

*source: FinAnalysis (2011)

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The table above demonstrated comparison of the current share price over NTA with its direct

competitor. In year 2007 and 2008, the value placed on Transurban Group was far much greater

than Toll Holdings. However, in 2009 and 2010, the valued placed on Transurban Group was

very much lower compared to Toll Holdings. Two assumptions can be derived base on the low

price to NTA ratio are Transurban Group is highly undervalued as compared to its competitor and

Toll Holdings is overpriced compared to its peer. Base on this model, Transurban Group share

will appear to be more attractive to the investors.

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9. VALUATION DISCUSSION

9.1 Dividend Discount Model (DDM)

In order to use this model we had to forecast the expected growth rates for the future dividends.

We made our forecast based on historical dividends, our future expectation on the economic

climate and expected future attributes of the company. It was extremely difficult to forecast the

future growth rates as Transurban was an unusual company which paid out higher dividends per

share relative to its earnings per share. However we did manage to forecast Transurban’s future

growth rates and growth phases.

Sensitivity analysis was also conducted after the intrinsic value was computed. The purpose of

the sensitivity analysis was to test the significances of our forecasted and calculated inputs. The

sensitivity analysis concluded that the accuracy of the forecasts and calculations would play a

significant part in deriving our intrinsic values, hence the importance of conducting research of

great integrity (GIGO - Garbage in garbage out).

Our analysis formulated by the dividend discount model derived an intrinsic value of $5.48 and

suggest that Transurban shares are trading at a discount of 3.1%, based on the market price of

$5.31 as of the 15/4/2011. Since the share price is trading at a discount the analysis using this

model concludes that the market share price for Transurban is undervalued and we would expect

the market to correct this in the future.

The dividend discount model we believe is a suitable model for the purpose of analysing

Transurban’s share price as the company has been paying consistent dividends and we believe

they will continue to do so in future periods.

9.2 Free Cash flow to Equtiy Model (FCFE Model)

The discounted FCFE model is computed a similar the dividend discount model however for the

FCFE model we use free cash flow to equity per share available to shareholders instead of

dividends paid to shareholders. Both models are discount cash flow models.

In this model we are also required to forecast the future FCFE. In forecasting future growth rates

for FCFE we have based our forecasted of the dividend growth rates and historical FCFE growth

rates. Our forecasted growth phases are the same as the forecasted growth phases for dividends,

however we expect the growth rates on FCFE to growth at a higher rate than the dividend growth

rates. We justify this analysis in section 8.2.1 of this report.

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The sensitivity of the forecast and calculations were also analysed and produced similar results to

the sensitivity analysis done on the dividend discount model. The sensitivity analysis concludes

that the inputs used for deriving the company’s intrinsic value is sensitive and requires

forecasting to the highest degree of integrity.

The intrinsic value of Transurban share was $5.45 this suggests that its share price is trading at a

discount of 2.5688% when compared to the market price of $5.31 as of the 15/4/2011. This

indicates that the market is undervaluing Transurban’s share and we expect that the market will

correct this at some point.

Discounted FCFE model is a great valuation model when evaluating intrinsic values of

companies that do not pay or consistently pay a dividend. We believe that this model is an

appropriate model as it does provide an intrinsic value in the range of the intrinsic value

calculated in the dividend discount model; the intrinsic value of the FCFE model being $5.45 and

$5.48 in the dividend discount model. However we prefer to conduct our valuation on the

dividend discount model as this company does historically consistently pay dividends where as in

FCFE of Transurban can be quite volatile. Due to the unpredictability of FCFE forecasts we have

made conservative growth estimates, this could under state the intrinsic value we calculated using

this model. The company’s intrinsic value could be trading at an even greater discount.

9.3 Price / Earnings Ratio Model (P/E)

The price earnings model (P/E) is a very important and common method to analyse company

stock and this model provides how much investors are willing to pay for a dollar of the

companies expected earnings. However, P/E ratio is the relative valuation ratios that is more

useful when compared to a company with similar risk and industry life cycle and comparing it to

the industry. We compare TCL with the transportation industry sector and Toll Holdings Limited

(TOL). We use the current price of $5.31 (as of the 15th

of April 2011) dividend by the expected

12-month earning to calculate the P/E.

When analysing the P/E ratio’s typically, the higher the P/E the more the market is willing to pay

for the company’s earnings and hence investors have higher expectations on the company’s

prospects. Conversely, low price earnings model indicates that low confidence in the company by

the market. However, it could also mean that the stock just has been overlooked by the market

and represents a potential for gain.

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Using the Earnings Multiplier Model formula, P/E ratio for Transurban is 106.88; this indicates

that investors are willing to pay $106.88 for every $1 of earnings that the company expected

earnings.

To help determine whether the share price of TCL is over / under priced, we can use the P/E ratio

to compare the prices of companies in the same sector against each other. For example, we have

compared TCL and TOL. Holding all else being equal, an intelligent investor would prefer to

purchase shares of TOL; although the share price is higher, what he would gain is more than 8

times of the earning power. In addition, we also compare Transurban with the toll road industries.

Transurban has a P/E (106.88) that higher than the market or industry average (45.31), thus high

P/E ratio and low earning growth rate means the stock price will be expected to decline some

point in the future.

In order to look at the change the EPS growth rate influence the P/E ratio, we completed the

sensitive analysis which was to test the significances of our forecasted and calculated inputs. The

sensitivity analysis put it that there is inversely relationship between the P/E ratio and the EPS

growth rate and also indicated that there would not be a significant influence on our results.

The biggest advantage of the P/E ratio is that it is easy to use and fathom. It can be used to make

quick decision although it is only a basic tool and method of evaluating the worth of the shares of

a company. Because of the volatile nature of stock prices, P/E ratio is largely due to the

subjective in nature, thus it is the disadvantage of the P/E ratio. Another disadvantage is there

being no ―right‖ P/E ratio because it depends on the investors’ willingness to pay for earnings.

The more you are willing to pay (you believe the company has good long term prospects over and

above its current position) the higher the ―right‖ P/E ratio is for that particular stock. In this case

we do not think that the P/E ratio is a suitable tool used to evaluate the value of Transurban share

as we only use one year forecast of its potential earnings. Also we do not think it is suitable as it

was difficult to find a competitor that was similar to the business and company structure to that of

TCL.

9.4 Price/ Book Value Ratio (P/B)

This model is useful in identifying which company is overvalued and which company is

undervalued based on the P/B ratio to ROE. If a company has a high P/B ratio and low ROE, then

it is likely that the company to be overvalued. However, if the company has both high P/B and

ROE, this indicates that the company has strong return to shareholders but still undervalued based

on P/B ratio.

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According to the data for Transurban Group, there was a decrease in the ratio from 2006 to 2008

and had slight increase from 2008 to 2010. From the analysis of P/B ratio, it showed that the

shares had been trading constantly above the book value per share. This shows that the company

are being valued by the market.

However, it is very tough to use P/B ratio to analyse the value of the company as there are many

other factors that may need to be taken into consideration. Although the P/B ratio gives the

investors the insight of which stocks are being undervalued, nevertheless it demonstrates very

restricted information for some industries with hidden assets which have great value are not

reflected in the book value (Investopedia 2011). Another factor that might cause discrepancies for

the P/B ratio calculations is the payout ratio for Transurban Group. The payout ratio for

Transurban Group in 2010 was absolutely high which was 525.2% and there was no previous

record of the previous payout ratio. As the payout ratio plays a fundamental part of the

calculation to compute the expected growth rate. Therefore the data retrieved might not be

sufficient to come to a conclusion of how the company is valued under this model. This model is

only appropriate for the investors who are looking at capital intensive or finance related business.

9.5 Net Tangible Asset Backing Model (NTA)

The net tangible asset backing indicates to us if investors would be able to get their money back

in the event of liquidation. Generally, a company is undervalued if its share price per unit of NTA

is more than the current share price. This means that investors will get more value for what they

are paying for which makes it attractive.

It is important to distinct total value of the business from net tangible asset as NTA does not

include intangible assets such as patents and rights. In theory, simple valuation of organisations

can be done independently of its tangible assets but in reality NTA is extremely vital as intangible

assets cannot be liquidated into money in the event of liquidation. Thus, any intangible assets

such as goodwill should always be compared to its net tangible assets of the business for

reasonableness.

In the case of TCL, this model is appropriate as TCL has a significant amount of assets which

makes NTA a very relevant measure. However, this measure can vary a lot between one firm’s

structure of assets and liabilities to another organisation’s structure so one must be cautious when

comparing to other assets. It is best to compare directly with an organisation with a similar

structure and industry to allow for meaningful comparisons.

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One weakness of the model is that it is based on historical data hence it does not take into account

of future cash flows and growth. This could significantly undervalue organisations that have just

started up or are heavily investing in revenue generating assets. Therefore, it should be noted that

while this measure is useful in business and valuation analysis, it should be used in conjunction

with other measures and analysis to give an accurate evaluation.

9.6 Preferred Valuation Method

Our preferred valuation method was the dividend discount model. This was our preferred model

over the other models because Transurban historically consistently paid dividends and it is

expected they would continue to do so in the future. It was preferred over the discounted FCFE

model because the FCFE future growth rates would be more difficult to predict since historically

the growth rates of FCFE have been extremely volatile making it difficult to forecast. The DDM

was also preferred to over the ratio relative valuation techniques since it was difficult to find

companies that were similar to Transurban and its structure. Another issue with the valuation

techniques was it does not give incites to the stocks intrinsic value and only gives incites to its

value compared to other companies ie; it might be good value compared to other companies

however there nothing to say that the company that the ratio is compared to is at fair market value.

83 | P a g e

10. CONCLUSION & RECOMMENDATIONS

After completing our evaluations conducted in our valuations analysis in section 8 of this report,

we received mixed results. The DDM and the FCFE models suggest that the share value of

Transurban is underpriced and is currently trading at a discount. The relative valuation techniques

used also suggests that the stock is worth buying with exception to the P/E ratio which suggest

we should avoid the stock or even sell the stock. Out of the five valuation methods used four of

our valuations would conclude that Transurban stock is worth buying or holding onto while only

one of the method used would lead to the conclusion that investors should sell or avoid TCL

stock.

We also believe that the dividend discount model was the best and most appropriate analysis

valuation of TCL stock, which was also one of the four models that stated TCL share price was

undervalued. Based on this information we would place a buy recommendation on TCL shares as

it is trading at a discount of 3.1%, based on the market price of $5.31 as of the 15/4/2011 from

the intrinsic value of $5.48 calculated from the dividend discount model.

At the completion of writing this report TCL share obtained from the ASX (2011) website was

trading at $5.44 as of the 13th

of May 2011. It can be observed that TCL share price had resin

from when we previous completed our valuation. Based on our required rate of return calculated

on the 15th

of April 2011 TCL share price would still be trading at a small discount.

Concluding this report we would place a buy-hold recommendation on TCL stocks, since TCL

shares are trading at a slight discount.

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11. APPENDIX

11.1 Appendix 1: Excel Raw Beta and Adjusted Beta Calculations

*** Further Excel spreadsheets can be provided on request. Not all calculations have been

included in the appendices as the calculation, formula and inputs have been explained throughout

this report.

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