In uncertain times, toll roads can provide investors with high levels of certainty.
A toll road by definition from the Cambridge dictionary is ‘a road that you have to pay to use. Your journey will be quicker but more expensive if you take the toll road’.
Generally there are three types of toll roads – ‘greenfields’, which are under construction, newly opened toll roads in ‘ramp up’, and mature roads. Hugh Dive who is the Chief Investment Officer at Atlas Funds Management is of the view that mature roads are preferable as investors can more accurately assess the traffic numbers and the earnings.
Dan Moore, Portfolio Manager from Investors Mutual says that history shows traffic forecasters tend to be overly optimistic and forecasting errors in the past saw the original owners of greenfield toll roads, Cross City Tunnel and Lane Cove Tunnel go into receivership.
It is important to understand that toll road investors don’t own the physical land or the road they build, they merely own the right to collect tolls for a specific period which is known as the concession period. After this period, the road reverts to the government and the debt repaid. Dive says that the finite life of a toll road concession is sometimes used as a reason not to invest in the sector but believes that this approach is too simplistic and doesn’t account for the actions that toll road operators can take to extend the life of the concession. In 2015, Transurban added extra lanes on the M2 motorway in Sydney and in exchange, saw an 11.5 year increase in the concession period for the Lane Cove Tunnel and an increase in truck tolls of 33%.
A toll road contract usually allows for tolls to increase, commonly in line with inflation, which makes their operational earnings resilient during periods of higher inflation.
Toll roads are attractive according to Moore due to their high level of recurring revenue, with built in price escalators, particularly if they are located in an area with a growing population.
Dive says that toll roads are long dated monopoly assets as no rival is going to build a competitor road next door to an existing road. Once construction is complete, ongoing costs for a toll road are low which results in high margins, which can be up around 80%.
Dive also likes the Government support for the sector and uses the example in NSW where Revenue NSW collects unpaid tolls on behalf of Transurban, suspending a drivers licence if they don’t pay. Trucks are required to use the recently completed North Connex and will receive a $194 fine if they attempt to use the ‘free’ roads above the tunnel.
While high fuel prices present some risk to toll road investors Moore believes that this is not a major concern for investors as most traffic is non-discretionary. He says that recessions accompanied by high unemployment is a bigger concern. The chart below supports Moore’s view as it shows continued traffic growth on the Sydney Harbor bridge during the oil crisis during 1973 – 1974.
Political risk, commonly referred to as sovereign risk is another factor when investing in infrastructure. Dive highlights the two key risks are:
Expropriation, which is the concession taken away from the toll road operator and
Regulation, where the government defaults on the toll road’s contractual obligations, ie not allowing tolls to increase in line with the formula stated in the contract
Political risk are quite low in the western world according to Dive and highlights these risks have largely been confined to developing countries such as South Africa and Malaysia.
Other considerations for investors is the capital structure of the company according to Moore. Excessive debt levels, makes any company more susceptible to short term risks and can lead to untimely dilutive equity raisings which impact investor returns.
Investors can gain access to this asset class through the two ASX listed toll roads in Transurban (largely Australian roads) and Atlas Arteria (European roads). Exposure to toll roads can also be achieved by investing in infrastructure funds offered by several funds management groups.
In a low interest rate environment, toll roads can help drive investors dollars further.
This article was published in the Australian Financial Review (AFR) on Wednesday 20th April 2022. Mark Draper (GEM Capital) writes monthly for the AFR about investment topics that impact investors.