Investment market update

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Despite continued bouts of uncertainty, the Australian market continued to push higher over the course of April, hitting a new six-year high in the process.

In the past month, the toll road operator Transurban won a highly contested tender by paying over $7 billion to acquire Brisbane’s main tollroads. UniSuper is Transurban’s largest shareholder and the company is owned by many of UniSuper’s investment options. In this update we share our thoughts on the company in the context of this acquisition.    

Performance of key markets

  % Change
Month FYTD 1 Year 3 Years p.a. 5 Years p.a.
Australian Shares (ASX 300)
1.7
18.2
10.1
8.8
12.3
US Shares (S&P 500) in US Dollars
0.7
19.3
20.4
13.8
19.1
US Shares (S&P 500) in Australian Dollars
0.8
17.8
35.0
20.3
13.7
Asian Shares (MSCI Asia)
-0.1
6.6
0.8
-1.0
9.1
Australian Dollar (AUD/USD)
0.0
1.2
-10.8
-5.4
4.8
Australian Fixed Interest (UBSA Composite)
0.9
3.8
2.7
6.9
6.1
Cash (UBSA Bank Bill)
0.2
2.2
2.7
3.7
3.9
Balanced option*
1.1
12.3
11.9
9.6
9.9

Returns are for periods to 30 April 2014. Past performance is not an indication of future performance.
* Returns relate to our Accumulation (not Pension) investment options and are published after fund taxes and investment expenses, other than account-based fees. 

Australian shares hit a six-year high

There was no shortage of nervous moments for financial markets during April. A sharp but short-lived sell-off on the back of weakness in US technology and biotech stocks, continued data confirming China’s growth slowdown, and rising tensions between Russia and Ukraine all weighed on sentiment. Though share markets were weaker in a number of Australia’s closest neighbours (notably China and Japan) most developed markets were able to shrug off these concerns and actually rose over the month. 

The Australian market was no exception. Despite a 10% fall in the price of iron-ore (Australia’s largest export commodity) and further strength in the AUD$ (which weighs on Australian company earnings) the Australian market was one of the better performers. Indeed, a 1.7% rise in Australian shares was enough to push the market to a new six-year high.

Company focus — Transurban and Queensland Motorways Limited 

In previous Market Updates (May 2012 and August 2013) we’ve discussed Transurban, a toll road company of which UniSuper is the largest shareholder, with over 10% of the company. Transurban recently won a highly contested tender to acquire Queensland Motorways Limited (QML), the owner of Brisbane’s main tollroads. The winning bid topped $7 billion which is at the top end of market expectations, raising some concerns that they had overpaid. 

Given the prominence in which Transurban features in a number of UniSuper investment options, we felt it timely to update members on the company, and our views on the QML acquisition.   

Our investment in Transurban

Transurban Group is an ASX top 50 company with a market capitalisation of around $13.3 billion following the QML acquisition. UniSuper started to acquire large parcels of the company in early 2012 when the share price was around $5.50. 

Previous updates outlined the rationale for our interest in the company. But in summary: 

  • high quality “fortress” assets, with monopolistic-like positioning, 
  • pricing power, delivering inflation protection, 
  • a strong balance sheet, and
  • steadily growing dividends, as shown in the table below.
6 MONTHS ENDING
CASHFLOW 
($M)
DIVIDENDS
(cents per share)
December 2011
390.0
14.5
June 2012
394.0
15.0
December 2012
416.9
15.5
June 2013
411.1
15.5
December 2013
463.2
17.0

Source: Transurban full year and half year presentations

Our initial foray into Transurban was followed up by further investments as the company continued to hit milestones, such as the successful completion of some key projects. 

Quality assets combined with good management typically leads to good bottom line results and that has been the case as the table showed. 

UniSuper now has approximately $1.3 billion invested in Transurban, and with the current share price of $7.10 our investment has returned about 18% p.a. since early 2012.      

Queensland Motorways—a logical strategic move, though at a full price

Big city toll roads are prized assets and anyone who travels on them would likely observe that traffic and tolls only seem to rise. Queensland Motorways is particularly attractive given our northern state’s faster growing economy, it’s an entire network (giving the owners more flexibility for new developments), and the contracts to operate the roads (known as ‘concessions’) are long-term, expiring on average in 2058.  

Given the above characteristics, it came as no surprise that the who’s who of the global infrastructure landscape bid for the company. Four consortia placed final bids which included interest from the Middle East, Asia, North America, Europe as well as Australia. Transurban was successful in acquiring the network. Of course, contested bids typically result in a high price and this was no exception. The market was predicting a range of $6.5 billion to $7.0 billion, so the price paid was at the top end.  

One doesn’t need to be a strategy expert to see the rationale underpinning Transurban’s acquisition. Transurban now has an interest in 12 out of 16 tollroads in Australia. On top of the growing revenues generated by the existing assets, Transurban is also in a unique position to take on future road projects, such as the M5 Widening and NorthConnex (NSW), and the CityLink Upgrade (Victoria). 

The commerce simply works out much more favourably for Transurban than a new entrant. Engagement with the NSW and Victorian governments on these future road projects was originated by Transurban, as it wouldn’t be feasible for another operator to do so. 

Another example: post the QML acquisition, AirportLink will be the only tollroad in Brisbane not owned by Transurban. AirportLink is currently in receivership and looks likely to be sold later this year. Transurban is clearly in a strong position to acquire this road, as it makes less sense for another operator to own one component of the Brisbane network.  

Overall, the QML bid diversifies Transurban’s existing assets and seals its position as the largest and most experienced road operator on Australia’s East Coast, covering Brisbane, Sydney and Melbourne’s toll road networks as shown on the following image.

Average daily traffic on Transurban’s roads

CIOupdateMay2014

Notwithstanding the strategic soundness of the QML acquisition, good strategy often gets brought undone by paying too high a price. We see this time and again with mergers and acquisitions. However, based on our own assessment of the transaction we are comfortable that Transurban has paid a full but fair price for QML.  

Transurban had a clear bidding advantage due to its cost synergies with its existing operating platform. Therefore, all things being equal, Transurban always had the capacity to pay more than the other bidders. Transurban’s operating margins are around 85% compared to Queensland Motorways 70%. Combining the two companies will obviously save in head office and accounting costs, road maintenance systems etc.  Maintaining one, rather than two, IT systems are a particular source of efficiencies—the tolling systems of ’e-tags’ and registration photos are quite sophisticated. Other salient points include:

  • It is commonly understood that the under bidder was within 1% of the winning bid.
  • Transurban’s share price is trading within 2% of the pre-bid share price, signalling broad market comfort.
  • Transurban confirmed that there will be no change to dividend guidance for the next two years, and that dividends will continue to be funded out of cash earnings.

A note on governance and alignment of interests

As is the case with all of our major investments, a pre-condition is our comfort with the Board and management. Transurban was certainly no exception given that its governance scorecard has had a chequered history. In October 2009, the company experienced a shareholder revolt when 67% of proxy votes opposed the remuneration report. While the vote was ostensibly against very excessive remuneration arrangements, it was also an effective vote against a Board and management team that had lost its way. 

Chris Lynch was appointed CEO in 2008 and he faced the ire of the shareholders in the early days of his tenure, but committed to get the company back on the right path. He metaphorically referred to Transurban as a “meat and potatoes” company, which implied a ‘back to basics’ management style of refocusing management on producing steadily growing cash flows and dividend streams from its prized assets.    

Lindsay Maxsted joined the Board in 2008, taking over as Chairman in 2010. Lindsay is also the Chairman of Westpac and a director of BHP. Lindsay is generous with his time when it comes to shareholder engagement, and he understands UniSuper’s strong desire that Transurban remains committed to a strategy of generating a steadily growing steam of cash flows and dividends. We have a great deal of confidence in his stewardship.  

Scott Charlton succeeded Chris Lynch in July 2012, and it would be fair to say that we were a bit surprised by the choice at the time. Apart from his investment banking background, Scott just doesn’t look like a “meat and potatoes” type of guy. We were quick to organise meetings with both Scott and Lindsay at the time of his appointment, and in a reasonably short period became increasingly confident that Scott was very well credentialed for the job. Apart from his investment banking / deal making expertise he has a deep experience in infrastructure development as a senior executive in Leighton Holdings and Lend Lease. Since Scott has been in the job we have added considerably to our investment.  

On top of receiving assurances that there would be no change to the overarching strategy, we’ve also taken comfort that Scott’s remuneration structure provides alignment with his financial interests and ours. Half of Scott’s long term (at-risk) incentive arrangements are based on the relative financial performance of Transurban (share price appreciation plus dividends) versus a comparator group of companies. 

The other half is based on growth in free cash flow per share. The latter metric is extremely important to us because it helps to protect against irrational acquisitions and projects that increase the size of the business, but adversely impact cash flows and dividends. Ideally, we would actually prefer this component to be a larger percentage of the total remuneration package which is something we might discuss with Lindsay the next time we meet. 



Past performance is not an indicator of future performance. This information is of a general nature only and may include general advice. It has been prepared without taking into account your individual objectives, financial situation or needs. UniSuper’s investment strategies will not necessarily be appropriate for other investors. Before making any decision in relation to your UniSuper membership, you should consider your personal circumstances, the relevant product disclosure statement for your membership category and whether to consult a licensed financial adviser. This information is current as at 8 May 2014.

This is not intended to be an endorsement of any of the listed securities named above for inclusion in personal portfolios. The above material reflects UniSuper’s view at a particular point in time having regard to factors specific to UniSuper and its overall investment objectives and strategies.