Transurban’s (ASX: TCL) fiscal 2025 adjusted EBITDA increased 7% to $2.85 billion on solid traffic volume growth and toll uplifts. Distributions rose 5% to $0.65 per security, in line with free cash flows, and guidance is for distributions of $0.69 in fiscal 2026.

Why it matters: A solid result with adjusted EBITDA in line with our expectations. We leave our forecasts mostly unchanged.

  • Free cash flow rose 7% to $2.0 billion, or $0.65 per security, benefiting from 2.2% growth in average daily trips, solid toll uplifts, flat operating costs, and a steady cost of debt. Guidance for distributions to increase 6% in 2026 implies robust free cash flow growth will continue.

The bottom line: We lift our fair value estimate for wide-moat-rated Transurban by 2% to $13.30 per security, mainly on the time value of money. The stock now trades 9% above fair value, though still in the 3-star zone.

  • The forward yield of 4.9% mostly unfranked, appears attractive considering distributions are likely to grow about 5% per year in the medium term.
  • But returns are not as attractive as they appear at first blush. Toll roads have finite lives and are handed to the government debt-free and for no consideration when concessions end. Transurban’s weighted-average concession life is about 25 years.

Between the lines: The West Gate Tunnel development is on track to be completed by the end of 2025. Management notes the builder has experienced some recent difficulties, which we interpret to mean the building cost is likely to rise again. But we don’t expect it to be material to Transurban’s valuation.

  • Transurban’s development pipeline is shrinking as projects are completed. Management is looking for more opportunities. We think the most prospective are in the Greater Washington Area, where it has existing operations and generates strong returns.

Business strategy and outlook

Transurban is a major toll road investor with concessions to operate motorways in Australia and North American. Concessions grant the right to operate the roads and collect tolls for predetermined amounts of time. The core Australian roads are integral parts of the motorway networks in Australia’s three largest cities: Melbourne, Sydney, and Brisbane. The roads benefit from strong competitive advantages, and the assets generate attractive returns on initial investment, warranting a wide economic moat rating.

Granting toll road concessions allows governments to use private capital and expertise to provide necessary improvements to road networks. Typically, concession life and toll profiles are set in negotiation prior to the road’s construction, with the intention of providing a fair return for investors. Tolls increase in line with the consumer price index or at an agreed fixed rate, though some roads with meaningful competition have dynamic tolling, such as Transurban’s US investments. When concessions end, the company returns the roads to the government for no consideration, after repaying all related debt.

Operating cash flow should increase strongly during concession lives, as solid revenue growth, driven by rising tolls and traffic volumes, is leveraged over a mostly fixed cost base. Cash flow available for distribution to investors increases in line with a road’s operating cash flow until about 10 years before the concession life ends; thereafter, a portion of operating cash flow is used to repay debt. Cash flow stops when concessions end. Concessions on the Australian roads are set to end between 2026 and 2065. Including the long-life US assets, the weighted average is about 25 years. To extend its existence, Transurban will look to build new roads or undertake road upgrades that may require new equity issues or increased financial leverage, given that the firm currently pays out all free cash flow as distributions to investors.

Typically, cash flow is defensive and grows strongly, but returns are lower than they appear at first blush, given that the road concessions have finite lives.

Bulls say

  • Core Australian roads generate defensive revenue that grows with traffic volumes and toll price increases, which are at a minimum pegged to inflation. Solid revenue growth and a high fixed-cost base translate to strong cash flow and distribution growth.
  • Transurban owns high-quality infrastructure assets with limited regulatory risk.
  • There are attractive organic growth opportunities, such as potential widening of roads.

Bears say

  • Building and acquiring new roads can destroy equity value as a result of overbidding and overly optimistic traffic forecasts.
  • Transurban has high financial leverage. This could be an issue if there is another pandemic or other disruption to traffic volumes.
  • Bond yields are likely to trend higher, detracting from profitability and the attractiveness of its distribution yield.