On April 30th, 2015, Transurban issued a press release regarding the Victorian Government announcement that it will progress Transurban’s proposal to deliver a new Melbourne motorway (called the Western Distributor), which will provide an alternaive to the West Gate Bridge and will keep trucks off the city’s inner west. On the same day, Standard & Poor’s (S&P) announced that it downgraded the credit ratings (both Unsecured and Secured ratings) of Transurban Finance Co. Pty. Ltd, the finance company for Transurban Group, from A- to BBB+. The company outlook was changed from Negative to Stable at the same time. In its rational, S&P explained that this downgrade was not due specifically to the Western Distributor project but to what it felt was a broader shift in Transurban’s financial policy:
- a FFO (Funds from operations) to Debt ratio target between 8 – 12% is no longer commensurate with a A- rating; and
- Transurban needs to finance growing dividend distributions; and
- the CityLink widening will be fully debt funded.
Of note is that S&P’s methodology doesn’t look at proportional contribution of each asset, which is the way Transurban reports to investors, but takes into account the entire scope of consolidation, as reflected in Transurban’s statutory reports. This means in effect that the rating agency doesn’t take into account the non-recourse nature (i.e. limited liability) of Transurban’s debt, as the company has shown support in the past to these assets, notably those in the US, if it was deemed of some importance to the group. Separately, the other major rating agency (Moody’s) issued a statement that depending on the details of the funding mix, the Western Distributor project could have a negative credit impact on Transurban. Given the large scale nature or the project, reported development costs of $5.0-5.5 billion and that it needs to run the North Connex $3 billion greenfield project concurrently they believe these projects would add significant operational and debt burden to Transurban. What is the impact on Transurban bonds and our recommendation? Moody’s current rating for Transurban is basically where S&P downgraded the company on April 30th. So to some extent, the recent rating action is just one rating agency catching up with the other. However if the construction plan and funding mix for the proposed project, which should be detailed over the next six months, was mainly relying on Transurban’s debt, we could see another rating downgrade by Moody’s. Currently our recommendation on the FRN due 2017 is a SELL, which is reinforced by these week’s announcements, even though the notes are of short maturity, we don’t feel investors are rewarded compared to the sizeable risks looming.