Atlas Arteria (ALX) owns and operates five toll roads across France, Germany and the USA. Traffic volumes continue to recover from Covid-19-related lockdowns, and we expect continued growth across the assets. The large acquisition of Chicago Skyway has shifted the investment profile of ALX to a higher growth, higher risk company, compared to the previous focus on portfolio optimisation. We see a continued likelihood of further deals, which may impact the ability of IFM or others to pursue a takeover.
Inflation-linked toll increases provide pricing power and help offset rising costs and maintain margins for the group. Each road has its unique calculation methodology, however, largely are CPI related. The Chicago Skyway also has a minimum floor of 2% embedded if inflation and GDP fall below.
French concessions may be up for re-tender. ALX’s largest asset both by distance and revenue is the co-ownership of the APRR group, which owns and operates 2,386km worth of motorway and 23m customers each year. French government concession discussions are seeing a shift in conversation towards a semi-regulated model instead of the current contracted model. The re-tendering of the concession which expires in 2035 is a key risk for the Group moving forward. This however has been slightly de-risked by the acquisition of Chicago Skyway with a concession life out to 2104, with a larger capital base placing the Group in a stronger position to participate in any re-tender process for concessions in France.
Distribution growth. We are expecting a distribution per share CAGR of ~3% from FY23-26e, however, note potentially higher capital requirements could dampen the upside. On the flip side, a continued weakening of AUD vs the EUR and USD would see scope for increased distributions in AUD terms.
Investment View
ALX has recently underperformed due to potential changes to the APRR concession structure. We believe fears are overblown and that the share price weakness provides an opportunity to add a quality defensive asset to portfolios. IFM remains the largest shareholder, continuing to increase its stake incrementally and still looms as a potential buyer of the Group.
ALX’s cash flows and distributions are defensive and the current yield of >6% is sustainable over the next few years. We initiate on ALX with a Buy rating with potential upside catalysts and valuation appeal compared to bond yields.
Company Background
Atlas Arteria is an Australian infrastructure company that owns and operates toll roads across Europe and North America. It was formerly known as Macquarie Atlas Roads (MQA) until it changed its name to Atlas Arteria in April 2018. The company's history dates back to its establishment as Macquarie Infrastructure Group (MIG) in 1996.
Macquarie Infrastructure Group (MIG) was formed by Macquarie Bank, before making its initial public offering (IPO) on the Australian Securities Exchange (ASX) in 1996, raising funds to invest in a diversified portfolio of toll roads around the world. Over the years, MIG expanded its toll road investments in various countries, including Australia, France, Germany, and the United States.
In 2010, MIG was restructured and renamed Macquarie Atlas Roads (MQA) as part of an internal reorganization by Macquarie Bank. This restructure aimed to separate Macquarie's toll road assets from its other infrastructure investments. Under the new name, MQA continued to own and operate a portfolio of toll roads. Some of its major assets included the APRR (Autoroutes Paris-Rhin-Rhône) network in France, the Warnow Tunnel in Germany, the Dulles Greenway in the United States, and more recently the acquisition of the Chicago Skyway.
Current Toll Road Ownership
ALX currently has ownership in 5 separate toll roads, predominantly in France with APRR generating ~82% of proportional toll revenue for the Group.
Figure 1: APRR is the most significant asset
Figure 2: FY23e revenue by toll road
Figure 3: Main assets located in France and North America
Traffic Recovery from COVID-19
2022 traffic levels across the Group have largely improved on 2019 volumes. The main exception is the Dulles Greenway which is predominantly an airport-related route, with traffic yet to fully recover as international air travel remains under pressure. We expect gradual improvement on that route and continued growth across the other roads given a return to overall mobility.
Figure 4: Traffic recovery solid, some travel-related routes still under pressure
A French Story
APRR network is on average ~30% faster than non-tolled roads and surveys show that travelling by car on tolled roads is the preferred option for trips between regional destinations. We expect continued growth for the APRR network from both light and heavy vehicles given its advantages over un-tolled roads. Traffic kilometres travelled growth has also exceeded GDP growth given network optimisation over the years. With increased traffic volumes, APRR has been able to increase its operating leverage and improve margins from 68% in FY08 to 74% in FY22, and we anticipated gradual improvement to ~75%. Margins are lower than key peer Transurban given the much longer roads that APRR operates at a lower toll revenue per kilometre.
Figure 5: Increased kilometres travelled
Figure 6: Traffic growth above GDP
Figure 7: APRR’s strong margin improvement over the years expected to continue
Is the APRR Concession Life Under Threat?
The French government released a 2021 report by Inspection Generale des finances (IGF) into autoroutes and the concessions of toll roads. Bruno Le Maire, the Minister of the Economy has referred this to the Council of State to find a solution to shorten “by a few years” the duration of concessions, however, we see the cost of cancelling a concession as prohibitive given the required compensation cost at market rates.
Markets are assuming that the concession will not be re-tendered and that the roads will be handed back to the government at the end of the concession life. Given that APRR is likely to generate ~75-80% of earnings in 2035, this will mean the distribution and capital value for the ALX would also shrink by the same amount. Our view is that the concession will be re-tendered back to the APRR group, however, note that adverse changes present a material risk to our thesis and valuation.
In the most recent speech at the AGM, management commented that the French Government’s key priority is closing out the pension reform. Both the Finance and Transport Ministers have affirmed during a parliamentary debate their view that the private concession model is the most effective way to operate the French toll road network. The Transport Minister is organising in the coming months a conference to discuss the future of the toll road concession systems once the current contracts expire. Recent debates have shown that the current direction for future concessions seems to be that the future will differ from what it has been since the 60s and very likely will have a different risk profile and a more regulated return environment.
One of the numerous options could be to have a regulatory system more like the airport’s regulatory model. There have also been discussions for any future contracts to have shorter durations, although that will depend on the amount of investment and operational service levels required to operate and improve the networks. The SANEF concession is the first to expire in 2031 and discussions are likely to commence on handover 7 years prior to expiry making the future structure of concessions a priority for the current government.
While other reviews are occurring concurrently, ALX is confident in the strength of its contractual position with its concessions as has been previously tested in 2015. There is opposition from certain stakeholders against any further extensions of the current concession contracts. ALX remain focused on presenting opportunities for investment and considering possible evolutions that would support the Government’s road transport and environmental objectives.
Skyway Acquisition and Strategy Pivot
With the bid from IFM in 2022 to acquire ALX, it appears that management and the board pivoted the strategy to both ensure its survival as a listed entity by acquiring the Chicago Skyway. This makes it increasingly difficult for an acquirer given a larger asset base, in addition to a growth strategy that is likely to see further M&A. The rationale also helped to increase the weighted average concession life of the portfolio with the APRR concession expiring in 2035. Whilst the rationale for the purchase may have been sound, the price paid appears to be above fair value, paying 43x trailing EBITDA and 38x the 2024e EBITDA forecast. The asset last sold in 2018 for a similar multiple, however, the outlook for traffic demand was likely better, and the interest rate environment more manageable. Nonetheless, the asset’s concession life out to 2104 and attractive inflation-linked toll regime provide a solid base for ALX to support its distributions. It is likely that the distribution will still decline by ~75% in the mid-2030s though when the APRR concession ends.
The acquisition also marks a shift in strategy from ALX from optimising the current asset base into a growth strategy through likely additional M&A. This shifts the investment profile to a higher growth, however at a higher risk given heightened execution and operational requirements. We, therefore, remain cautious about the outlook for the Group and the ability to execute on delivering shareholder returns through strategic acquisitions.
Tolling Regimes & Inflation Offset
Each asset has a slightly different tolling escalator contract, providing different outcomes. APRR tolls can rise at 70% of CPI with additional increments agreed under any investment plans with the government authorities. Chicago Skyway has the most favourable regime. Overall, the group has a solid link to CPI increases, providing valuable inflation offsets.
Dulles Greenway is currently under legislation to alter the agreement from a standalone decision each year to instead lower tolls for motorists through the implementation of distance-based tolling and CPI linkage, which in the short-term would be a headwind to revenue, but a long-term positive outcome with forecastable toll escalation in-line with CPI. The decision is likely to be longer dated with local elections looming in November. We would expect an outcome in CY24.
Figure 9: Assets have solid CPI linkage, with renegotiation on Dulles Greenway
Valuation Considerations
ALX has relatively secure cash flows and operates high-quality defensive assets, with the ability to pay out sustainable distributions over the life of the asset concessions. The distributions per share have been rising over the last decade, driven by asset optimisation and acquisitions, rising at a CAGR of ~16% from FY16 to FY22. We don’t anticipate growth to be as strong moving forward, with distributions likely to rise at a CAGR of ~3% from FY23-26e. ALX has retained its guidance for 40cpu for FY23.
Figure 10: Distribution growth slowing to GDP+ style growth
With ALX being predominantly a yield stock, we look back at the historical correlation between forward distribution yield and the Australian 10-year bond yield. The average spread over the last decade has been ~2.2%, with the current spread at ~2.8%. Whilst this is above historical levels, we don’t anticipate a much higher yield for ALX over the next 3 years and expect bond yields to remain relatively steady based on the latest commentary from the RBA. We would look for a spread of >3% for us to take a more positive stance on valuation. It is worth noting however that the current yield above 6% is close to the highest it has been, and we do believe this can be sustained over the coming years.
Figure 21: Yield slightly above historical spread to the 10-Year Australian bond yield
When compared to peers, ALX currently has a far higher yield than other global toll road operators. This can partly be explained by recent currency movements, where a weaker AUD compared to the Euro acts as a benefit for $A distributions, given it earns the majority of its revenue in Euros.
Figure 13: Yield attractive compared to peers
Figure 14: Some recent yield expansion explained by falling AUD
Big bidder?
IFM Group have been creeping higher on the register of ALX for some time now, and reached over 15% of the issued securities, buying a significant number above $8.10 per share back in June 2022. IFM has continued to purchase shares when they can on the market, and as of the last update, currently own 21.82% of the voting power. IFM have traded in and out of the stock over the past 12 months, remaining net buyers for the period. Buying has been executed around the $6.00 range. We believe IFM will continue to grow its overall shareholding at the rate that the regulator allows (3% every 6 months), providing a solid ‘downside protection’ to the share price of around $6.00. We also anticipate IFM may come in with a full offer for the company if the share price does fall below this range, providing a potential upside risk catalyst, however note there is the potential for IFM to acquire a controlling stake without paying a control premium, although this will likely take a number of years to achieve.
Balance sheet:
Whilst debt is above historic levels, the rating agencies put ALX in a strong position. Fitch rates APRR an A with a stable outlook and S&P rates APRR an A- with a stable outlook. Current Net Debt/EBITA as at 31 December 2022 sits at 3.4x, comfortably below the default covenant of 7.0x. Interest cover is also well in excess of any covenants at 14.8x vs the 2.2x requirement. We are comfortable with ALX’s debt profile and don’t see any immediate concerns given that traffic volumes and cash flow should continue to improve. The debt is predominantly fixed, providing protection from further rate increases. ALX has also called out ~$3bn in liquidity if they needed to access it.
Risks to Investment View
Investment View
The ALX share price has recently been under pressure, due to increased concerns around potential changes to the APRR concession structure from the French government. We believe the fears are overblown and that the share price weakness provides an opportunity to add a quality defensive asset to portfolios. We do however note that legislation changes and a non-renewal of the concession would present a material risk to the company and our investment thesis, given that APRR represents ~75-80% of the group’s earnings and valuation. IFM remains the largest shareholder, continuing to increase its stake incrementally and looms as a potential buyer of the Group.
ALX’s cash flows and distributions are defensive and the current yield of >6% is sustainable over the next few years, backed by continuing traffic volume recovery. The weighted average concession life has been materially increased to ~37 years by the recent acquisition of the Chicago Skyway. The purchase, however, has introduced a pivot in strategy, from optimising current assets to one of M&A growth, which does introduce potential execution risk. We initiate on ALX with a Buy rating with potential upside catalysts, defensive cash flows and sustainable distribution, as well as valuation appeal compared to bond yields.
