TOLLING: COMMERCIAL, IN CONFIDENCE

Kurt Forsgren offers his insights into the most critical developments for the toll road sector this year and beyond and concludes that toll road operators have good reason for quiet optimism

Toll facility operators are mostly faring well. As GDP growth trends upwards in every region, roads are becoming busier ­– thereby improving financial margins for many operators. In turn, there is a stable outlook for rated toll road facilities across Canada, Europe, Latin America, and Asia Pacific. The US, meanwhile, enjoys a positive outlook.

This growth can create hurdles, however. Higher traffic volumes may precipitate the need for greater infrastructure requirements and capital expenditures ­– either to add capacity on existing toll networks or to build new projects altogether. Further disruptive factors are afoot: the electrification (and, eventually, greater automation) of the motor industry continues as most regions tighten emissions regulations, while consumer preference edges toward these technologies. These newer mobility services require road operators to adapt their business models accordingly – one of the major developments we expect to continue this year and beyond.

The future should remain brighter, regardless. Buoyed by supportive regulatory regimes and concession networks, operators are proving their resilience against potential downsides – which is reflected in the hive of merger and acquisition (M&A) activity currently underway. As such, the toll road sector continues to demonstrate its resilience as an asset class in the eyes of infrastructure investors.

The outlook

GDP growth, which averages 3.9 percent globally, informs this position.[1] S&P Global Ratings typically considers demographic changes and geopolitical risks that affect the movement of people and goods. And, taking this into account, rated toll facility operators have generally performed very well. In the period from January 2017 to April 2018, S&P upgraded 15 toll road issuers and downgraded five.

Surpassing the performance of every other region was the US, which enjoys the only positive outlook in the world. There are plenty of contributing factors: we expect America’s economy to grow by 2.8 percent this year and 2.2 percent in 2019; nearly 86 percent of commuters’ journeys in the US are completed by car;[2] and the economy is in good stead – full employment is almost in sight, while the average household income is rising. And, given that vehicle miles travelled (VMT) is rising, too, we believe that traffic volume growth for America’s toll roads is set to continue.

Each region has its nuances, of course, but let’s first consider the common trends. This year, we can expect further evolution in technologies that will likely improve both the operational efficiency and financial flexibility for many toll road operators – be they public agencies or private concessionaires.

Electronic transponders – and the transition towards barrier-free (or open) tolling, more generally – have helped to modernise the sector. The benefits have been clear: we have seen reductions in toll evasion, road congestion and carbon emissions; while road safety has improved, along with opportunities to harvest data and insights around road usage. As these technologies grow in sophistication, we expect more toll operators and highway infrastructure owners to expand electronic transponder or pay-by-plate schemes. Such upgrades, we believe, could serve not only to reduce congestion but also to generate new revenue streams.

There are many shared disruptive forces, too. Among them are inadequate public funding for roadway improvements. A lack of funding has precipitated a shift towards concessions and tolling worldwide. For perspective, the U.S. State of California’s total infrastructure backlog (the necessary funding to maintain existing infrastructure at a minimum standard) is US$67 billion. The state governor attributes US$47 billion of this figure to the state’s highway system. This prompts the perennial question: “Who should pay for infrastructure upgrades and maintenance?” Invariably, concessions and tolling are the most-preferred answers, rather than tax-rate hikes.

A second disruptor comes from shifting consumer behaviours and technological advancements in the automotive industry. The growth of autonomous vehicles (AVs) and ride-sharing could radically change traffic dynamics, especially for commuter roads that provide free access for high-occupancy vehicles. Depending on their market characteristics, AV development, in particular, could prosper from the controlled environment that tolling facilities and managed lanes will likely create. Working in unison, these developments could serve, in effect, to add capacity without the need for new highway projects.

That said, AVs are not particularly imminent; advanced, fully-autonomous vehicles becoming mainstream remains some decades away. In any case, their development largely relies on closer coordination between governments and toll road operators. Also required are changes to concessions’ existing toll charge agreements – not to mention ways to address the industry’s overarching concerns about safety and changes to insurance liabilities.

Increased M&A activity?

More nuanced, meanwhile, is the role that M&A activity will continue to play in the sector. One area of notable development is Europe. The low interest rate environment has boosted this market – and has arguably given greater financial flexibility for companies to either pursue acquisitions or to distribute higher dividends. Despite the sector’s expected robust performance in Europe, it is crucial to note that M&A activity and large investments could lead to significantly higher leverages.

A notable transaction in the pipeline is the takeover of Spain-based operator, Abertis. Atlantia recently teamed up with its counter-bidder, German construction company Hochtief AG (itself owned by Spanish construction company ACS), in a cash-settled voluntary tender offer. The transaction, should it complete, would be the sector’s largest in recent years, and create the world’s largest transport infrastructure group.

Europe’s largest toll road network operators (TRNOs) should continue to propel M&A activity, in our view. Many are seeking to expand, diversify, and replenish cash flows of maturing concessions while gaining higher returns from projects under constructions. Despite high asset prices, which have come largely thanks to limited availability and increasing competition for proven infrastructure assets, prospective M&A deals shouldn’t threaten rating stability for most issuers.

Elsewhere, the landscape is mixed. For instance, M&A deals in America have remained strong over the past two years. This comes as greenfield investment opportunities under public-private partnership (P3) frameworks have been far and few between. Canada, on the other hand, has seen little appetite among its provincial governments for new volume-based toll-road projects. Despite this, Transurban recently agreed to buy a hybrid toll road concession, A25, in Montreal, at C$840 million in a rare M&A opportunity for this market.

Transurban has been particularly active in other markets, too. The main toll road operator in Australia closed a deal with the Victorian government for the Western Distributor project, a tunnel navigating under the Westgate freeway in Melbourne. The deal closed at approximately A$5.5 billion. On the M&A front, the process for the New South Wales government’s sale of 51% of the WestConnex project is continuing, with binding bids currently due in July 2018.

Preparing for automation

In a market quietly growing in confidence, it is nonetheless crucial to consider the ways in which the sector is evolving. What changes can we expect next? Most imminent will be the further rise of the electric vehicle – largely seen as the precursor to AVs. The automotive industry’s impact on toll roads, however, will largely depend on whether consumers opt for ownership of their vehicle, rather than the mobility-as-a-service model. In short, it’s too early to say exactly how the toll sector will need to respond, but future action may nonetheless be required.

For now, the market can push on. Though financial flexibility might be more constrained in certain regions, attractive financing conditions could help to accelerate investment decisions. And, with GDP growth helping to increase traffic on the world’s roads, toll road operators should see their credit stability broadly supported. All things considered, upgrades and increased capital expenditure could be among the likely outcomes.

Kurt Forsgren is managing director, US Public Finance, at S&P Global Ratings

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