ConnectEast (CEU) reported the first 25 days of October traffic. Traffic growth was 4.5% for October which is above the 3.3% in September. Revenue growth was slightly lower at 4.0%, down from 5.0% in September. Management indicated no decision had been made about future dividends.
Impact
The traffic growth is encouraging and running above our ramp up expectations of 2% per month, thus it will be slightly positive to short-term earnings. The slightly lower revenue growth likely reflects that more cars are starting to use the road, which is encouraging given the economic cycle and the pressure on the households. With the exception of December/January (seasonally lower), a maintenance of this growth trend will minimise the time CEU needs to rely on its ramp up reserves.
Dividend policy and the board's confidence is vague. Two issues we think are likely to influence the board's decision over future dividends is the prevailing share price and the participation rate. The latter is now down to 51% resulting in strong reliance on the underwriters for the fixed component of the dividend, and half the cash provided in the non underwritten component being lost to investors. Each dividend re-investment plan is potentially seeing 2.5% of the capital being issued which may cause some indigestion for the share price in the current environment. With Transurban Group (TCL), Macquarie Communications Infrastructure Group (MCG), RiverCity Motorway Group (RCY), BrisConnections Units Trusts (BCSCA) already cutting dividends, it does not seem unreasonable to expect CEU will move to a more fiscally conservative approach. As a result, we have adjusted our dividend forecasts to zero until the road exits equity lock up which we are forecasting in 2012.
A benefit from the approach is that CEU retains approximately $57m of cash on balance sheet. This provides some flexibility that it remains well within coverage limits on the debt while the road ramps up. From a valuation impact the removal of the dividend lowers the internal rate of return of dividend re-investment participating investors and increases the internal rate of return of the participating investors, but has no impact on the net present value.
Earnings revision
No change to earnings.
Price catalyst
12-month price target: $1.03
Catalyst: Ramp up continuing to accelerate in response to education programme.
Action and recommendation
Three months in the road is ramping up nicely. Cutting the dividend may be seen as a negative, but we believe the investors already expect this, thus the impact should be minimal. From a valuation perspective there is no impact.
At this stage, roads in development and early stage ramp up are on the nose for investors, and certainly not our top pick in the sector, but we still see value in the business, thus maintain our Outperform recommendation.
CEU Price at posting:
73.1¢ Sentiment: Buy Disclosure: Held
