what's driving down the share price?, page-17

I have been buying some AZJ shares over the past few weeks.

Having taken (for the first time) a proper look through their listed history, since the QR National IPO in 2010, I have been quite impressed by the Company’s steady operational improvement over the years.

While the business model has hardly changed at all, apart from the disposal of some underperforming assets along the way, its EBITDA margin has increased from less than 30% in FY11-FY12 to as high as 48% in FY18-FY20.

As to the business’s capability of generating surplus capital: after a relatively capital-intensive half decade (FY11-FY15), over the past 5 years alone AZJ has managed to spit out 3.1bn$ in cumulative Free Cash Flow and returned as much as 3.6bn$ (48% of current Market Cap) to shareholders in the form of dividends and buy-backs, while leaving [Net Debt]/EBITDA at a comfortable 2.4x.

Remarkably, this has happened in a regulatory environment that has become more onerous over time: even after the agreement with customers for the revision of the UT5 Access Undertaking was reached in May 2019, its revised terms remain more restrictive to AZJ (vis-a-vis the previous UT3 and UT4 versions) in terms of Maximum Allowed Revenue on the regulated business.

Looking ahead, this now appears to be a prudently geared enterprise (relative to a semi-monopoly infrastructure business), trading at an undemanding 7.5x EV/EBITDA and offering a 9.5% FCF yield on Market Cap; that looks quite attractive to me, on a risk-adjusted basis, in the current and prospective yield environment.

While coal freight volumes are likely to gradually decrease going forward, irrespective of what China decides to do in the short term, the regulated pricing mechanism on AZJ’s below-rail business (whereby Maximum Allowed Revenue is a function of Regulated Asset Base and WACC, not of actual freight volumes) should provide a natural offset, allowing the Company to increase their rail access tariffs accordingly.

As to the unregulated above-rail business, the secular decline in coal volumes is likely to be compensated over time by growth in the Bulk sector (i.e. non-coal commodities, such as iron ore, agriculturals, etc.), where EBIT has increased from -14m$ in FY17 to +90m$ in FY20 thanks to a mix of new contracts and achieved operational efficiencies.

While the overall business does have a degree of positive correlation with the broad economic cycle, its essential-service and semi-monopoly nature makes it less prone to disruption in times of turmoil.

Right now, a 2.0%*NAV capital allocation for me, with room to increase going forward if/when markets get shaky again.

All usual caveats apply, etc.