2011

Company Valuation Report

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Table of Contents
1. EXECUTIVE SUMMARY ........................................................................................................ 5 2. INTRODUCTION TO TRANSURBAN GROUP ................................................................... 9 2.1 Overview ................................................................................................................................ 9 2.2 History .................................................................................................................................. 10 2.3 Share Price Performance ...................................................................................................... 12 2.4 Products and Services ........................................................................................................... 14 2.5 Toll Roads ............................................................................................................................ 15 2.5.1 CityLink ......................................................................................................................... 15 2.5.2 M2 Hills ......................................................................................................................... 15 2.5.3 Lane Cove Tunnel .......................................................................................................... 15 2.5.4 M1 Eastern Distributor .................................................................................................. 15 2.5.5 M7 Westlink .................................................................................................................. 16 2.5.6 M5 Motorway ................................................................................................................ 16 2.5.7 Pocahontas 895 .............................................................................................................. 16 2.5.8 Capital Beltway HOT Lanes .......................................................................................... 16 2.6 Corporate Strategy and Objectives ....................................................................................... 16 2.7 Sources of Competitive Advantage ...................................................................................... 18 2.8 Ownership Structure ............................................................................................................. 19 2.9 Capital Structure ................................................................................................................... 20 2.10 Management Structure ....................................................................................................... 21 3. INDUSTRY ANALYSIS.......................................................................................................... 23 3.1 Overview .............................................................................................................................. 23 3.2 Industry External Drivers ..................................................................................................... 23 3.3 Market Segmentation: .......................................................................................................... 25 3.4 Products and Services Segmentation: ................................................................................... 25 3.5 Major Market Segmentation ................................................................................................. 26 3.6 Industry Participants/Competitors ........................................................................................ 27 3.7 Porter Analysis ..................................................................................................................... 29 3.8 SWOT Analysis .................................................................................................................... 31 3.9 Industry Outlook................................................................................................................... 34 4. ECONOMIC ENVIRONMENT ............................................................................................. 36 2|Page

4.1 Overview .............................................................................................................................. 36 4.2 Macroeconomic Indicators ................................................................................................... 36 4.2.1 Oil Prices........................................................................................................................ 36 4.2.2 Inflation .......................................................................................................................... 38 4.2.3 Interest Rates.................................................................................................................. 41 4.2.4 Exchange rates ............................................................................................................... 42 4.3 Economic outlook................................................................................................................. 44 4.3.1 Estimated Market Return ............................................................................................... 44 5. CURRENT ISSUES ................................................................................................................. 46 5.1 Macroeconomic Factors ....................................................................................................... 46 5.1.1 Increase in Oil Price ....................................................................................................... 46 5.1.2 Increase Level of Debt to Disposable Income ............................................................... 46 5.1.3 Availability of Public Transport .................................................................................... 46 5.1.4 Government ................................................................................................................... 47 5.2 Microeconomic Factors ........................................................................................................ 47 5.2.1 Potential Investments ..................................................................................................... 47 5.2.2 Competitors.................................................................................................................... 47 6. FINANCIAL ANALYSIS ........................................................................................................ 49 6.1 Dupont Analysis ................................................................................................................... 51 6.1.1 EBIT/Sales ..................................................................................................................... 53 6.1.2 Sales/Total Assets .......................................................................................................... 53 6.1.3 EBIT/Total Assets.......................................................................................................... 54 6.1.4 Interest Expense/Total Assets ........................................................................................ 54 6.1.5 Net Before Tax/Total Assets.......................................................................................... 55 6.1.6 Total Assets/Common Equity ........................................................................................ 55 6.1.7 Net Before Tax/Common Equity ................................................................................... 55 6.1.8 Tax Retention Ratio ....................................................................................................... 56 6.1.9 Return on Equity ............................................................................................................ 56 7. VALUATION ASSUMPTIONS ............................................................................................. 58 7.1 Required Rate of Return (CAPM) ........................................................................................ 58 8. VALUATION ANALYSIS ...................................................................................................... 60 8.1 Dividend Discount Model (DDM) ....................................................................................... 60 8.1.1 Dividend Forecast .......................................................................................................... 61

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8.1.2 Intrinsic Share Price ....................................................................................................... 63 8.1.3 Sensitivity Analysis ....................................................................................................... 63 8.2 Free Cash Flow to Equity Model (FCFE Model) ................................................................. 65 8.2.1 Cash Flow Forecast ........................................................................................................ 66 8.2.2 Intrinsic Share Price ....................................................................................................... 67 8.2.3 Sensitivity Analysis ....................................................................................................... 68 8.3 Pricing Earning Ratio ........................................................................................................... 69 8.3.1 Sensitivity Analysis ....................................................................................................... 72 8.4 Price/Book Value Ratio (P/B) .............................................................................................. 73 8.4.1 Sensitivity Analysis ....................................................................................................... 75 8.5 Net Tangible Asset Backing Model (NTA) ......................................................................... 75 9. VALUATION DISCUSSION .................................................................................................. 78 9.1 Dividend Discount Model (DDM) ....................................................................................... 78 9.2 Free Cash flow to Equtiy Model (FCFE Model) .................................................................. 78 9.3 Price / Earnings Ratio Model (P/E) .................................................................................. 79 9.4 Price/ Book Value Ratio (P/B) ............................................................................................. 80 9.5 Net Tangible Asset Backing Model (NTA) ......................................................................... 81 9.6 Preferred Valuation Method ................................................................................................. 82 10. CONCLUSION & RECOMMENDATIONS ...................................................................... 83 11. APPENDIX ............................................................................................................................. 84 11.1 Appendix 1: Excel Raw Beta and Adjusted Beta Calculations .......................................... 84 12. REFERENCES ....................................................................................................................... 85

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1. EXECUTIVE SUMMARY
Transurban Group (TCL) is an Australian based company that and was first listed on the Australian Stock Exchange (ASX) on the 14th March 1996. The industry that it is in is industrials and the sector is transportation on the ASX. It specialises in the operation and management of toll roads. TCL main headquarters are in Australia however their operations extend to North America. TCL also continues to search for other opportunities abroad to add to its portfolio of investments in toll roads. The share price movements of TCL have been extremely volatile in recent years the period from March 2006 through to March 2011; TCL was trading at prices ranging from a monthly high of $8.299 to a monthly low $3.996. In more recent times preceding August 2010 TCL share price has been experiencing an upwards trend which can be seen as a positive sign. At the start date of writing this report TCL share price was trading at $5.19 (as of 23/3/2011) and at the conclusion of this report TCL share price is trading now at 5.44 (as of 13/5/2011). Transurban operates and owns tolls, its operations provides specific products and services. Its main product is the electronic tagging devices used for toll roads. The electronic tagging devices that are known as e-TAG and e-PASS, the tagging device that is sold to commuters in Melbourne for use on CityLink is known as the e-TAG. The CityLink is Transurban flagship toll road. Transurban is also involved in the business of consulting and are experts in their industry. Their consulting clients are from the public sector such as councils and governments domestic and abroad. Their expertise is in the development and management of electronic toll roads, traffic projection and modelling. Transurban is a company that is highly leveraged and this is explored through examining their capital structure. The five years history of the company demonstrated that the company had a high net gearing ratio. This also indicated that Transurban Group had been heavily financed by the outside parties. A company should have a well balance net gearing percentage as debt is always a cheaper source of financing compared to equity financing but a highly geared company would be risky to the company as the interest repayment would be very high. On the other hand, the interest cover ratio of Transurban Group was relatively low for the past five years. Interest cover ratio is vital as it measures the amount of profit available to cover the interest expenses of the company. Therefore, the higher the ratio the less risks the company is bearing.

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The Toll Road Operators industry has been growing steadily over the last decade as governments seek to lower the cost of transport infrastructure through Public Private Partnerships (PPPs). And as the main supporting partner, Transurban contributes most to the growth by the enhancement projects of new toll roads and increased traffic on existing toll roads. The company holds the greatest market share in Australian toll road industry at around 33.6%. In the coming years, the industry revenue is expected to be pushed higher as the increasing opening of new toll road and tunnel. The strong Australia economy as well as increasing population density will see higher demand for toll road as a result of boosting road freight activity. However, any increase in the fuel price as a result of Carbon Pollution Reductions Scheme (CPRS) will infer users to switch from using toll road to using to public transportation. The porters 5 forces tool is a powerful tool helps to better understand the strength of the industrys current competitive position as well as the strength of a position that the toll road operators are considering moving into. There are five important forces that determine competitive power in Australian toll road, but the most valuable force determining industry attractiveness is competitive rivalry. The competition in this industry is increasing and operators will face competition with price, customer service levels and product differentiation. The companys major strengths include its leading position, holding dominant assets enable to maintain its market share in the industry. The enhancement of existing road assets not only deliver more value to the community but will also boost profit to TCL. However, TCL also suffers from outstanding debt problem which will affect shareholders dividends payments. Apart from that, the proposition of CPRS along with traffic congestion adds to the threats to Transurban with travel reduction. Transurban Groups future potential growth can be affected by the economic environment such as macroeconomic and microeconomic factors. Examples of macroeconomic factors that will affect Transurban Group are oil price, level of debt to disposable income, inflation and government regulation. As the oil price increase, there will be less people using their cars as transportation and thus fewer consumers using the toll road. When the level of debt increases, the level consumers disposable income will decrease and consequently consumers have to reduce their level of expenditure by avoiding high petrol costs and toll costs. Inflation will cost the level of expenditure to rise, as the prices of the consumer goods increase. Thus, travelling with own transport will incur a higher cost. Government regulation such as increase in taxes and upgrading the public transports will also affect the companys profitability level. 6|Page

Microeconomic factors are factors that affect individual economy choices as well as individual decision makers. Examples of the microeconomic factors that will affect the company are potential investments and competitors. It is imperative for the company to be consistent in discovering the potential investments which can bring in more revenue to the company. Potential investments for Transurban Group can be the acquisition of potential growth assets and upgrading the existing assets. Competitors play a vital role in affecting the decisions that will be made by Transurban. When the rivals are performing well, the company will need to resolve with alternative ways to boost up the companys performance level as well as to outperform them. EBIT is used to measure the amount of profit that the company can generate irrespective of other external factors such as how the business if financed and government regulations. The five years historical data demonstrated that average growth of Transurban Group was 187%. On the other hand, EPS had been incurring negative figures from 2006 to 2009 and had a large increase in 2010 which overturned the figure into positive value. This also portrayed that the companys profits generating ability was very high. The ROE of Transurban Group had been relatively low for the past five years. However, looking at the big increase in ROE in 2010 and upon the completion of the future upgrading projects, it is very likely that the ROE will increase in future. The preferred valuation method was the dividend discount model. This was the preferred model over the other models because Transurban historically consistently paid dividends and we expect would expect this to continue in the future. It was preferred over the discounted FCFE model because the FCFE future growth rates would be more difficult to predict and it was also preferred over the ratio relative valuation techniques since it was difficult to find companies that were similar to Transurban and its structure. The DDM and the FCFE models suggest that the share value of Transurban is underpriced and is currently trading at a discount of 3.1%, FCFE model suggests that TCL share is trading at a discount of 2.5688%. The relative valuation techniques used also suggests that the stock is worth buying with exception to the P/E ratio which suggest we should avoid holding the stock or even sell the stock. The five valuation methods used, four of our valuations conclude that Transurban stock is worth buying or holding, while only one of the method used would lead to the conclusion that investors should sell or avoid TCL stock. Based on this information we recommend a buy-hold recommendation on TCL stocks, since TCL shares are trading at a discount. TCL shares is trading at a discount of 3.1%, based on the market 7|Page

price of $5.31 as of the 15/4/2011 from the intrinsic value of $5.48 calculated from the dividend discount model.

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2. INTRODUCTION TO TRANSURBAN GROUP

Transurban Group Company Details:
ASX Listing Code Official Listing Date GICS Sector GICS Industry Group GICS Industry Internet Address Registered Office: Market Cap Total Shares Quoted Last Close TCL 14 March, 1996 Industrials Transportation Transportation Infrastructure http://www.transurban.com.au Level 3, 505 Little Collins St, MELB, VIC, AUSTRALIA, 3000 $7,478,000,000.00 1,443,500,000 $5.18 (as of 23/3/2011) *Source: Australian stock exchange (2011) & Morningstar DatAnalysis (2011)

2.1 Overview
Transurban Group (TCL) is an Australian based company with its headquarters located in Australia, TCL has offices in Melbourne and Sydney. They also have vested interests in North America so they have offices in America; their American offices are located in New York, Washington DC and Atlanta. The Group is currently in the top fifty companies listed on the Australian Stock Exchange. Transurban Group is in the industry of transportation and infrastructure. Its a toll road owner, operator and they are involved in the development and management of electronic toll roads. The company started out as a single purpose business which was for the purpose of CityLink in Melbourne (Transurban 2011). They currently have interests in eight toll roads and have approximately 5 million customers around the globe. TCL interests can be seen in table 1.
Table 1: Transurban Group Interests in Toll Roads
ROAD AUSTRALIA CityLink (Melb) Hills M2 (Syd) Lane Cove Tunnel (Syd) Eastern Distributor M1 (Syd) Westlink M7 (Syd) Motorway M5 (Syd) Virgina, USA Pocahontas 895 Capital Beltway HOT lanes (under construction) INTEREST 100% 100% 100% 75.1 50% 50% 75% 67.5% *Source: Transurban (2011)

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2.2 History
Transurban group was formed in 1992, it started out as a joint venture between two engineering firms. The two firms in the joint venture at the time were Australian company Transfield Construction Pty Ltd and a Japanese company Obayashi Corporation. The joint venture was for a submission with the Government of Victoria to build, own, maintain and operate Melbourne City Link (Morningstar DatAnalysis 2011). In 1995 the Victorian Government accepted their submission and TCL was listed on the Australian Stock Exchange in 1996. The CityLink project consisted of two major sections, the Westlink which connects the Tullermarine and Westgate Freeways and the Southern Link which connects the Monash and Westgate freeways (TCL Annual Report 2000). The project involved financing design, construction, marketing, operation and maintenance of the toll roads. CityLink was first open to traffic in August 1999, the development of the electronics tolling system on City Link which is a cashless tolling system was a world first (InvestSMART 2011). The City Link project endured numerous setbacks. There was the late delivery of the Central Toll Computer System; this prevented the tolling of the Western Link until eight months after contracted completion date and four and a half months after the section opened to traffic. The Western Link operated without tolling on the 15th August 1999 and commenced tolling on the 3rd January 2000. Between the financial period of 30th June 1999 and 3rd January 2000 TCL derived no net revenue from the City Link project (TCL Annual report 2000). On the 19th February 2001, the Burnley Tunnel suffered a structural failure in an arch of its structure. As a result of the structural failure the tunnel was closed for nine days. Transurban lost approximately $1.9 million dollars in toll revenue and incurred $0.6 million dollars in consulting fees (TCL Annual Report 2001). In 2001 in an out of court settlement the Transfield Obayashi Joint Venture agreed to pay Transurban $157 million in damages (Millar R, & Moynihan, S 2007). In 2001-02 it was a big year for Transurban, it was a year of transformation. In August 2001 Transurban negotiates its release as a single-purpose entity with the Victorian government. Being a single-purpose entity the company was legally restricted to the business of operating and developing Melbourne CityLink (TCL Annual Report 2002). In April of that year the group filed an expression of interest for Lane Cove Tunnel in Sydney and in February 2002 and the management team makes a major trip overseas to find new business opportunities. Towards the end of the 2002 financial year Transurban group finalised a debt refinancing package worth $1.7 billion, this increased the companys ability to raise capital and invest in other projects 10 | P a g e

domestically and internationally. During the period CityLink also launches a cost reduction program to save $1 million per month on customer service and marketing costs, in July 2002 CityLink achieves that target and reduces cost down from $3.5 million to $2.5 million. Revenue from tolls and fees for traffic in 2002 financial year was up 41.8% from the previous year. TCL had another great year 2002-03; CityLink Revenue topped $230 million demonstrating higher growth than what was initially forecast. In that period revenue was 10.7% higher than the previous year. In the month of October Transurbans consortium wins the $2.23 billion Westlink M7 project in Sydney at the time it held a 40% share in the Westlink M7 project. It was the first of many projects in Sydney; TCL financed the project by raising $430 million in equity (TCL Annual Report 2003). Over this period the company was prospering, the future looked bright and there was plenty of optimism about TCL. In 2003-04 financial year traffic on Melbourne increased by 6% that saw revenue grow by 10.1%, this was another positive year for TCL. Over the year they introduced other programs designed to increase revenue and cut costs. In July they introduced a new video tolling product which attracted more than 34,000 new accounts and generate over $1.5 million in revenue (TCL Annual Report 2004). CityLink continued to develop further programs to cut operating costs and increase revenue. In December 2003, Transurban and Macquarie Infrastructure Group agreed to set up a tolling venture as New South Wales (NSW) six tolling roads would eventually move from manual toll roads to electronic tolling, they already have a current joint venture in Westlink M7. Transurban continued to increase its stake in NSW roads when it purchased 8.1% share in Hills Motor way on 19th April. TCL was entering in further bids for business opportunities. Transurban was bidding to develop and operate the Mitcham-Frankston project and entered a tender in Sweden. The tender in Sweden was TCL first tender outside of Australia and the tender was unsuccessful (TCL Annual Report 2004). During this period it was one where TCL was actively seeking new projects domestically and overseas to increase returns to its stakeholders. The financial year for 2004-05 was an excellent year for investors, company securities grew from the start of the 2004-05 financial year from $4.87 a year and trading at a high of $7.45 (TCL Annual report 2005). That year Transurban was listed as one of the top fifty companies on the ASX. Transurban were also successful in a takeover bid for Hills Motorway (M2) where it would become 100% owner of the M2. The 100% ownership of the M2 and 40% ownership of the M7 made TCL a major stakeholder of around half of Sydneys motorway. In early 2005 Transurban reached an agreement on the upgrade of the Tullermarine/Calder interchange, however they were unsuccessful in the bid for Mitcham-Frankston Freeway. TCL however continued its interest in 11 | P a g e

international opportunities. In the US they were targeting potential projects in the State of Virginia, whilst also setting up an office in the United Kingdom building relationship with potential partners and monitoring potential opportunities. Revenue on the CityLink was also up during the period it was up 8% during the 2004-05 period (TCL Annual Report 2005). Transurban had its first international toll road in June 2006, it was the Pocahontas Parkway in Richmond, Virginia in the United States. The Companys portfolio of toll roads now consisted of four toll roads. TCL and its partners also opened Sydneys Westlink M7 eight months early while TCL had the full electronic tolling system working ten months early earning a performance bonus of $8.3 million (TCL Annual Report 2006). The company continued enhancing its portfolio of toll roads by adding more toll roads to its portfolio. TCL takeover of Sydney Roads Group (SRG) increases TCL stake in five out of the nine motorways in Sydney (TCL Security holder review 2007). The Security holder review of Transurban (2007) states that on December 2007, TCL construction partner Fluor and the Commonwealth of Virginia reached a financial close on the Capital Beltway Hot Lanes project in Virginia. The joint agreement will allow TCL to operate the lanes for 75 years (TCL Security holder review 2007). On August 2008 TCL further increased its stake in its toll roads it already has interests in. It further increase an addition 2.5% in Westlink M7 taking its interest to a total of 50%. While in September 2007 TCL acquired an additional 3.8% in Airport Motorway Group, taking its invested interest in Eastern Distributor to 75.1% (TCL Security holder review 2008). During the 2009-10 financial year TCL posted an annual net profit turnaround. It posted a profit turnaround of $59.605 million which was up from the $16.134 million loss from the previous financial year (Herald Sun 2010). The profit turnaround for 2009-2010 financial year was the first profit made in ten years. TCL continued to increase its portfolio in toll roads it announced on the 10th of May 2010 that it had reached agreements to acquire the Lane Cove Tunnel, in August the group assumed operational control (Morningstar 2011). The 2011 results will be released in the near future.

2.3 Share Price Performance

The following chart (figure 1) compares the five year historical performance of TCL share price against the All Ordinaries Index from the period of March 2006 through to March 2011. During 12 | P a g e

that period TCL was trading at prices ranging from a monthly high of $8.299 to a monthly low $3.996. When TCL was trading at an all time high on May 2007 the share price rapidly declined from then. The All Ordinaries Index also declined in close proximity. This would suggest the share price of TCL is correlated to movements in market indices. It can be seen from figure 1 TCL share price has depreciated further than the market (relative to the All Ordinaries Index) through periods prior to March 2009 where it was trading at all time low. The 20 month moving average of TCL share price would suggest that there is a downwards trend however early 2010 the trend started to flatten out and the share price was improving, possibly even changing trends.
Figure 1: TCL Share Prices vs. All Ordinaries Index (5 Years Closing Monthly Prices)

*Source: ASX (2011)

The next chart (figure 2) compares the past six months of the daily share price of TCL with the six month daily change of the All Ordinaries Index. The pricing movements seen in figure 2 show that from periods preceding August 2010 TCL share price was experiencing an upwards trend following the trend of the All Ordinaries Index. This would also further clarify that TCL and the All Ordinaries are closely correlated. The upwards trend can also be seen from the twenty day moving average of TCL share price. The upwards trend slowly steadied from early November to present. During the six month period it can be said that the price of TCL stock price was extremely volatile as during the period there was a fluctuation in share price of around 19%, However TCL share price has improved which is a more positive sign.

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Figure 2: Share Prices vs. All Ordinaries Index (6 month Closing Daily Prices)

*Source: ASX (2011)

Transurbans stock price was last trading at $5.30 at the close of trade (25th March 2011), although it is still trading below its previous high it has recovered from trading at its five year low in early to mid 2009.

2.4 Products and Services

Transurban operates and owns tolls in Australia and North America and through these operations it provides specific products and services. Its main product for what its known for is the electronic tagging devices used for toll roads. The electronic tagging devices that are used in Australia are known as e-TAG and e-PASS. The main tagging device that is sold to commuters in Melbourne for use on CityLink is known as the e-TAG, with e-TAG account commuters can travel through toll roads in Melbourne and Sydney. The e-PASS account is for commuters that only occasionally use toll roads and can only be used for travel on Sydneys Westlink M7 tolls. The two accounts allow up to four vehicles to be registered on the one account. They also offer commercial e-TAG for businesses which require account holders to have at least five vehicles registered on the one account. Visitors that are in Sydney they can purchase the visitors e-PASS which allows visitors to travel on all Sydney toll roads for up to 30 days (Roam 2011). Transurban is also involved in the business of consulting they are experts in their industry and offer consulting services. Their consulting clients are from the public sector such as councils and governments domestic and abroad. Their expertise is in the development and management of electronic toll roads, traffic projection and modelling.

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2.5 Toll Roads

Transurban has interests in eight toll roads, six of the eight toll roads are in Australia and two are in America. The six toll roads in Australia are the CityLink, M2 Hills, Lane Cove Tunnel, M1 Eastern Distributor, M7 Westlink and M5 Motorway. The two toll roads in America are the Pocahontas 895 and Capital Beltway HOT lanes.

2.5.1 CityLink
The company flagship asset is CityLink which is 100% owned and managed by TCL. It connects to three major freeways, the West Gate, Tullermarine and Monash. The freeways link to Melbourne manufacturing hubs, city, port and airport with around 22 kilometres of motorway. Melbournes CityLink was one of the worlds first fully electronic toll roads with currently more than 1.8 million vehicles registered to use the toll roads. CityLink was first opened to traffic in August 1999 and the company has a concession to operate the road until 2034 (Transurban 2011).

2.5.2 M2 Hills
Sydneys M2 motorway was first open to traffic in 1997 and was acquired by Transurban in June 2005. The M2 in Sydney has 21 kilometres of motorway, it links the lower north shore of the city with the northwest regions and connects to the Westlink M7 and the Lane Cove Tunnel. The M2 is a combination of electronic toll and cash toll connections, there are certain lanes for each. The company has 100% interest in the M2 and currently has a concession to operate the road until 2042 (Transurban 2011).

2.5.3 Lane Cove Tunnel

Lane Cove Tunnel has about 3.6 kilometre of motorway it connects to the M2 and has a fully electronic tolling system. The tunnel is located in Sydney it was opened to traffic in 2007 and was acquired by Transurban in August 2010. It is 100% owned by the company and they have a concession to operate the road until 2037 (Transurban 2011).

2.5.4 M1 Eastern Distributor

The M1 is 6 kilometres of motorway that links Sydneys City Centre, Harbour Bridge and Tunnel, southern suburbs and Sydneys airport. The road contains a combination of electronic and cash tolling and includes a 1.7 kilometre tunnel. The road was first opened to traffic in 1999 and was acquired by the company in 2007 with a concession to operate the road until 2048. TCL has a 75.15% interest in this asset (Transurban 2011).

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2.5.5 M7 Westlink
The M7 Westlink consists of 40 kilometres of motorway in Sydney and links to M2, M4 and the M5. The road is a full electronic toll operated road and improves access to Western Sydney by helping motorist avoid traffic lights. The M7 was opened to motorist in 2005 and was acquired by the company also in 2005. They currently have 50% interest and a concession to operate the M7 until 2037 (Transurban 2011).

2.5.6 M5 Motorway
Transurbans sixth asset in Australia is the M5 in Sydney, the M5 is 22 kilometres of road and connects the F5, M5 East and M7 Westlink motorway. The motorway contains a combination of electronic and cash tolling system. It was first open to traffic in 1992 and was acquired by TCL in 2007. The company has a 50% interest and a concession to operate the toll road until 2023 (Transurban 2011).

2.5.7 Pocahontas 895

The Pocahontas 895 was the first international toll road added to Transurban toll road portfolio. TCL acquired the asset in 2006 with a 75% stake and has a contract to operate the road until 2105. The Pocahontas 895 is a 14 kilometres stretch of road in Richmond, Virginia, USA and is a combination of cash and electronic tolls (Transurban 2011).

2.5.8 Capital Beltway HOT Lanes

The Capital Beltway HOT Lanes is a project that Transurban is currently completing, the construction began in early 2008 and is expected to open in 2013. The construction consist of 22 kilometres of electronically tolled HOT lanes with an additional two lanes added to each direction bring the total to twelve lanes. TCL has a 67.5% interest in this asset which is still currently under construction (Transurban 2011).

2.6 Corporate Strategy and Objectives

According to the Transurban annual report (2010) the chairman of Transurban Group, Mr Lindsay Maxsted, year 2010 was a great year in term of growth in revenue on all the Australian assets and 13% of increment in EBITDA. These results had facilitated the generation of 31.8% growth in underlying free cash to $347.5 million. Since year 2008, objective to reduce cost had been delivered successfully this will save the corporation $45.3 million, twice as much as what 16 | P a g e

was expected from the original cost cutting target. The following highlights the projects that will be carried out by Transurban Group as part of their development strategy and objectives to be achieved in the coming future: 1. MI-Citylink upgrade in Melbourne Extra lanes and freeway management system will be constructed to improve the traffic flow and reduce congestion on M1 which includes CityLinks southern section. The cost is estimated to be $1.39 billion. The upgrading of M1 is forecasted to increase the traffic level to additional 7% on CityLink within 5 years and improving the safety level when travelling on the busy road corridors. 2. Hills M2 upgrade in Sydney Additional lanes will be built in both directions along 14.5km of the motorway and widening the tunnel as well as installing new tolled ramps to improve the access to the motorway and alleviate congestion. The cost is approximately $550 million. Upon the completion of the upgrade, it is expected to drive in more traffic by approximately 17,300 average daily trips by year 2016. 3. M5 widening in Sydney (Interlink Road Project) Expanding the 21km motorway which is the main route for freight, passenger and commercial between Port Botany and Sydney airport and South West Sydney to three lanes in each direction to reduce traffic jams. The cost of the project is approximately from $350-$450 million. The project is estimated to increase the traffic and boast up the revenue. In terms of economy benefits, M5 widening will enhance the network connection between the airports, industrial hubs and ports. The overall outcome is it will reduce the travelling time for road users. 4. Building 58 new bridges and two electronic tolled Hot Lanes in Washington DC (US) On a 22km section of the 1-495 ring road, two new electronically tolled Hot Lanes will be built in each direction which increase the total number of lanes from 8 to 12.In term of replacing the old infrastructure, 58 new bridges and overpasses will be constructed. The project will cost approximately $US2 billion. In terms of economic benefits, over the year of 2008 to 2013, the massive project opens up 11,800 jobs for the public and $2.7 billion in the economic for the Washington metropolitan area. 5. 1-95/395 Hot Lanes Project Collaborating with Fluor-Lane, both are working with the Virginia Department of 17 | P a g e

Transportation in reviewing and finalising the financial plan, scope and timeline for the 195/395 Hot Lanes Project Transurban Group is very optimistic about the future where the projects are to be carried out will boost the corporations cashflows in long term, driving the returns and creating value for the shareholders.

2.7 Sources of Competitive Advantage

Transurban Group has been actively carrying out massive multi millionaire dollars projects as part of their development plan to expand their territory in Australia as well as in United States. Several factors that make Transurban Group being competent in the market are: 1. Technology advancement enables the Transurban Group to appear as the world leader in electronic tolling and providing excellent customer service with more than one million fully interoperable e-Tag devices. 2. High barriers to entry into the market due to the government regulation and high cost of establishment make Transurban Group one of the dominant players in the road tolling market. 3. Transurbans traffic forecasting is highly regarded which strengthen the asset acquisitions and projects enhancement. 4. Efficiency of the operation and management teams in ensuring all the massive projects are constructed effectively according to the timeline. 5. Diversification of capital funding options. 6. Good relationship with the lenders, stakeholders and governments which creates more business and development opportunities in future. (TCL Annual Report 2006) The definition of competitive advantage is an advantage that the company has over its competitors which allow the company to perform better in the market. Examples of competitive advantage are customer service, companys cost structure, product and facilities offered, network distribution and the companys management (Investopedia 2011).

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2.8 Ownership Structure

Table 2: Transurban Substantial Shareholders as at Last Notice 01/09/2010
Shareholding Share Held (%) Capital Partners Pty Ltd 187,139,384 13.50 Canadian Pension Plan Investment Board 182,552,346 12.90 *Source: Transurban Group Annual Report (2010)

The two largest shareholders of the Transurban Group since 2009 were Capital Partners and Canadian Pension Plan Investment Board. From year 2009 to 2010, there was a declination of total shares held by Capital Partners which was 2.09% and CPPIB was 0.51%. Ontario Teachers Pension Plan Board was in the list of the substantial shareholders in year 2009 withholding 12.22% of the securities and was dropped out in 2010. Other companies that were substantial sold over the past 12 months were National Australia Bank, BlackRock Investment Management Limited, Capital Partners and Ontario Teachers Pension Plan Board (MorningStar 2011).
Table 3: Distribution of Shareholders of Stapled Securities
Ordinary Shares 1-1,000 1,001-5,000 5,001-10,000 10,001-100,000 100,001 > Total Number of shareholders 24,717 31,107 7,109 3,845 225 67,003 Number of Shares 9,743,880 78,306,126 50,916,469 81,493,545 1,220,830,613 1,441,290,633 *Source: Transurban Group Annual Report (2010)

The total numbers of individual shareholders were 67,003 and the total numbers of shares held were 1,441,290,633. Ordinary shareholders have voting rights and each share represents one vote. Besides that, there were 5,687 holders of less than a marketable parcel of shares.
Table 4: List of the Top Twenty Shareholders as at 01/09/2010
Shareholder AMP Life Ltd ANZ Nominees Ltd ANZ Nominees Ltd (i) Argo Investments Ltd Australian Foundation Investment Co. Ltd Australian Reward Investment Alliance Bond Street Custodians Ltd Citicorp Nominees Pty Ltd Cogent Nominees Pty Ltd CS Third Nominees Pty Ltd Djerriwarrh Investments Ltd HSBC Custody Nominees (Australia) Ltd Shares Acquired 11,785,190 10,029,735 5,175,821 3,405,099 14,825,726 8,776,444 3,266,846 33,402,284 17,403,961 5,055,376 3,895,156 479,852,426 Shares (%) 0.82 0.70 0.35 0.24 1.03 0.61 0.23 2.32 1.21 0.35 0.27 33.29

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145,496,316 10.09 J P Morgan Nominees Australia Ltd 349,974,664 24.28 National Nominees Ltd 7,156,613 0.5 Queensland Investment Corporation 9,404,426 0.65 RBC Dexia Investor Services Australia Nominees Pty Ltd 4,880,206 0.34 RBC Dexia Investor Services Australia Nominees Pty Ltd (i) 2,867,732 0.20 RBC Dexia Investor Services Australia Nominees Pty Ltd (ii) 12,389,880 0.86 UBS Nominees Pty Ltd 10,422,999 0.72 UBS Wealth Management Australia Nominees Pty Ltd Total 1,139,466,900 79.06 *Source: Transurban Group Annual Report (2010)

The total shares held by these top twenty shareholders were 1,139,466,900 which was equivalent to 79.06%.

2.9 Capital Structure

Table 5: TCL Net Gearing Ratios

Year Net Gearing (%)

2006 150.51

2007 87.97

2008 83.62

2009 100.04

2010 80.43

*Source: Morningstar DatAnalysis (2010)

Net gearing ratio is measured by (total liabilities cash) divided by shareholders equity. It gives the measurement of the contribution of long term lenders to the long term capital structure of the business taken into consideration of how much cash received by the company. The level of gearing is vital in assessing the risks where it represents the extent where the company is financed by outside parties (Atrill et al.2008). A high net gearing means that the company is heavily financed by outside parties therefore it is vital for a company to have a well balance net gearing percentage. From 2006 to 2008, the gearing ratio dropped significantly by 66.9% and remained at 80.43% in 2010. This is positive change as a decrease in gearing ratio means that the company reducing its risk as debt represents a financial obligation. As compared to 2006, the net gearing was very high, which indicated that the company went into negative gearing where the company geared more than it should. However, the net gearing percentage was still very high in 2010. Gearing is often necessary to finance the business and it increases the return on equity provided it is justified by the returns generated from the assets.
Table 6: TCL Interest Cover Ratio

Year Net Interest Cover Ratio

2006 0.08

2007 0.31

2008 -0.11

2009 0.68

2010 1.14

*Source: Morningstar DatAnalysis (2010)

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Interest cover ratio demonstrates the measurement of the amount profit available to cover the interest expenses of the company. Interest Cover Ratio is profit before interest and tax divided by interest expenses (Atrill et al.2008). For 2006, the interest cover ratio was relatively low, 0.08 which mean that the level of profit to cover the interest payments was low and therefore higher risk. For 2008, the ratio was -0.11 indicating that the business performance was bad because the level of profit was insufficient to cover the interest payments and as a result the corporation needed to come out with a solution to maximise the level of profit. There was an improvement in ratio from 2009 to 2010 which was partly due to the cost reduction plan successfully being carried out in 2008 which save the company $45.3million. Hence, the higher the interest cover ratio, the lower the risk and vice versa.

2.10 Management Structure

Figure 3: TCL Management Structure

The board of directors of Transurban Group comprises of eight non executive directors, one chairman and a chief executive director. The board is being structured where each of the members of the board has different experience, qualifications and skills to ensure effective discussion as well as efficient decision making. The main role of the board is to provide strategic guidance and effective management for the company. Non executive directors do not get 21 | P a g e

involved in running the day to day business, therefore they are considered as independent from the management. They only monitor the executive activities and play an important role when there is conflict of interest. On the other hand, executive director get involved in the day to day business management and is normally a full time employee. There are three committees being established to assist the board in discharging the responsibilities which are Remuneration Committee, Nomination Committee and Audit and Risk Committee. These committees comprise of only non executive directors. Remuneration Committee is accountable of integrates financial report, audit functions of external and internal and deal with risk management systems whereas Nomination Committee is to deal with appointing new board members and performance of the committee and board. Audit and Risk Committee focuses on directors remuneration as well as incentives and remuneration packages for CEO and other senior executives.

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3. INDUSTRY ANALYSIS
3.1 Overview
The industry which the Transurban group primarily operates within is Australias Toll Road Operators industry. The primary activities of this industry include the terminal facilities provision as well as the operation of toll bridge, toll road, weighbridge, and vehicular ferry or punt. For TCL Ltd, it mainly involved in the development and management of toll roads in Australia and the USA. According to IBISWORLD (2010), The Toll Road Operators industry has been growing steadily over the last decade as governments seek to lower the cost of transport infrastructure through Public Private Partnerships (PPPs). As a result, industry revenue has grown by an average of 3.8% per annum to be worth an estimated $2.6 billion in 2010-11. Growth has been supported by new toll roads and increased traffic on existing toll roads. And the increasing opening of new toll roads is bound to have a large effect on the industry, providing a large source of growth. Despite the internal factor of the high demand for toll bridge and road operations, the key success of the industry also results from the external factors, such as: Optimum capacity utilization, Long-term site tenure and location to provide stability, provision of a related range of goods/services ("one stop shop") and advanced technology to reduce costs and increase efficiencies (IBISWORLD 2010).

3.2 Industry External Drivers

The Key External Drivers section mainly looks at the key factors outside the control of an individual business that determine the industry's performance. For Australians toll road operator, there would be four dominant factors boosting the development of the industry in accordance with 2010 industry report. The first factor of the demand for passenger travel is caused by the rapid growth of vehicle ownership. The industry is sensitive to motor vehicle usage in the cities, both private and commercial vehicles. Our research report predicts the number of motor vehicles will tend to increase significantly in the following years, and by 2014 the number of vehicle owners will reach to around 17million (Figure 4). These rising amount will to a large extent support the stable income of the industry.

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Figure 4: Expected Number of Motor Vehicles in Recent Years

*Source: IBISWORLD (2010)

Apart from the rising number of vehicle, real household disposable income contributes proportionally towards the operation of the industry. The greater the disposable income of households the greater the expected demand for use of toll roads. Toll roads provide convenient travel routes but toll fees can be costly especially when a free alternative route available (IBISWORLD, 2010). Figure5 shows that the disposable income fluctuates dramatically from 2007 to 2012.
Figure 5: Expected Household Disposable Income In Recent Years

*Source: IBISWORLD (2010)

Moreover, legislative compliance requirements for services to road transport and the demand for road freight transportation will provide sustained momentum for the steady growth for the industry as well. 24 | P a g e

3.3 Market Segmentation:

Market segmentation is the process of splitting customers, or potential customers, in a market into different groups, or segments.

3.4 Products and Services Segmentation:

Toll road operators are the most profitable segment of the products and services in the industry (figure 6), contributing 79% of industry value in 2011 (IBISWORLD 2011). Beyond the operations of toll roads, the market also includes the provision of support and maintenance services. Industry revenue is expected to boost over the next five year with the opening of the Clem Jones tunnel and Hale Street Link in Brisbane. The Brisbane Airport link is due to be completed in 2012. Container parking, handling, equipment and refurbishment facilities make up the second main resource of income for toll road provider. The industry report states that this segment is closely linked to the port and international trade activity. And it will be hit by the looming Australian recession as trade activity freezes. Besides, the segment of weigh bridges it is closely related to the transportation industry and plays a considerable role in the industry (8%). However, as economic activity grow slowly in Australia; the amount of freight being transported falls significantly which to some extent drives down the revenue from this segment. Vehicle ferries which provide ferry and punt services for vehicles only takes up 1% according to the figure 6. This segment provides services to locals and tourists, as the economic condition improves; demand is expected to recover in the following years.

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Figure 6: Products and Services Segmentation

*Source: IBISWORLD (2011)

3.5 Major Market Segmentation

The major market of this industry is primarily made up of three segments: private motoring (44%), commercial motoring (36%) and trade activity (20%) (IBISWORLD 2010). Private motoring the main resource of revenue, demand from private motorists is negatively related to the price of oil. Due to the soaring price of oil, many motorists simply choose to use public transport than pay the high price for fuel in addition to tolls, parking fees and a congestion levy on inner city car parks. However statistics from IBISWORLD shows the lower price of fuel, and public transport systems that are stretched to capacity will cause some motorists to shift back to the use of toll roads in 2009-10. On the other hand, the use of commercial vehicles is influenced by the economic condition. For example, demand from commercial uses fell in 2008-09 as slower economic conditions decreased freight volumes in Australia. However it rebounded in 2010-11 as Australian consumers increase spending, and retailers and manufacturers rebuild inventory levels. The trade activity segment involves import/export and wharf-related logistics operations, which are subject to movements in trade volumes (IBISWORLD 2010).Since imports and exports in this industry are low and steady, domestic demand will equal to revenue in the absence of imports and exports.

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Figure 7: Major Market Segmentation

*Source: IBISWORLD (2011)

3.6 Industry Participants/Competitors

The dominant competitors in the Australian toll group are Transurban Group, ConnectEast Group and Queensland Motorways Limited and other companies. The followings are the snapshot of major participants in the industry.

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3.7 Porter Analysis

Porter's 5 Forces analysis deals with factors outside the toll road operator industry that influence the nature of competition within it, the forces inside the industry (microenvironment) that influence the way in which firms compete, and so the industrys likely profitability is conducted in Porters five forces model. Porter defined the forces which drive competition, contending that the competitive environment is created by the interaction of five different forces acting on a business. In addition to rivalry among existing firms and the threat of new entrants into the market, there are also the forces of supplier power, the power of the buyers, and the threat of substitute products or services. Porter suggested that the intensity of competition is determined by the relative strengths of these forces. These five forces can be neatly brought together in a diagram like the one below:
Figure 8: Porters Five Forces

*Source: Mind Tools (2011)

1. Supplier Power: The analysis of supplier power typically focuses first on the relative size and concentration of suppliers relative to industry participants and second on the degree of 29 | P a g e

differentiation in the inputs supplied. The ability to charge customers different prices in line with differences in the value created for each of those buyers usually indicates that the market is characterized by high supplier power and at the same time by low buyer power. The key selling industries to the toll road operator make up of metal container manufacturing, lifting and material handling equipment manufacturing and road and bridge construction. Supplier power is high in this case. The technology applies to those specialized manufacture as well as construction is unique and patent. This means there are mere substitutes to replace suppliers in this industry. 2. Buyer Power: The most important determinants of buyer power are the size and the concentration of customers. Other factors are the extent to which the buyers are informed and the concentration or differentiation of the competitors. This force is relatively high where there are few large players in the market. However, as the toll road operator industry is marketed directly to private vehicle users and different commercial transportation industries in various areas, therefore the relative buying power is relatively low. 3. Competitive Rivalry: The intensity of rivalry, which is the most obvious of the five forces in an industry, helps determine the extent to which the value created by an industry will be dissipated through head-to-head competition. The most valuable contribution of Porter's five forces framework in this issue may be its suggestion that rivalry, while important, is only one of several forces that determine industry attractiveness. Competition in this industry is medium and the trend is increasing and competition for toll roads are public roads that act as substitutes (IBISWORLD, 2010). While with a large number of operators, competition in the container services industry is fierce. Operators compete on price, customer service levels and product differentiation. 4. Threat of Substitution: A threat from substitutes exists if there are alternative products with lower prices of better performance parameters for the same purpose. They could potentially attract a significant proportion of market volume and hence reduce the potential sales volume for existing players. Threat of substitution is considerable high, public road and transportation acts as substitutes for commercial traffic along with transport of freight. The high price of fuel will result in a significant number of commuters abandon their cars in favour of public transport. Beyond the high price of fuel, the tough economic conditions will keep pressure on toll roads as many Australians cut spending and use public transport.

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5. Threat of New Entry: The threat of new entrants is usually based on the market entry barriers. They can take diverse forms and are used to prevent an influx of firms into an industry whenever profits, adjusted for the cost of capital, rise above zero. In contrast, entry barriers exist whenever it is difficult or not economically feasible for an outsider to replicate the incumbents position. Barriers to entry in this industry are high and are steady; the ability to demonstrate to governments the benefits associated with Build-Own-Operate-Transfer (BOOT) and Public Private Partnerships (PPP) schemes is the main barrier by entering in this industry. Besides, the incredibly high cost of building transport infrastructure prevents new firms who intending to get involved in.

3.8 SWOT Analysis

SWOT Analysis is a useful technique for understanding a companys external and internal environment which is an important part of strategic planning process. Internal factors to the firm usually can be classified as strengths(S) or weaknesses (W), while external factors are defined as opportunities (O) or threats (T) (QuickMBA 2010). The SWOT analysis provides information that is helpful in matching the firms resources and capabilities to the competitive environment in which it operates. The company Transurban will be analyzed by this four aspects as follows: Strengths: Leading player in the market Holding dominant toll road assets in Australia Asset enhancements Good road performance and safety Innovative transport solutions Transurban, a major player in the marketplace holds approximately 33.6% market share in Australian toll roads industry. Its assets include CityLink (Melbourne), Westlink M7 and Hills M2 (both in Sydney). Apart from that, Transurban also acquired Sydney Roads Group (SRG), which had interests in three major toll roads Eastern Distributor M1 (75.15%), M4 (50.61%) and M5 (50%) (IBISWORLD,2010). These advanced electronic toll road assets play dominate roles in Australian toll road market and it also represent the main income for TCL. According to IBSIWORLD 2010, there were approximately 3.2 million customers using all Transurban roads

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in 2006, and the number of toll road users as well as revenue increase due to the increasing activity of Australias economy. On the other hand, Transurban always devotes to upgrade their existing road assets - projects such as enhancing CityLink's corridor in Melbourne and the Hills M2 motorway in Sydney which will deliver more value to the community. The enhancement improves congestion, safety, driver experience, and travel times. The benefits are moving towards a substantial growth profile. TCL considers Safety as the first priority and insists that safe workplace for their employees and safe roads for the customers. The company undertakes a number of routine safety initiatives on roads where they have management control including routine road safety inspections, incident inspections, and independent road safety audit etc. In some extent, these series of conducts will minimize the probability of road accident as well as establish a reputation for its safety. TCL is a provider of Innovative solutions; Transurban always looks at new pieces of infrastructure and develops new ways to improve their transport networks. Transurban has the expertise and experience to play a strategic role in addressing different challenges which make their existing infrastructure work better and create a more sustainable future. Weaknesses: Outstanding High Debt Levels Given the massive investment and enhancement required, without doubt, Transurban need a large amount of fund to finance its projects. However, statistics from Crude Oil Peak shows the company has accumulated a debt mountain of around $4billion. Up to now, most of the previous debt has not been paid back, but refinanced. The refinancing is done for longer periods to avoid early capital repayments and the repayment problem is pushed into the future. This rolling over of debt has continued recently, when Transurban obtained a bank loan of $740 million for the M2 widening in Sydney. Shareholders might also suffer from the debt problem in that interest payments reduce the dividends they receive, not to mention that the share value drops with higher debts. There does not appear to be any intention to pay back debt in the foreseeable future. The next debt for the M5 widening is already around the corner. Opportunities: Potential Future Transactions 32 | P a g e

Transurban continue to look for further opportunities in the US and Australia that fit their strict investment criteria. In the US, they are actively monitoring significant long-term opportunities, with a focus on Virginia and Georgia (Transurban 2011). For example, the company is developing HOT lanes on the Capital Beltway (I-495)one of the most congested roadways in Washington,DC. The project will maximize capacity and adding value to existing infrastructure corridors. On-going Population Growth The On-going population growth in Australia indicates the generation of higher traffic Volumes. Transurban knows their current toll way assets cant satisfy the increasing needs and that is the reason why TCL undertakes project upgrades. The recent CityLink upgrade is starting to deliver higher traffic flows and enhancements to the M2 & M5 in Sydney should be completed in 2012. As a result, TCL revenues are expected to continue to grow steadily as toll road users increase. The Purchase of Lane Cove Tunnel In May 2010 Transurban brokered a deal to purchase the Lane Cove Tunnel for an estimated $630.5 million (IBISWORLD, 2010). Transurban said that the acquisition of the Lane Cove Tunnel, a 3.6 kilometre roadway in Sydney's north, would increase Transurban's exposure to Sydney's north-west corridor, one of the city's fastest growing business and residential areas. And the Lane Cove Tunnel toll-road concession arrangement will incrementally benefit Transurban's strong business profile by providing some further cash flow diversity to the group. Threats: The Proposition of Carbon Pollution Reductions Scheme (CPRS): Toll roads generate revenue through motor vehicle use and that travel produces greenhouse gas (GHG) emissions. Public policies and community action designed to cut emissions. The Australian Federal Governments proposed emissions trading scheme-the Carbon Pollution Reduction Scheme (CPRS) is one of the action aimed for GHC, which is scheduled to commence in July 2011. Transurban may be exposed to indirect impacts from the introduction of the CPRS in the form of higher energy prices (like fuel price), higher construction materials costs and a potential impact on traffic numbers (Transurban, 2009). In the case of transport fuels, that is the oil refineries. The increased costs will be passed to consumers of fuel. The carrying out of the scheme will have the potential to reduce travel and revenue on toll roads. Urban Congestion and Traffic Management

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In Australia, the Bureau of Infrastructure, Transport and Regional Economics estimate that, without reform, urban road congestion could cost the national economy $20 billion by 2020 nearly double todays estimates. High traffic volumes have resulted in low speeds, slow travel, and significant delays in peak periods. Given the challenges posed by climate change, simply building more roads and allowing cities to continue to sprawl is not the answer. How to develop new ways in addressing the challenges posted by urban congestion is another problem that Transurban faces.

3.9 Industry Outlook

According to IBISWORLDs prediction, the next five years Australian toll road operator will be dominated by the opening of the Clem Jones Tunnel and Hale Street Link in 2010 and the Brisbane Airport Link in 2012. Increased capacity will push industry revenue higher, up by an average of 3.4% per year over the five years through 2015-16 to be worth $3.1 billion. The strong development of Australias economy, the numbers of trucks as well as commercial vehicles will increases. This will combine with the opening of opening new toll roads in Brisbane and the completion of upgrades to CityLink in Melbourne to boost industry revenue. Besides, as the economy recovers, real household disposable income are expected to increase and Australian customers are deemed to spend their higher disposable income. Therefore, the demand for toll road will be boosted which is supported by higher road freight activity. In 2010-11, road freight revenue is forecast to grow by an average of 4.4% per year over the next five years after growing by a strong 6.6 % (IBISWORLD 2010). The proposition of the Carbon Pollution Reductions Scheme (CPRS) will impose a carbon cost on the upstream producers of carbon emissions. In the case of transport fuels, the increased costs will be passed on to consumers of the fuel. Any increase in the price of fuel as a result of a carbon price will see a small percentage of private motorists move from the use of cars to public transport while others will seek to reduce their transport costs by using public roads and avoiding toll roads. However, this scheme has been delayed until 2013 and the delay in implementation and possible changes and amendments means it is unclear what, if any effect a carbon price will have on the industry. Secondly, in the past couple of years, the fuel prices have been experienced extraordinary fluctuation and are not expected to return. As global economies begin to recover from 2010-2011, the price of oil is expected to cool down and demand will increase. For many Australian, vehicles 34 | P a g e

become an essential transport tool and the stable fuel price encourages the extensive use of vehicles (IBISWORLD 2010). This will support an increase in the number of vehicle journeys on toll roads over the period through 2015-16. Road congestion Australia is expected to increase significantly over the next 20 years with the Bureau of Infrastructure, Transport and Regional Economic forecasting that road congestion will cost the Australian economy $20.4 billion per year by 2020. Apart from that, due to an increasing population density in cities across the country it is likely that any new major road projects will include significant land acquisitions costs or require the building of tunnels (IBISWORLD 2010). It is impossible that governments alone can fund the required investment in new roads, bridges and tunnels. Therefore, government is likely to seek assistance from private operators to fund such projects, creating new toll roads and this would boost industry revenue. New traffic projections of North-South tunnel (a new toll road) in Brisbane indicate that the potential number of vehicles using the tunnel could be higher. The 6.8 kilometre tunnel running from Woolloongabba in Brisbane's south underneath the Brisbane River and Story Bridge to Bowens Hills in the city's inner-north opened in 2010 and the project of the airport link is expected to be completed and opened to traffic in 2012 (IBISWORLD 2010). The new road and tunnel will boost the industry revenue.

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4. ECONOMIC ENVIRONMENT
4.1 Overview
After a sharp, broad and synchronized global downturn in late 2008 and early 2009, an increasing number of countries have registered positive quarterly growth of gross domestic production (GDP), along with a notable recovery in international trade in 2010 and 2011 ( World Economic Outlook 2011). The world economy is expected to grow at about 4.5 percent a year in both 2011 and 2012, with advanced economies growing at only 2.5 percent and emerging developing economies growing at a higher 6.5 percent (World Economic Outlook, 2011). Emerging Asian economics are leading the world recovery; particularly China while advanced economies Europe and United States lag behind International Monetary Fund 2011). The world economic is on the mend. However, the recovery is expected to remain sluggish and uneven. The conditions for sustained growth remain fragile (IMF 2011). Transurban Group is a toll road owner and operator with interests in Australia and North America. Its business comes from the Australian market and American markets, thus future earnings are leveraged primarily from the outlook of these economies. Thus we will focus on Australian and American economies for the macroeconomics analysis.

4.2 Macroeconomic Indicators

It is important to look at a range of macroeconomic indicators to evaluate the state of the current economy and forecast the future outlook. In this report, oil prices, inflation, interest rates and exchange rates will be discussed.

4.2.1 Oil Prices

Crude oil prices behave much as any other commodity with volatile price swings in times of shortage or excess supply. The crude oil price cycle may extend over several years responding to changes in demand as well as OPEC and non-OPEC supply (WTRG Economics 2009). Oil prices have surged to about $110 a barrel April 2011, as precautionary demand and risk premiums have increased in response to the oil supply shock triggered by events in the MENA (Middle East and North Africa) region. The key cyclical factor was stronger-than- expected growth in demand for commodities during the second half of 2010, which drove up oil prices for 2011 to about $90 a barrel by early January2011, up from the $83 a barrel expected in April 2010.

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Figure 9: Global Oil Demand and Production by Region (Millions)

*Source: International Monetary Fund (2011)

The run-up in oil prices preceding the onset of the oil supply shock reflected a number of factors. Annual growth in oil demand in 2010 was 3.4 percent, the highest rate since 2004.Oil supply responded to the unexpected increase in oil demand, but not to the full extent possible. Global oil production is estimated to have increased by 3.2 percent in 2010 (World Economic Outlook 2011).

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Figure 10: OPEC and Non-OPEC production

*Sources: IMF Primary Commodity Price System (2011)

OPEC crude oil production, which is subject to production quotas, rose by 1.8 percent, contributing one-quarter to the increase in global supply (Left panel and figure 10). Global oil production is estimated to have increased by 3.2 percent in 2010. Higher-thanexpected non-OPEC production contributed about half of the surprise increase in supply. Declines in the North Sea were more than offset by higher production elsewhere, notably in Brazil, China, Russia, and the United States, reflecting incentives for investment and field decline management embodied in rising oil prices and, in the case of Russia, changes to the tax regime to cover high production and development costs (Right panel and figure 10).

Owing to the raising crude oil price, consumer may choose other transportation instead of Transurban Groups toll roads, it would be expected that families will be cutting back on expenses for family budgets. Consequently, Transurban Groups trading in South America and Australia will be influenced.

4.2.2 Inflation
In mainstream economics, the word inflation refers to a general rise in prices measured against a standard level of purchasing power. Previously the term was used to refer to an increase in the money supply, which is referred to as expansionary monetary policy or monetary inflation (Trading Economic 2011). The inflation rate in Australia was last reported at 2.7 percent in the fourth quarter of 2010. The most well known measures of Inflation are the CPI which measures consumer prices, and the

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GDP deflator, which measures inflation in the whole of the domestic economy (Trading economic 2010).
Figure 11: Australia Inflation Rates (2008 -2010)

*Source: Trading economics of Australia (2011)

Figure 12: Australia Long Run Inflation (1960-2010)

*Source: Reserve Bank of Australia (2011)

The Governor and the Treasurer have agreed that the appropriate target for monetary policy in Australia is to achieve an inflation rate of 23 per cent, on average, over the cycle. Seeking to achieve this rate, on average, provides discipline for monetary policy decision-making, and serves as an anchor for private-sector inflation expectations. Inflation in Australia is moderate due to slow wage growth, exchange rate appreciation and easing demand (Inflating Target RBA 2011).

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Treasurer Wayne Swan believes inflation is expected to rise a quarter of a percentage point in the March quarter of 2011, as a result of Australia's devastating floods (Herald Sun 2011). As inflation rises, the price of oil and the price of consumer goods are expected to rise, this will result in a decrease of the demand which in result an expected fall in consumption. Consumers will take the cheaper alternatives of transportation, Transurban Group will possible face a decrease in revenue in Australia.
Figure 13: US Inflation Rates (2005-2010)

*Source: Trading Economic (2011)

As we can see from the chart, the inflation starts to increase at the beginning of 2010. The inflation rate in United States was last reported at 1.6 and 2.1percent in January and February of 2011 and at 2.7 % in March of 2011. US Consumer Price Index for All Urban Consumers (CPI-U) increased 2.1 percent before seasonal adjustment over the last 12 months, the Bureau of Labour Statistics reported on March 17. For the month, the index increased 0.5 percent prior to seasonal adjustment in 2010 (Trading Economic 2011). However, in the US oil prices played a lead role in the rise of inflation during 2010 the current level of inflation (Dec 2009- Nov 2010) is 1.1%, and energy prices increased in the U.S. by 3.9%. (Bureau of Labour Statistics (BLS) 2011) Because of increasing inflation, the price of oil and consumer goods will rise; this will lead to decrease in demand and consumption. Consumer may choose the cheapest way to travel (e.g: public transaction) instead of toll road.

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4.2.3 Interest Rates

Figure 14: Australia Interest Rates (2004-2010)

*Source: Trading Economic (2011)

From 2004 to 2010, Australia's average interest rate was 5.81 percent reaching a record high of 7.50 percent in 2008 and a record low of 3.00 percent in April of 2009. Interest rates are controlled by the central bank (Reserve Bank of Australia). The official interest rate is the cash rate. The cash rate is the rate charged on overnight loans between financial intermediaries, this is determined in the money market as a result of the interaction of demand and supply of overnight funds (Trading Economic 2011). Since the global financial crisis, the RBA has reduced the cash rate to record lows in order to help stimulate the economic. The cash rate in Australia was last reported at 4.75 percent. Reserve Bank of Australia decided on the 1st March 2011, to keep interest rate unchanged at 4.75% (RBA 2011). Westpac Economist Bill Evans predicts that the next interest rate rise will come in April 2011, and this will be the first of three for that year (Tom Reid 2011).

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Figure 15: US Interest Rates (2002-2010)

*Source: Trading economic (2011)

US Interest rate (2002-2010) shows that the interest rate in US has increased by 4.28% from 1.02% in May 2006 to 5.3% in October 2007 and has decreases to 0.25% in January 2009, this can be seen in figure 15. In the United States, interest rate decisions are divided between the Board of Governors of the Federal Reserve (Board) and the Federal Open Market Committee (FOMC). The Board decides on changes in interest rates after recommendations submitted by one or more of the regional Federal Reserve Banks. The FOMC decides on open market operations, including the desired levels of central bank money or the desired federal funds market rate. According to Trading Economics 2010, the Federal Reserve has kept interest rates unchanged at 0.25% from January 2009 to August 2010 (Trading economic 2011). The low interest rates would make it attractive for business spending as it would be cheaper for Transurban to fund new projects and also reduce current debt. Less interest expenses will result in increase in net profit.

4.2.4 Exchange rates

The behaviour of currencies in the foreign exchange market is hard to forecast because there are many factors to consider across many countries.

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Figure 16: Australian Dollars vs US Dollars (2010-2011)

*Source: RBA (2011)

Australias real exchange rate has appreciated over the last years, driven largely by an increase in the term of trade and bringing with it benefits and challenges for the broader economy. Many variables have been identified as correlating with the real exchange rate, including productivity, inflation and investor perceptions (RBA Economic Competition 2010). The rise of interest rate has had positive effect on the AUD in the last month. Inflation has increased as a result of a decrease in money supply (i.e. currency), this means an increase in inflation rates will cause increase in the price of Australian products. This will create less demand for Australian product (decrease Australian export) which leads to a depreciation in AUD (appreciation in USD). The stronger currency is likely to negate higher earnings from the growing commodity exports and may result is cautious business sentiment for sometimes. For example, Australia dollar appreciation will affect business in America and the profit in America will decline. Thus, there will be a higher risk of exchange between the countries.

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4.3 Economic outlook

Figure 17: World Economic Growth Rate (2004-2010)

*Source: World Economic Situation and Prospect (2010)

Overall, the worlds GDP is expected to climb in the future since economic recovery is on the mend. In 2010 it was a year of recovery, it was sputtering and many questioned whether the recovery was real and if it could be sustained. In 2011 things are looking brighter following a booming stock market up 13%, a new 2011 Tax Stimulus package, and housing markets stabilizing around the country. But the one major area of concern is unemployment, which is high around 10% despite improving corporate and small business profits (Todays Economic 2011). As a result of the positive economic outlook consumer and business confidents is expected to be strong as the world economy is experiencing the expansionary phase of the business cycle.

4.3.1 Estimated Market Return

Since Gross Domestic Product (GDP) growth serves as an indication of the level of economic activity, we assume expected market returns are driven by the changes in GDP growth. If GDP growth is high, then it indicates that the level of economic activity in the economy is high and consequently investors are optimistic and confident about the current economic condition as they are expecting a higher return for their investments. As seen in the table below, if change GDP is over 5%, then estimated market return will be 25% and the assumed probability that it will occur is 15%, there will be a weighted expect market return of 3.75%. Inversely, if GDP declines, then it indicates that the economic activity is slowing down and investors may not expect as high of a market return. The table below shows that if the change in GDP declines is in the range of 3% 4%, then estimated market return will be 15% and the probability of that occurring is 40% there will be a weighted 6% expect market return. We expected that there will be a strong to weak 44 | P a g e

growth in RGDP hence we have weighted the probability heavily in those periods (75%). The table below shows the inputs that have been used to calculate the expected market return for the current period. The expected market return for the period is expected to be 11%.
Table 7: Estimated Market Return
Macroeconomic Performance (% Change in Real GDP Very Strong (>5%) Strong (3% - 4%) Weak (1% - 3%) Very Weak (<-1%) Estimated Market Return Probability Expected Market Return

25% 15% 5% -5%

15% 40% 35% 10% E(Rm)

3.75% 6.00% 1.75% -0.50% 11%

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5. CURRENT ISSUES
Transurban Group like many of peers also faces external factors that affect its future and potential growth. Macroeconomic and microeconomic factors will now be discussed to examine the current issues that the company may face during a time of rising prices and in a recovering world economy.

5.1 Macroeconomic Factors

5.1.1 Increase in Oil Price
The increase in world oil price since 2009 has reflected the combination of expectations of the recovery of world economy which lead to a higher consumption in oil. Investment and speculative demand are also among the factors that contributed to the rise in world oil prices. From 2009 to 2010, Australias crude oil and condensate production is forecasted to drop by 2.3% from 2008. Thus, due to the lower production in year 2009, Australias crude oil and condensate exports are forecasted to drop by 2.4% and consequently causes the prices of oil to increase by 3.5% to 9.1billion. As a result, the increase in oil prices has a major impact of declination in consumption of petrol. Consumers decrease their petrol consumption level by travelling with public transport instead of driving their own vehicles. This will cause the total revenue of Transurban Group to decrease due to the diminishing level of traffics (ABARE, 2011).

5.1.2 Increase Level of Debt to Disposable Income

Among the other countries in the world, Australia has the highest household debt to disposable income ratio. This has a negative indication as in average Australia household has bigger debts (Denning D 2010). According to RBA, debt to disposable income ratio had increased from 92.4 in 2009 to 97.4 in 2010. The latest RBA report showed that interest rates had increased which overall increases the interest payments as a share of disposable income have increased from 10.6% in 2009 to 12.1% for 2010 due to the monetary policy taken by RBA to control the inflation rate (RBA 2011). As Australians are engaging in the higher level of debts, therefore they need to cut down on their daily expenditure in order to sustain the debt repayments. It is a bad sign for the growth of revenue for Transurban Group as people cut down on their travel cost by consuming less petrol or avoid paying toll by using public transports.

5.1.3 Availability of Public Transport

Depending on the location of the areas, public transports can be a threat to Transurban Group. Due to technology advancement, public transports such as buses, trains and trams are built 46 | P a g e

connected to most of the areas especially in big cities like Melbourne and Sydney. Statistics showed that yarra trams and metro trains have been delivering average of 80% in their performance achieved (Yarra Trams 2011). The efficiency of public transports had been consistently increased which boost the confidence of passengers in taking public transports. Hence, more people will start to take public transports as it is more convenient and save costs.

5.1.4 Government
Few massive projects carried out by the Transport Victoria Government such as regional railway stations upgrade and Westlink will have negative impact on the traffic growth of Transurban Group. The upgrade of regional railway stations enhances the connectivity with bus and coach services and better access to rail services. Improvement of passenger amenities promotes the numbers of people taking public transports (Victoria Department of Transport 2011). NSW governments strategy to speed up the plan and construction of the 23 km North West rail link will have negative impact on Transurbans profit level. The North West rail link will connect the passengers from areas including Castle Hill and Rouse Hill to the city making the travelling to and from city a cheaper and easier way (NSW Department of Transport 2011). Upon the completion of all these projects, the number of passengers using the tollway will decline as more passengers are using public transports.

5.2 Microeconomic Factors

5.2.1 Potential Investments
Transurban Groups growth was attributed a lot to acquisitions on strong assets and investments into new information technology systems. According to the latest half yearly report, Westlink M7 had great potential of maximising the revenue return as southern section of the road in Sydney had high industrial development which would continue to deliver more traffic. Western Sydney continued to deliver high population growth and high employment which would drive in more traffic along M7. Besides that, according to the half yearly report of Transurban Group, there was 10.3% in the growth of revenue which indicated that the growth rate had been strong (Transurban Half Yearly Report 2011). Therefore, Transurban Group should invest in upgrading the Westlink M7 as one of the project in future to sustain more traffic along M7.

5.2.2 Competitors
Due to high cost of establishment and extensive government regulations, the entry of new competitors to the markets is tough. Nevertheless competitions within the industry still exist. 47 | P a g e

Connect East and Queensland Motorways are the two largest competitors to Transurban Group. There are few major projects such as Eastern recreation precinct, Eastlink service centre, Somerfield, The key industrial park and Peninsula Link along the Eastlink tollway will be completed in 2011 and 2013 are forecasted to generate more traffics towards the eastern surburbs (CEU Annual Report 2010). As for Queensland Motorways, there are two major projects being commenced by them which are Gateway upgrade project and free flow tolling on Gateway and Logan motorways. The completion of these two projects will bring positive outcomes to the public as it provides better connections for business, tourism and industry and reduces traffic congestion (Queensland Motorways 2009). It can be seen that the eastern freeway is dominated by Connect East and upon the completion of the projects along the Eastlink, traffics will be diverted from the North suburbs towards the Eastern suburbs. On the other hand, Queensland Motorway is on the move to dominate the toll roads in Queensland which restrict the expansion of Transurban to that particular state. The impact is estimated will decrease traffic growth of Transurban Group.

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6. FINANCIAL ANALYSIS
Transurban Groups financial statements are complied consistent with the Australian accounting standards and has been audited by the PriceWaterHouseCoopers accounting firm.
Figure 18: Historical Income Summary (5 years)

*Source: Morningstar DatAnalysis (2011)

Transurban Group had been experiencing strong increase in operating revenue. There was a total increase of 344 million which equivalent to 84.52% from year 2006 to year 2010. There was a 49 | P a g e

big increase which was 136 million in operating revenue from year 2007 to 2008. The large increase in the operating revenue was due to the successful acquisition asset of Eastern Distributor (ownership of 75.15%) and M5 Motorway (ownership of 50%). Eastern Distributor generated total revenue of 73.7 million while M5 Motorway managed to generate total revenue of 163.6 million which contribute to the increase in the Transurbans operating revenue (Security review 2008). Overall the strong level of growth in Transurban Group had indicated that acquisition and upgrading of assets managed to drive in more traffic and capture a larger consumer group.
Table 8: EPS Growth Compared to EBIT Growth

Year 2006 2007 2008 2009 2010

EPS (Cents) -7.6 -17.2 -13.1 -1.9 4.6

Growth (%) -126.31 23.83 85.49 342.11

Growth EBIT (%) 370 -144.68 633.33 80.36

*Source: FinAnalysis (2011)

EBIT (Earnings before interest and tax) is used to measure the profitability level of the firm which capture the businesses ability to generate profit on its sales irrespective of other factors such as government taxation policy of incorporation or how the business is financed. Transurbans EBIT margin had increase of 370% from 2006 to 2007 and had decreased of 144% in 2008. The decrease in EBIT margin for 2008 was due to the acquisition of new assets, Eastern Distributor and M5 Motorway where the depreciation charged on new assets employed were larger. There was a massive increase in EBIT from 2008 to 2010 which was 1061.9%. Other factors such as increase in toll fees on heavily populated urban areas had contributed to the increase in operating revenue hence higher EBIT and massive cost reduction since 2008 which save the company of total $45.3 million reduced the operating expenses eventually contributed to the increase in EBIT (TCL annual report 2009). EPS (Earnings per share) had been showing negative figures since 2006 to 2009 which indicate that Transurban Group had been heavily financed by debt due to the company been actively acquiring new assets in year 2007 to generate more revenue. It showed improvement in EPS after 2007 but still remained negative figures because the new assets had not been generating sufficient revenue to cover the financing costs of the company. However, the dividends were still being paid out to meet the investors expectations and also the company was very optimistic to turn around the negative EPS into positive EPS once the assets started to generate sufficient revenue 50 | P a g e

in future. There was strong growth in EPS in 2010 which was 342.11% which turn around the negative EPS into positive value which had proven the companys ability to generate profits for the investors.

6.1 Dupont Analysis

Dupont Analysis provides a detailed analysis in evaluating the return on equity for the company. The extended Dupont system captures the evaluation of the companys profit margin, total asset turnover, the effect of financial leverage on the company as well as the effect of income taxes on ROE.
Figure 19: Dupont ROE Analysis Framework

*Source: Merck & Company, A comprehensive Equity Valuation Analysis

To conduct the analysis of Dupont ROE, Transurban Groups financial performance have been compared relative to its peers which are CTI Logistics Limited (CLX) and Toll Holdings Limited (TOL).

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Table 9: Summary of Extended Dupont Analysis

*Source: FinAnalysis (2011)

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6.1.1 EBIT/Sales
EBIT or can be considered as reported earnings before interest and tax and it attempts to measure the profitability of the firm. Through this ratio, the investors can compare the efficiency of the company in generating profit with the peers and gain a broader view in making investment decision. The EBIT margin for Transurban Group had increased from year 2006 to 2007 but had deteriorated in 2008 and experienced an increase again from 2009 to 2010. Comparing to all the peers, Transurban Group had not been performing well in 2006 and 2008 but managed to outperform all the peers in 2010. Toll Holdings had been experiencing decrease in EBIT ratio and CTI Logistics on the other hand had been consistently maintaining the EBIT ratio on the average of 0.12. Transurban Group had the highest EBIT ratio in 2010 as the previous assets acquisition managed to bring in higher revenue to the company. Therefore, it is very optimistic that Transurban Group will continue to experience positive marginal growth as the company begin to benefit from the assets acquisition as well as massive upgrading projects that will drive in more revenue.

6.1.2 Sales/Total Assets

Total asset turnover ratio is to measure the effectiveness of a firms use of its total asset base. Therefore the higher is the ratio; the higher is the volume of sales thus higher the profitability of the firm. Transurban Group had the lowest total asset turnover ratio comparing to the other peers. According to the ratio, Transurban Group had not been able to maximise the usage of the asset in generating more income. The latter is due to Transurban Group had been carry major fix assets that caused the ratio to be low. However, Transurban Group had been showing consistent increase in the ratio until 2009 and remained unchanged in 2010. This showed that the company was trying to improve the management of the assets and became more efficient in handling the assets. It is most likely that Transurban Group total asset turnover ratio will remain low due to the company carry a higher fix asset base comparing to the rest of the companies.

6.1.3 EBIT/Total Assets

The return on asset ratio (ROA) measures the efficiency of the firm in delivering profits from the assets regardless the size of the firm. A high ROA indicates that the company has a good financial and operational performance and vice versa. Transurban Group had the lowest ROA ratio comparing to the competitors. Transurban Group had been massively expanding and acquiring new assets which caused the company went into heavy financing. In year 2008, Transurban Group had a negative ROA ratio as the new acquired assets were not ready to generate more revenue as well as massive upgrading projects been carried out had caused the ratio to decline. However, there was an improvement in the ratio after 2008. CTI Logistics had the highest ROA ratio comparing to the rest which indicated that the company had the best financial and operational performance comparing to Toll Holdings and Transurban Group. It is expected that the ROA for Transurban Group will increase in future upon the completion of the massive upgrading projects such as MI-Citylink, Hills M2 and M5 in Sydney.

6.1.4 Interest Expense/Total Assets

The interest expense to total debt ratio reflects the interest rate that the company has to pay on its total debt. A high interest expense ratio is not a good indication for the company because the company is paying a high interest rate on the debt and thus will increase the total expenditure of the company. Transurban Groups interest expense ratio had been consistently remaining on the average of 1.6% which was low. This was due to the offset of interest revenue. It also came to show that although the company incurred a high interest expense but the company had been managing the repayment of interest effectively. It is very optimistic that the company will continue to maintain the low interest expense ratio in the future.

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6.1.5 Net Before Tax/Total Assets

This ratio attempts to measure the level of return on the companys asset base before tax. The ratio is quite similar to EBIT/Total asset except it takes into consideration of the effects of interest payments. The ratio had been showing negative figures from 2006 to 2009 which clearly indicated that the level of return on the companys asset before tax was bad and came to prove that the company was not making enough profit to cover the expenditures. However, there was a big increase about 150% in the ratio from 2009 to 2010, which showed significance improvement in the profitability level and where the company had access to more funds before tax. It is very likely that Transurban Group will continue to have increase in the ratio as the expansion of the operations will bring in more profits in future.

6.1.6 Total Assets/Common Equity

This ratio is to examine how a company uses debt to finance its assets. It is also known as financial leverage multiplier. The higher the ratio, the higher the financial leverage and this indicates that the company is relying heavily on debt to finance its assets. Transurban Group had the highest financial leverage ratio comparing to the competitors and this came to prove that the company had been heavily financed by debts because of the companys expansion strategy. The ratio overall decreased from 312% in 2006 to 260% in 2010 which demonstrated that the company had reduced amount of debts as more revenue were generated to cover the expenditures. Transurban Groups ratio is likely to remain relatively high depending on the companys future strategies in expanding the business as it might need extra funds to finance the massive projects.

6.1.7 Net Before Tax/Common Equity

This ratio indicates the return to equity holders before payment of tax. Transurban Group had been showing negative ratio from 2006 to 2009 which demonstrated that the return to the equity holders were poor. Comparing to the other peers, CTI Logistics had the highest return to the equity holders. 55 | P a g e

As Transurban Group had weak performance for the past 4 years, it showed a huge improvement in 2010 where the ratio had increased about 144% from -1.49% to 0.65%.

Looking at the improvement in the ratio, it is very likely that the ratio will continue to increase in future as the company is very optimistic in bringing in more profits to the shareholders with their current strategy plans.

6.1.8 Tax Retention Ratio

This ratio measures the proportion of net income before tax that is not paid in the form of taxes. The higher the ratio, the lower the rate of the tax paid. The tax retention ratio for the Transurban Group had been inconsistent as it experience low rate in 2006, 2008 and 2009 and relatively high in 2007 and had the highest in 2010 which was 233%. Transurban Group had been paying the lowest rate of tax in 2010 comparing to the other competitors.

6.1.9 Return on Equity

ROE measures the companys profitability by demonstrating how much profit the company is generating using the money that is invested by the shareholders.
Figure 20: Five Year Average Return (2006-2010)

*Source: FinAnalysis (2011)

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Transurban Group was the weakest performer comparing to its peers as it had the lowest average ROE for the past 5 years. CTI Logistics was the strongest performer as it had the highest average ROE which was above the average benchmark. Toll Holdings on the other hands had been performing well and managed to achieve ROE slightly higher than the average benchmark.

However, comparing to the ROE of Transurban Group from 2006 to 2010, there was a big increase from -2.5% to 1.5%.

Transurban Group is very heavily relying on the consumers using the service of the toll road; therefore the profits as well rely heavily on the traffics. Taken into considerations of the few massive upgrading projects, upon the completion of the projects, there will be higher level of traffics and the company is very likely to boost up the ROE in the coming future.

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7. VALUATION ASSUMPTIONS
The valuation that will be conducted on Transurban will be on its intrinsic share price value, certain valuations models and techniques are used. The data that will be used for the purpose of this analysis will be based on the firms and the S&P 200 historical data, as well the analysis on the economic outlook.

7.1 Required Rate of Return (CAPM)

The required rate of return for Transurban must be derived in order to use the valuation models, as it will give the discount factor relevant for use in valuation models throughout this report. To calculate the required rate of return the capital asset pricing model (CAPM) is utilised. The CAPM is made up of three components the risk-free rate ( ), market risk premium ( ) and Beta ( ). The CAPM is based on the idea that investors must be compensated for taking on an investment. The two forms of compensation is the time value of money which is represented by the risk-free rate and the second form of compensation is for taking on additional risks which is represented by the product of the assets beta and market risk premium (Investopedia 2011). The CAPM equation required to calculate the relevant discount factor used in the valuation models is presented below:

Risk-free rate (

The risk-free rate is the return that the investors can expect with no risk associated to it. The riskfree rate that will be used for the purpose of the valuation models will be the current 10 year Australian Treasury bond yield. The yield for the 10 year government bond is currently 5.575 percent as of the 15th April 2011 (Reserve Bank of Australia 2011). Market return ( )

The market return is based on the analysis that was performed on the economic outlook. It was calculated that based on the current economic environment the expected market return would be 11 percent. (The full calculation for the expected market return can be seen in section 4.3.1, table 7). Market risk premium ( )

The market risk premium is the difference between the expected return of a risky asset that exceeds the risk less asset. The market risk premium is derived from the difference between the 58 | P a g e

expected market return (11%) and the risk-free rate (5.575%). The market risk premium that was calculated is 5.425 percent. Beta ( ) The beta coefficient is a measure of systematic risk, also known as non-diversifiable or market risk. It measures the systematic risk of a particular risky asset relative to that of a fully diversified market portfolio. The market portfolio for valuation purposes will be based on the S&P200. To calculate the beta the five year monthly total returns indices between 1/1/2006 1/3/2011 for S&P200 were used as the market return and the total return indices for Transurban Group were used for the same period. The equation for the raw beta is as follows:

The equation for adjusted beta is as follows:

The raw beta calculated is 0.6132 and from converting it to an adjusted beta figure it was calculated to be 0.7408. Since the Beta is less than one this indicates that Transurban group inherits less systematic risk than the market. The adjusted beta will be used in the calculation of required rate of return since the beta of individual assets tends to move towards the mean market beta in the long-run. (Refer to appendix 1 for excel beta calculations). Required Rate of Return (CAPM) Calculation By inputting the variables in the CAPM formula investors required rate of return can be derived.

The required rate of return for Transurban stock is calculated to be 9.5939%. This is the investor required rate of return that will be used in the valuations models.

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8. VALUATION ANALYSIS
8.1 Dividend Discount Model (DDM)
The dividend discount model is used to evaluate the intrinsic value of a companys share price. This model is useful for valuation purposes where it can be seen that a company pays dividends. The theory of the model is to determine all the present values of a companys expected future dividends payables to shareholders (Reilly & Brown 2009). To forecast a companys future dividends the appropriate assumptions for dividend growth rates must be used. There are two evaluations models for the DDM that need to be taken into consideration. One of the models that need to be taken into consideration is the stable growth rate model also known as the constant growth rate model. This model is used for when the dividend growth is constant generally in where dividend growth is stable. The requirement in order to use this model is that the required return ( ) must be greater than the dividend growth rate (g). If it is not this violates the assumptions of this model. The equation for the stable growth DDM model is shown below:

The second model is the multi-stage dividend growth rate model. In this model the dividend growth rate can be greater than the required rate of return in the short-run. In this model it takes into account different stages of dividend growth which depend primarily on the attributes of the company, the stages of the business cycle and on the economys future economic outlook. The equation for the multi-stage growth DDM is shown below:

Where:

Since our future expectation of Transurban is for it to experience several growth phases before the company enters into the mature growth phase, both models will be utilised to calculate the intrinsic value of Transurban Groups share price. In calculating the intrinsic value the companys future dividend growth rates must be forecasted.

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8.1.1 Dividend Forecast

The dividend for 2010 that was used was $0.24 per share. This is the sum of the interim dividend for 2010 and the final dividend for 2010 (TCL Annual Report 2010). The full dividend for 2011 was not able to be used since the final dividend for 2011 has not been paid. Firstly we will examine the historical dividend growth rates which can be seen in the table below.
Table 10: Transurban Historical Growth Rates

*Source: company data (Fin Analysis) (2011)

Over the past four years from 2007 to 2010, Transurbans ordinary dividend payment has experienced significantly fluctuation during this period especially the dramatically drop of DPS from 57c to 22c between 2008 and 2009. In addition to the decrease freight volumes from the slower economic conditions, the level of dividends was under further pressure. According to Theage (2009), in 2008 Transurban captured headlines as it raised almost $1 billion capital and shifted from its debt-funded model towards paying distributions out of cash flow. As a result, Transurban's dividend for the half-year has been cut from 28c to 11c (57c to 22c for whole year) and Transurban's net profit follows a $16.1 million loss in 2008/09. After the sharp fall, TCL gained a gradually increase in its dividend payment. For the full year 2009/2010, it was reported that the companys net profit had reached $59.418 million which is up 342% on the prior year (Theweat 2010). Transurban declared a final distribution of 12 cents per security unfranked, bringing total distributions for 2009/10 to 24 cents unfranked. Besides that, Transurban said it expected to pay a higher total distribution in 2010/11 of at least 26 cents, based on the positive outlook for Transurban in the year. Also, despite of the economic cycle, a cost reduction program conducted by Transurban had delivered total savings of $45.3 million since June 2008. This is more than double the original cost reduction target announced at that time. Transurban chief executive officer defined the results and growth in EBITDA was the outcome of continued efforts in pursuing value for the security holders. And the continuing rising distributions of dividends for shareholders demonstrates confidence in the firms capacity to continue to add value.

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Currently, the interim dividend is declared to be 13c per share in the first half year of 2011, but TCL group affirms the expectation to pay distribution in the whole financial year of at least 26c per security. This is supported a strong pipeline of growth projects that would deliver a significant increase to group cash flows and drive returns for security holders over the long term. Although Transurban has provided no guidance to dividend price in the following several years, however we maintain an optimistic attitude towards the steadily revenue growth as well as DPS growth for the firm with the following reason: On-going population growth which should generate higher traffic volumes; The recent CityLink upgrade starting to deliver higher traffic flows The tolls that Transurban charges road users are usually indexed to inflation which suggests toll growth of around 3% per annum given the current inflation rate. We expect to see a stable to mid strength dividend growth rate of 8% in the following three years (2011- 2013) as the enhancements to the M2 & M5 in Sydney will be completed in late 2012. The Hills M2 upgrade is a clear demonstration of attractive enhancement projects that can be undertaken on Transurbans mature toll roads (BusinessSpectator, 2009). These projects unlock capacity for the benefit of Transurban security holders and road users alike. Transurban is forecasted to enter a high dividend growth stage with the growth rates of 14% for about three years. Chris Lynch, the chief executive of TCL, said "We are forecasting 7% uplift in traffic across CityLink by 2015 - over and above regular growth - as a result of the upgrade project." Increasing the dividend signals that directors are confident in the future ability of the company to maintain cash flow. However, we consider the firm will get into a stable stage in the long run with low dividend growth rate which is estimated to be 3% from 2017 onwards. We develop the following timeline according to the assumption weve made:
Table 11: Forecasted Dividend Growth Rates
PHASE 1: Slow - Moderate Growth Stage 2011 - 2013 -Dividend growth rate of 8% -The accomplishment of M2 & M5 enhancement -Construction on the Capital Beltway (I-495) High Occupancy Toll (HOT) lane project with its first tolls expected in early 2013 PHASE 2: High Growth Stage 2014 - 2016 -Dividend growth rate of 14% -The commencing use of the upgrade projects -Traffic volume is expected to be 17,300 average daily trips by 2016 PHASE 3: Stable Growth Stage 2017 - Onwards -Dividend growth rate of 3% -Stable economy -Dividend growth rate close to the level of macro-eco long term growth

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8.1.2 Intrinsic Share Price

Transurban Groups intrinsic share price was calculated to be $5.48, the calculations for the intrinsic values can be seen below in table 12. The calculations were based on the three growth phase that we have made in our assumptions and also based on our required rate of return that we have calculated using the capital asset pricing model. To calculate the intrinsic value of Transurban share price we have used the multi-stage dividend growth model and the stable stage growth model. Comparing our intrinsic value of $5.48 and the market price of $5.31 as of the 15/4/2011, it would suggest that Transurban shares are trading at a discount of 3.1%.
Table 12: Transurban Group Intrinsic Share Price (DDM Excel Calculation)

8.1.3 Sensitivity Analysis

The outcome and accuracy of the intrinsic value in DDM valuation is dependent on variables that have been forecasted in the model, therefore it is necessary to test the significance of these variables. The variables that need to be considered are the growth phases and the required rate of return. Transurban required rate of return is dependent on its market risk premium and the beta. In table 12 we compare the sensitivity of the required rate of return based on different market risk premiums and beta values to measure the outcome of Transurban intrinsic share price.

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Table 13: DDM Beta and Risk Premium Sensitivity (Discount Sensitivity)

It can be seen from the above table that as the companys beta and risk premium increase the intrinsic share price of TCL decreases and vice-versa. It can be seen from the CAPM equation in section 7.1 that as market risk premium or if beta increases the required rate of return required by investors would increase; since the investors are taking on more risk. Based on the current dividend growth rates, for investors to take on more risk reflected by the increase in the required rate of return, investors would want to pay a lower price for the share. Hence increasing betas and market risk premiums would cause the intrinsic share price to decrease and vice-versa. Dividend growth rate sensitivity and its influence on the intrinsic value using the dividend discount model should also be considered. Table 14 below shows the intrinsic price based on the sensitivities of the different growth phases.
Table 14: Dividend Growth Rate Sensitivity

The table above shows that as growth rates increase the intrinsic share price will increase and vice-versa, holding the required rate of return constant. This is also logical, if investors required rate of return remains the same and as dividend growth rates increase investors will be paid a greater return. If investors returns are increasing relative to their required rate of return they will be willing to pay more for the stock. 64 | P a g e

The sensitivity analysis completed for the DDM model shows that the variables forecasted and calculated are sensitive to the calculation of the intrinsic value of its share value. This suggests that the accuracy of the intrinsic value derived is highly dependent on the accuracy of the forecasted growth rates and required rate of return calculated.

8.2 Free Cash Flow to Equity Model (FCFE Model)

The discounted free cash flow to equity model like the dividend discount model is used to calculate the intrinsic value of a companys share price. This model is useful for evaluation purposes where a company does not pay a continuous dividend or any dividends at all. The theory of the model is to determine all the present values of a companys expected future free cash flow to equity available to shareholders (Reilly & Brown 2009). There are also two discount models that need to be considered for valuation of the companys intrinsic value, the stable growth FCFE model and the multi-stage FCFE growth model. The first model to be considered is the FCFE stable growth model; in this model the growth rate is constant as the companys free cash flow to equity is increasing at a constant rate. The requirement is that the required rate of return ( ) must be greater than the FCFE growth rate ( ). If it is not this violates the assumptions of this model.

The equation for the FCFE stable growth model can be seen below:

The second model that needs to be considered is the FCFE multi-growth rate model in this model the FCFE growth rate can be greater than the required rate of return in the short-run. This model takes into account different stages of dividend growth which depend primarily on the attributes of the company, stages of business cycle and on the economys future economic outlook. The equation for the FCFE multi-stage growth model can be seen below:

Where:

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Both of the models will be used in conjunction to one another for our valuation of Transurbans intrinsic share value. Both models will be used as we have forecasted for several different growth phases before the company enters into its mature growth phase. The growth rates for the FCFE must be forecasted in order to use these models.

8.2.1 Cash Flow Forecast

The free cash flow to equity for 2010 that was used is $0.0763 per share. The values used to calculate the free cash flow to equity is obtain from the companys financials from Fin Analysis. The FCFE is calculated from the following equation below:

Assumptions for FCFE calculations: Net Earnings are represented by net profit after tax (NPAT) Debt ratio is calculated from Total Liabilities / Total Assets The rest of the values are taken as is from Fin Analysis

The calculations for FCFE is then converted to a per share figure. In order to convert this to a per share figure we divided the FCFE by number of shares outstanding. The number of shares outstanding is calculated by the market capitalization of Transurban divided by the market price at the end of the corresponding period. Table 15 shows the historical figures of FCFE of Transurban between 2006-2010.
Table 15: Historical FCFE Growth Rates

*Source: company data (Fin Analysis) (2011)

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The historical FCFE shows that its growth rate of FCFE is extremely volatile the extremes are from 109.07% growth from one year to -108.05% in another year. This indicates that the forecast for future expectations on Transurbans FCFE is subject to certain extremes. However the negative growth rate experienced in 2008 could be explained by the global financial crisis (GFC) which we would expect to have a negative impact on the companys cash flow. The future FCFE growth rates have been forecasted based on the analysis detailed in section 8.1.1 of this report. Our analysis expects that Transurban will experience three phases of growth in the coming future. However it is expected that the growth rate phase for FCFE will greater than the growth rate phase from the dividend discount model. Our analysis expects this to be the case since we expect that for the future periods for all the current financing projects that Transurban has undertaken will be in near completion and they will not undertake new projects in the coming future. We expect there to be an increase in cash inflow as the cash outflow is expected to decrease because of the completion on their current projects in the next coming years. Our analysis of the FCFE growth rates has concluded that Transurban will experience several phases of growth, the slow growth stage, high growth stage and stable growth stage. The FCFE growth rate forecast can be seen in table 16 below.
Table 16: Forecasted FCFE Growth Rates
PHASE 1: Slow - Moderate Growth Stage 2011 - 2013 - FCFE growth rate of 32% -The accomplishment of M2 & M5 enhancement -Construction on the Capital Beltway (I-495) High Occupancy Toll (HOT) lane project with its first tolls expected in early 2013 PHASE 2: High Growth Stage 2014 - 2016 -FCFE growth rate of 41% -The commencing use of the upgrade projects -Traffic volume is expected to be 17,300 average daily trips by 2016 PHASE 3: Stable Growth Stage 2017 - Onwards -FCFE growth rate of 3% -Stable economy -FCFE growth rate close to the level of macro-eco long term growth

It can be seen from table 16 that the first phase (slow growth stage) will be from periods 20112013 growing at a rate of 32% and phase 2 (high growth stage) will be from periods 2014-2016 growing at a rate of 41%. Phase 3 (stable growth stage) it is expected that Transurban will grow at a constant rate of 3% as company enter into the mature stage of growth, which is expected to grow at the level of macro-economic growth.

8.2.2 Intrinsic Share Price

Based on the forecasted growth rate for FCFE in section 8.2.2 the intrinsic value of Transurban share is $5.45 which would suggest that its share price is trading at a discount of 2.5688% when compared to the market price of $5.31 as of the 15/4/2011. The calculations and inputs for the discounted FCFE model are shown in table 17. 67 | P a g e

Table 17: Transurban Group Intrinsic Share Price (FCFE Model Excel Calculation)

8.2.3 Sensitivity Analysis

The outcome and accuracy of the intrinsic value of the discounted FCFE model like the DDM valuation is dependent on variables that have been forecasted in the model. Since they will have an effect of the model it is necessary to test the significance of these variables. The variables that will be tested are the growth phases and the required rate of return. The inputs that effect Transurban required rate of return is the market risk premium and the beta. In table 18 comparisons on the sensitivity of the required rate of return based on different market risk premiums and beta values to measure the outcome of Transurban intrinsic share price.
Table 18: Discounted FCFE Model Beta and Risk Premium Sensitivity (Discount Sensitivity)

Table 18 shows an inverse relationship between Transurban intrinsic value based on the FCFE model with Transurbans beta and the market risk premium. As the market risk premium or Transurban beta increases the intrinsic value of Transurban share value decrease and vice-versa. This is also consistent with the sensitivity of dividend discount model computed earlier in section 8.1.3 of this report.

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The growth rate sensitivity in certain growth phases and its influence on the intrinsic value using is also considered. Table 19 represents the intrinsic price based on the sensitivities of the different growth phases.
Table 19: FCFE Growth Rate Sensitivity

The growth rate phase of Transurban has a positive relationship with the intrinsic value of its share derived from the discount FCFE model. If either growth from the first or second growth phase increases the intrinsic value of a share will also increase and vice-versa. Holding the required rate of return constant and increasing the growth rate input from what was previously forecasted investors will be receiving a return greater, hence investors would be prepared to pay more for the stock. The opposite effect will occur when the growth rate forecasted is lower. The sensitivity analysis done for the discount FCFE model shows that the intrinsic value is sensitive to the growth rate forecast and the calculated required rate of return. This suggests that accuracy of the intrinsic values using this model is highly dependent on the forecasted growth rates and calculations of the required rate of return. The sensitivity of the discounted free cash flow model is just as sensitivity as the dividend discount model.

8.3 Pricing Earning Ratio

The P/E Ratio is the relative valuation ratios that compare the companies with similar attributes on the basis of several relative ratios, say, comparing companies with similar risk and industry life cycle. This model attempts to compare the current share price with the companys earnings per share. The P/E ratio model (Earning Multiplier Model) is used by investors to estimate the value of common stock. For example, if investors are willing to pay 10 times expected or normal earnings, they would value a stock they expect to earn $2 a share during the following year at $20. The earning multiplier can be computed as follows:

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Price/Earnings Ratio= Earnings Multiplier:

However, the infinite period dividend discount model (DDM) can be used to indicate the variables that should determine the value of the P/E ratio as follows:

Now if we divide both sides of the equation

(earning per share), the result is:

Therefore earnings multiplier can be ultimately simplified as:

Thus, this model implies that P/E ratio is determined by: The expected dividend payout ratio (dividends divided by earnings) The estimated required rate of return on the stock ( ) The expected growth rate of dividends for the stock (g)

However, this formula cannot be used for the company (TCL), for EPS does not growth at a constant rate. Thus, in this report, we will use the earnings multiplier model formula to calculate the P/E ratio. Given the above formulas and information, we can now calculate the P/E ratio for Transurban:
Table 20: P/E Ratio forecast 2011
2010 Current market price Dividend/EPS Growth rate Earnings per share Estimated P/E ratio 0.046 2011f 5.31 0.08 0.04968 106.88 *Market Price as of the 15/4/2011

Here we expect the growth of the earning derived from per share to be in line with dividend growth rate in this slow growth stage as the enhancement projects of M2 and M5 are nearly

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reaching completion. Our computed P/E ratio of 106.88 suggests that investors are willing to pay $106.88 for every $1 of earnings that the company generates. We will now then use this ratio and compare it to other benchmarks. In evaluating Transurbans P/E ratio to determine whether it is over / underpriced in the transportation sector, we can use TCL's P/E ratio and EPS growth rate to compare it to its industry sector as well as the selected company- Toll Holdings (TOL) in the same sector.
Table 21: TCL VS. The Transportation Industry Sector:

Industry Transportation

F/cast year1-EPS Growth (%) 35.78

Current Price/Earnings 45.31

*Source: FinAnalysis Industry data (2011)

Transurban has a P/E (106.88) that higher than the market or industry average (45.31), this means that the toll road industry is expecting big things in the coming future. For example, the company will increase its influence on the industry, and probably has some comparative advantage to its competitors operating in the same industry or market. A higher P/E ratio usually reflects a higher expectation of future company growth (ThisMatter 2010), which means along with its larger market value, Transurbans investors expect the company to experience high growth in near future. Compared to the industry statistics, TCL has a considerable high P/E ratio and low earning growth rate, this indicates the firm has to live up to the high rating by substantially increasing its earnings, or the stock price will need to drop. Based on the P/E ratio and its growth rate the stock is overpriced by the market when comparing it to the transportation industry. TCL VS. TOL: We also compare Transurban to other competitors in the same industry sector, we picked Toll Holdings Limited (TOL). According to the data from Fin Analysis, we are given 0.76 as the beta for TOL. Therefore the required rate of return ( ) for TOL can be computed based on the previous outcome of CAPM as shown below:

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Recall that ( ) for Transurban is 0.0959, which is slightly less than that of TOL. From the formulas:

We see the inverse relationship between re and stock price, which indicates that as re increases, the price of stock will decrease. In table 22 TCLs and TOLs required rate of return ( ), EPS growth rate and P/E ratio are presented to compare and make a relative valuation assessment.
Table 22: TCL VS. TOL:

Company TOL TCL

Required rate of return(Re) in (%) 9.698 9.59

Earnings growth rate (%) 11.31 8

P/E ratio 13.82 106.88

*Source: FinAnalysis Industry data (2011)

Its commonly understood that higher earnings growth rates translate to higher P/Es, because investors are expecting higher earnings growth in the future compared to companies with a lower P/E. Holding other things being equal, higher growth firms (TOL) should have higher P/E ratios than lower growth firms (TCL).Since TOL has more than 3% higher EPS growth rate than TCL, but a lower P/E ratio than that of Transurban. This means investors of TCL are hoping to get substantial high growth in their earning but in fact it is not. Therefore, the share of Transurban could be overvalued by the market in some extent. On the other hand, a higher required rate of return indicates higher risk for the company, that is, the investment in TOL would be more risky than TCL. Holding other things being equal, higher risk firm is supposed to have lower P/E ratios than lower risk firms. As the risk of two firms is similar, they should have similar P/E ratio but in fact there is a big difference of their value of P/E. Again, TCLs share price must be overpriced. 8.3.1 Sensitivity Analysis The result obtained by the P/E model will be influenced by the changes in dividend growth rate assumption as we have assumed the EPS growth rate is in line with dividend growth rate. Therefore, when dividend growth rate increases, the value of EPS will rise. However, due to the inverse relationship with earnings per share and P/E ratio, the higher growth rates will generate lower value of P/E ratio.

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Table 23: P/E Growth Rate Sensitivity

This also indicates that our twelve month forecast will have a small influence on our calculated P/E ratio and on our conclusion of our valuations. If our forecast were slightly off it would make an insignificant influence on the outcome of our evaluation as the P/E ratio is still over 100 and well above the industrys and TOLs P/E ratio.

8.4 Price/Book Value Ratio (P/B)

This model attempts to measure and allows the investors to compare the companys market value of equity to book value of equity. Thus, this model is effective for investors to identify those stocks that are currently undervalued. A stock where the market value is lower compared to the expected book value ratio is definitely worth buying. Before calculating the Price/book value ratio, there are few steps needed to be completed such as the calculating expected book value of the company and the expected book value per share. Expected book value is computed as:

After computing the expected book value, expected book value per share can be calculated by EBV/No. outstanding shares. The balance sheet for Transurban Group in 2010 demonstrated the number of shares outstanding which manage to make the calculation proceed further. Current share price as at (15th April 2011): $ 5.31 Number of outstanding shares: 1414.29 million Therefore,

The formula that is used to calculate the price/book value ratio is:

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Using the forecasted growth rate which was 8%, the ratio indicated that at the financial year end, Transurban Groups share will be trading at 1.66 times its expected book value of 3.19 per share. The purpose of the ratio is to serve as a reference for the investors in seeking for shares value before it is discovered by other potential investors which cause the price to bid up subsequently. A more effective way of analysing the P/B ratio is to compare the ratio with the past years performance.
Table 24: Transurban Book Share Value 2006-2010

Year Book Equity (000 in $) Shares Outstanding (000) Book Value ($ per share) Current Market Price ($) P/B Ratio

2006 2462200 816630 3.02 6.95 2.31

2007 4016900 1068380 3.39 8.01 2.13

2008 4074600 1218260 3.07 4.23 1.26

2009 3841100 1281360 2.74 4.18 1.39

2010 4176500 1414290 3.19 4.24 1.44

*Source: FinAnalysis(2011)

The table above (table 24), shows P/B ratio was decreasing from 2006 to 2008 and had increased again from 2008 to 2010. A relatively high P/B ratio would be the preference of value investors while a relatively low P/B ratio would be the preference of growth investors. According to the table 24, the P/B ratio for the 5 consequent years did not go below 1 which indicated that the company did not trade below its book value. Comparisons of the P/B ratio with the direct competitor will portrait a better view in term of the equity value of the company.
Table 25: Comparison of P/B ratio of Transurban Group with Competitor

Year TCL TOL

2006 2.31 1.46

2007 2.13 2.57

2008 1.26 1.86

2009 1.39 1.67

2010 1.44 1.41

*Source: FinAnalysis(2011)

The table showed that Transurban Group P/B ratio was lower compared to Toll Holdings from 2007 to 2009. The latter showed that the Toll Holdings equity was more of value compared to Transurban Group. Nevertheless, Toll Holdings had been experiencing decline in P/B ratio from 2008 until 2010 and Transurban Group was experiencing an increase in the ratio. In 2010, Transurban Groups P/B ratio was higher compared to its competitor indicated that the value of the company had increase. Therefore for 2010, the equity for Transurban Group has more value 74 | P a g e

compared to Toll Holdings. Hence, looking at the upward trend of Transurban Group in the P/B ratio, investors are willing to pay more per dollar of book value of shareholders equity of Transurban than Toll Holdings. Therefore evaluating the P/B ratio and also enforced by the calculation of the forecasted growth rate, in future the share price is expected to increase and thus it is attractive at the moment for the investors to buy. Furthermore, compared to year 2006 and 2007, the P/B ratio is relatively higher than 2010, and thus ratio of 1.44 seems to be a fair valuation for the investors.

8.4.1 Sensitivity Analysis

As to examine the relationship between the growth rate and the P/B ratio, different value of growth rates had been computed.
Table 26: P/B ratio over Growth Rate Sensitivity

Growth Rate (%) EBV ($ in millions) EBVPS ($) P/B

5 4385.33 3.10 1.71

6 4427.09 3.13 1.7

7 4468.86 3.16 1.68

8 4510.62 3.19 1.66

9 4552.39 3.22 1.65

10 4594.15 3.25 1.63

11 4635.92 3.28 1.62

*Source: FinAnalysis (2011)

According to the table, there was an inverse relationship between the growth rate and the P/B ratio. As the value of the growth rate increased, the value of the P/B ratio decreased and vice versa. The objective of the table is to measure the accuracy and the sensitivity of how the different value of growth rate will affect the P/B ratio. The table also demonstrated direct relationship with the expected book value per share. As the growth rate was larger, the EBVPS was larger. If the growth rate was forecasted inaccurately, it would cause the inaccuracy in the calculation of P/B ratio. Therefore, it is imperative to use an accurate growth rate or it would cause discrepancies in the calculation of P/B ratio.

8.5 Net Tangible Asset Backing Model (NTA)

The net tangible assets per share ratio demonstrate how much per share investors would receive if the company is to be liquidated immediately. Investors capital loss would be represented by the difference between the purchase price of the share and ratio. Thus, this model is to provide the insight to the investors the level of security that the company will be provided when the company is liquidated. Net tangible asset per share ratio is to be calculated as followed: 75 | P a g e

Transurban Group 2010 balance sheet demonstrated the following values: Net Assets: $4176.5 million Intangible Assets: $7678.59 million Number of Shares: 1414.29 million Therefore, NTA= (4176.5-7678.59)/1414.29 = -2.48 The negative value indicated that when the company went into liquidation, the investors would not be getting any value for the shares. Due to the limited liability investors will not have to pay for the share but lose all the shares if the company went into liquidation. To provide a thorough analysis on the NTA per share ratio, comparison of the companys current share price to its NTA per share by dividing the current share price by NTA can be made as follows: Current Share Price / NTAB= 5.31/2.48 = 2.14x The value demonstrated that the investors are currently paying 2.14 times higher than the value of one unit of its NTA. To make a precise interpretation regarding the NTA value, it is always better to make comparison with its direct competitor.
Table 27: NTA Backing Model Comparison

Year TCL TOL

2006 2.03 3.56

2007 0.38 -1.52

2008 0.8 2.17

2009 -3.39 1.23

2010 -2.48 1.52

*Source: FinAnalysis (2011)

From the table, it indicated that Transurban Group had been weak in providing insurance to the investors if the company went into liquidation. For year 2009 and 2008, Transurban Groups NTA ratio had been negative showing bad indication to the investors when the company goes into liquidation.
Table 28: Current Share Price Per NTA

Year TCL TOL

2006 3.42 3.95

2007 21.1 -9.53

2008 5.29 2.77

2009 -1.23 5.08

2010 -1.71 3.61

*source: FinAnalysis (2011)

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The table above demonstrated comparison of the current share price over NTA with its direct competitor. In year 2007 and 2008, the value placed on Transurban Group was far much greater than Toll Holdings. However, in 2009 and 2010, the valued placed on Transurban Group was very much lower compared to Toll Holdings. Two assumptions can be derived base on the low price to NTA ratio are Transurban Group is highly undervalued as compared to its competitor and Toll Holdings is overpriced compared to its peer. Base on this model, Transurban Group share will appear to be more attractive to the investors.

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9. VALUATION DISCUSSION
9.1 Dividend Discount Model (DDM)
In order to use this model we had to forecast the expected growth rates for the future dividends. We made our forecast based on historical dividends, our future expectation on the economic climate and expected future attributes of the company. It was extremely difficult to forecast the future growth rates as Transurban was an unusual company which paid out higher dividends per share relative to its earnings per share. However we did manage to forecast Transurbans future growth rates and growth phases. Sensitivity analysis was also conducted after the intrinsic value was computed. The purpose of the sensitivity analysis was to test the significances of our forecasted and calculated inputs. The sensitivity analysis concluded that the accuracy of the forecasts and calculations would play a significant part in deriving our intrinsic values, hence the importance of conducting research of great integrity (GIGO - Garbage in garbage out). Our analysis formulated by the dividend discount model derived an intrinsic value of $5.48 and suggest that Transurban shares are trading at a discount of 3.1%, based on the market price of $5.31 as of the 15/4/2011. Since the share price is trading at a discount the analysis using this model concludes that the market share price for Transurban is undervalued and we would expect the market to correct this in the future. The dividend discount model we believe is a suitable model for the purpose of analysing Transurbans share price as the company has been paying consistent dividends and we believe they will continue to do so in future periods.

9.2 Free Cash flow to Equtiy Model (FCFE Model)

The discounted FCFE model is computed a similar the dividend discount model however for the FCFE model we use free cash flow to equity per share available to shareholders instead of dividends paid to shareholders. Both models are discount cash flow models. In this model we are also required to forecast the future FCFE. In forecasting future growth rates for FCFE we have based our forecasted of the dividend growth rates and historical FCFE growth rates. Our forecasted growth phases are the same as the forecasted growth phases for dividends, however we expect the growth rates on FCFE to growth at a higher rate than the dividend growth rates. We justify this analysis in section 8.2.1 of this report. 78 | P a g e

The sensitivity of the forecast and calculations were also analysed and produced similar results to the sensitivity analysis done on the dividend discount model. The sensitivity analysis concludes that the inputs used for deriving the companys intrinsic value is sensitive and requires forecasting to the highest degree of integrity. The intrinsic value of Transurban share was $5.45 this suggests that its share price is trading at a discount of 2.5688% when compared to the market price of $5.31 as of the 15/4/2011. This indicates that the market is undervaluing Transurbans share and we expect that the market will correct this at some point. Discounted FCFE model is a great valuation model when evaluating intrinsic values of companies that do not pay or consistently pay a dividend. We believe that this model is an appropriate model as it does provide an intrinsic value in the range of the intrinsic value calculated in the dividend discount model; the intrinsic value of the FCFE model being $5.45 and $5.48 in the dividend discount model. However we prefer to conduct our valuation on the dividend discount model as this company does historically consistently pay dividends where as in FCFE of Transurban can be quite volatile. Due to the unpredictability of FCFE forecasts we have made conservative growth estimates, this could under state the intrinsic value we calculated using this model. The companys intrinsic value could be trading at an even greater discount.

9.3 Price / Earnings Ratio Model (P/E)

The price earnings model (P/E) is a very important and common method to analyse company stock and this model provides how much investors are willing to pay for a dollar of the companies expected earnings. However, P/E ratio is the relative valuation ratios that is more useful when compared to a company with similar risk and industry life cycle and comparing it to the industry. We compare TCL with the transportation industry sector and Toll Holdings Limited (TOL). We use the current price of $5.31 (as of the 15th of April 2011) dividend by the expected 12-month earning to calculate the P/E. When analysing the P/E ratios typically, the higher the P/E the more the market is willing to pay for the companys earnings and hence investors have higher expectations on the companys prospects. Conversely, low price earnings model indicates that low confidence in the company by the market. However, it could also mean that the stock just has been overlooked by the market and represents a potential for gain.

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Using the Earnings Multiplier Model formula, P/E ratio for Transurban is 106.88; this indicates that investors are willing to pay $106.88 for every $1 of earnings that the company expected earnings. To help determine whether the share price of TCL is over / under priced, we can use the P/E ratio to compare the prices of companies in the same sector against each other. For example, we have compared TCL and TOL. Holding all else being equal, an intelligent investor would prefer to purchase shares of TOL; although the share price is higher, what he would gain is more than 8 times of the earning power. In addition, we also compare Transurban with the toll road industries. Transurban has a P/E (106.88) that higher than the market or industry average (45.31), thus high P/E ratio and low earning growth rate means the stock price will be expected to decline some point in the future. In order to look at the change the EPS growth rate influence the P/E ratio, we completed the sensitive analysis which was to test the significances of our forecasted and calculated inputs. The sensitivity analysis put it that there is inversely relationship between the P/E ratio and the EPS growth rate and also indicated that there would not be a significant influence on our results. The biggest advantage of the P/E ratio is that it is easy to use and fathom. It can be used to make quick decision although it is only a basic tool and method of evaluating the worth of the shares of a company. Because of the volatile nature of stock prices, P/E ratio is largely due to the subjective in nature, thus it is the disadvantage of the P/E ratio. Another disadvantage is there being no right P/E ratio because it depends on the investors willingness to pay for earnings. The more you are willing to pay (you believe the company has good long term prospects over and above its current position) the higher the right P/E ratio is for that particular stock. In this case we do not think that the P/E ratio is a suitable tool used to evaluate the value of Transurban share as we only use one year forecast of its potential earnings. Also we do not think it is suitable as it was difficult to find a competitor that was similar to the business and company structure to that of TCL.

9.4 Price/ Book Value Ratio (P/B)

This model is useful in identifying which company is overvalued and which company is undervalued based on the P/B ratio to ROE. If a company has a high P/B ratio and low ROE, then it is likely that the company to be overvalued. However, if the company has both high P/B and ROE, this indicates that the company has strong return to shareholders but still undervalued based on P/B ratio. 80 | P a g e

According to the data for Transurban Group, there was a decrease in the ratio from 2006 to 2008 and had slight increase from 2008 to 2010. From the analysis of P/B ratio, it showed that the shares had been trading constantly above the book value per share. This shows that the company are being valued by the market. However, it is very tough to use P/B ratio to analyse the value of the company as there are many other factors that may need to be taken into consideration. Although the P/B ratio gives the investors the insight of which stocks are being undervalued, nevertheless it demonstrates very restricted information for some industries with hidden assets which have great value are not reflected in the book value (Investopedia 2011). Another factor that might cause discrepancies for the P/B ratio calculations is the payout ratio for Transurban Group. The payout ratio for Transurban Group in 2010 was absolutely high which was 525.2% and there was no previous record of the previous payout ratio. As the payout ratio plays a fundamental part of the calculation to compute the expected growth rate. Therefore the data retrieved might not be sufficient to come to a conclusion of how the company is valued under this model. This model is only appropriate for the investors who are looking at capital intensive or finance related business.

9.5 Net Tangible Asset Backing Model (NTA)

The net tangible asset backing indicates to us if investors would be able to get their money back in the event of liquidation. Generally, a company is undervalued if its share price per unit of NTA is more than the current share price. This means that investors will get more value for what they are paying for which makes it attractive. It is important to distinct total value of the business from net tangible asset as NTA does not include intangible assets such as patents and rights. In theory, simple valuation of organisations can be done independently of its tangible assets but in reality NTA is extremely vital as intangible assets cannot be liquidated into money in the event of liquidation. Thus, any intangible assets such as goodwill should always be compared to its net tangible assets of the business for reasonableness. In the case of TCL, this model is appropriate as TCL has a significant amount of assets which makes NTA a very relevant measure. However, this measure can vary a lot between one firms structure of assets and liabilities to another organisations structure so one must be cautious when comparing to other assets. It is best to compare directly with an organisation with a similar structure and industry to allow for meaningful comparisons.

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One weakness of the model is that it is based on historical data hence it does not take into account of future cash flows and growth. This could significantly undervalue organisations that have just started up or are heavily investing in revenue generating assets. Therefore, it should be noted that while this measure is useful in business and valuation analysis, it should be used in conjunction with other measures and analysis to give an accurate evaluation.

9.6 Preferred Valuation Method

Our preferred valuation method was the dividend discount model. This was our preferred model over the other models because Transurban historically consistently paid dividends and it is expected they would continue to do so in the future. It was preferred over the discounted FCFE model because the FCFE future growth rates would be more difficult to predict since historically the growth rates of FCFE have been extremely volatile making it difficult to forecast. The DDM was also preferred to over the ratio relative valuation techniques since it was difficult to find companies that were similar to Transurban and its structure. Another issue with the valuation techniques was it does not give incites to the stocks intrinsic value and only gives incites to its value compared to other companies ie; it might be good value compared to other companies however there nothing to say that the company that the ratio is compared to is at fair market value.

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10. CONCLUSION & RECOMMENDATIONS

After completing our evaluations conducted in our valuations analysis in section 8 of this report, we received mixed results. The DDM and the FCFE models suggest that the share value of Transurban is underpriced and is currently trading at a discount. The relative valuation techniques used also suggests that the stock is worth buying with exception to the P/E ratio which suggest we should avoid the stock or even sell the stock. Out of the five valuation methods used four of our valuations would conclude that Transurban stock is worth buying or holding onto while only one of the method used would lead to the conclusion that investors should sell or avoid TCL stock. We also believe that the dividend discount model was the best and most appropriate analysis valuation of TCL stock, which was also one of the four models that stated TCL share price was undervalued. Based on this information we would place a buy recommendation on TCL shares as it is trading at a discount of 3.1%, based on the market price of $5.31 as of the 15/4/2011 from the intrinsic value of $5.48 calculated from the dividend discount model. At the completion of writing this report TCL share obtained from the ASX (2011) website was trading at $5.44 as of the 13th of May 2011. It can be observed that TCL share price had resin from when we previous completed our valuation. Based on our required rate of return calculated on the 15th of April 2011 TCL share price would still be trading at a small discount. Concluding this report we would place a buy-hold recommendation on TCL stocks, since TCL shares are trading at a slight discount.

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11. APPENDIX
11.1 Appendix 1: Excel Raw Beta and Adjusted Beta Calculations

*** Further Excel spreadsheets can be provided on request. Not all calculations have been included in the appendices as the calculation, formula and inputs have been explained throughout this report.

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