Narrow-moat-rated Atlas Arteria (ASX: ALX) finished 2023 relatively strongly, with December quarter toll revenue increasing 6% on average compared with the previous corresponding period on a like-for-like basis.

For the full year 2023, proportionate toll revenue increased 7% on 3% growth in traffic and solid toll increases. The result was close to our expectations, though France was a little better and the U.S. a little weaker than we expected. We adjust our 2023 earnings forecasts marginally but leave longer-term forecasts largely unchanged.

We maintain our $5.85 per security fair value estimate, which incorporates an $0.50 takeover premium, and consider the stock slightly undervalued. While the firm offers an attractive distribution yield of over 7%, it has a short average concession life, with the key asset APRR in France handed back to the government for no consideration in 2035.

The 31.4%-owned APRR performed well in 2023, with toll revenue increasing 6% to EUR 2.84 billion on Consumer Price Index-linked toll increases and 3% growth in traffic volumes.

Revenue and traffic were 12% and 3% above 2019 levels, showing a full recovery from the pandemic. Car traffic volumes are benefiting from low unemployment, more holiday traffic, and motorway upgrades. Truck volumes were relatively flat in 2023, but they weren’t hurt much by the pandemic and, thus, haven’t grown as strongly in the recovery. Additionally, truck volumes are depressed by soft French GDP growth and inter-Europe trade. We forecast solid revenue growth again in 2024 for APRR on similar tailwinds, tapering off to 3%-4% over the medium term.

In the U.S., operating conditions remain more difficult. At the wholly-owned Dulles Greenway, 2023 toll revenue increased 9% to USD 73 million, mainly on a 6% improvement in average daily trips. Nonetheless, toll revenue and trips remain 19% and 26% below 2019 levels, given the slow return to office in the Greater Washington Area.

Business strategy and outlook

Atlas Arteria is a global toll-road group. By far its most valuable asset is a 31% stake in Autoroutes Paris-Rhin-Rhone. Despite APRR's dominant motorway network in eastern France, the short concession life, high base capital expenditure requirements and subdued organic growth make it less attractive than some motorways.

Longer-term distribution growth is likely to be held back by higher interest rates and, from the mid-2020s, the need to pay off all debt at APRR before handing the motorway concession back to the government in 2035. After the APRR concession ends, Atlas Arteria’s distributions will fall by two thirds to a level supported by the smaller Dulles Greenway and Chicago Skyway.

APRR is one of the largest tolled motorway groups in Europe. Concessions covering its main network end on Nov. 30, 2035, and on the smaller AREA network on Sept. 30, 2036. These concessions are relatively short compared with those for other listed toll-road operators.
When the concessions end, the roads are returned to the government for no consideration and after repaying all debt. The APRR concessions set base toll increases at 70% of the consumer price index, or CPI, excluding tobacco, and set a base level of maintenance and upgrade capital expenditure of about EUR 200 million per year.

Atlas Arteria also owns 100% of Dulles Greenway and 66.67% of Chicago Skyway. Along with high debt levels, the main issue for Greenway is weak traffic volumes following the pandemic and as competing roads have been upgraded. After failing debt service coverage tests in recent years, Greenway is not allowed to pay distributions to investors. The Skyway also suffers from weak traffic volume growth, but tolls increase relatively quickly and its balance sheet is sound.

Atlas also owns the Warnow Tunnel in Germany, but it is tiny, contributing 1% of proportional earnings before interest, taxes, depreciation, and amortisation (“EBITDA”).