Stock Story: Ferrovial

April 2023

In the US and Canada, despite these countries being viewed as bastions of free enterprise, private ownership of toll roads and airports is uncommon, notwithstanding long-held investor expectations that the market would follow trends seen in other places like Europe or Australia. For investors this has left these markets as outliers for the size of their economies, and with limited opportunity for private investment in these key transport assets. Despite the constraints, one company that has developed a foothold in this market is Ferrovial.

Ferrovial is a multinational company that focuses on toll roads and airports, as well as having construction and services businesses. Within the infrastructure part of the business, its North American toll roads represent the most important part of its operation with assets like its flagship investment in the 407 ETR in Toronto, as well as its managed lanes in the United States; and airports, with investments in major hub airports like Heathrow in London and JFK in New York.

The 407 ETR in Canada is arguably one of the most attractive toll road concessions in the market, where Ferrovial holds a 43.23% stake in the asset. The road provides a route across Toronto to the north of the city with the main competing route being the 401 highway, which is often regarded as the busiest road in North America and suffers from major congestion issues. In addition, the 407 ETR operates under a long-term contract that extends to 2098, and toll price increases that have few restrictions – with no specific cap on toll prices so long as traffic remains above specified levels. The pricing flexibility is key and stands in contrast to many toll roads that have more restrictive pricing clauses embedded in their contracts. We believe traffic conditions should remain favourable given positive migration dynamics, a solid economic outlook, and its role as a transit route across the high-population areas of Toronto, which has Lake Ontario to the southern side limiting the ability for an effective competing route to be built. This ongoing traffic growth across the city provides not only a growing market, but with the major congestion on the competing 401 Highway, our view is this should also drive more cars onto the 407 ETR.

The 407 ETR is a key investment attraction within Ferrovial; however, the company has been growing its business throughout the United States by developing its high- occupancy toll lanes (“HOT” lanes) or managed lanes. The distinguishing feature of these HOT lanes is they operate using dynamic pricing. This means that to guarantee and maintain a minimum average speed, the tolls are automatically adjusted higher as the speed of vehicles drops towards the minimum threshold. Users are charged based on their marginal willingness to pay, rather than a cap set by the concession grantor. While this can lead to high tolls at certain periods, some feedback suggests customer satisfaction is higher when tolls are higher, as it means the competing free road is heavily congested and therefore the time savings are even greater.

The company operates a portfolio of these managed lanes including key assets in the fast-growing region of Dallas-Fort- Worth, Texas; Charlotte, North Carolina; and in a highly congested yet affluent area of Virginia that serves traffic heading to Washington D.C. Further, the company has flagged ongoing potential opportunity for new developments in Georgia where the company has submitted bids for a prospective managed lane project. We believe that the success of Ferrovial’s HOT lanes and its innovative, world-leading dynamic pricing model demonstrates the company’s strong IP and competitive advantage.

Ferrovial’s primary airport holding is a 25% stake in Heathrow. Heathrow operates under a “single till” model meaning the entire operation is subject to price regulation. This model is less attractive than a “dual till” model that allows for the separation of the regulated aeronautical business from commercial operations (such as retail or property developments). However, the single till model does provide strong inflation protection. In addition to some smaller holdings in the airport sector, the company is also undertaking a major project in New York, with the development of a new JFK International Terminal 1 called New Terminal One (NTO), which is expected to see Ferrovial invest US$1.1 BN to develop a new 38-year concession that will see NTO take over from Terminals 1, 2 and 3.

Ferrovial also operates a construction business. While we do not view this business as particularly advantaged or attractive, the size of the business is minor in the context of Ferrovial and we consider it an acceptable risk to gain access to such high- quality toll road assets, particularly the 407 ETR and US- managed HOT lanes.

While Ferrovial is currently based in Spain, given its ongoing strategy to grow and develop its US business, the company is undertaking a process intended to see it ultimately become dual listed in the US, enhancing liquidity and access to capital that should allow it to continue to capitalise on its world-leading position that it has established in this market.

Sources: Company filings.