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Pacific National

Pacific National 10-year AUD deal

The Investment Strategy

  • Revenue from coal is expected to drop from 42% (of rail revenue as at FY21) to 30% by 2025-2030 as rail freight increases as a portion of rail revenue
  • Rail freight transport has inherent benefits for the economy and community in terms of lower accident costs and carbon emissions
  • Australia’s urban freight task to increase 60% by 2040, of which PN will directly benefit from via inland rail network
  • FY21 results illustrated strong containerised freight and grain volumes, coal production issues have been resolved, and demand is returning post COVID-19

IAM Capital Markets View

Pacific National (PN) is a key player in Australia’s infrastructure transportation sector. PN’s strategy is to transform the rail freight industry across Australia, with a role in mitigating emissions and having a positive environmental and social impact.

In our view, this remains a low risk, investment-grade credit. The company’s shareholders have been willing to forego dividends to protect the BBB-/Baa3 rating. These shareholders are experienced infrastructure investors with over USD1.7trn assets under management. Coal haulage contracts are largely on a take or pay (ToP) basis, which protects the issuer from counterparty risk. The weighted average coal contract is 5.8 years, while a freight contract is 2-4 years respectively.

A common misconception with PN is that it supports coal transportation only. This is inherently wrong, and the company is slowly diversifying out of coal and into rail freight. In fact, revenue from coal is expected to drop from 42% (of rail revenue as at FY21) to 30% by 2025-2030 as rail freight increases as a portion of revenue. Over time, the development of the 1,700km Inland Rail Network will increase the competitiveness of rail against road transportation and help this diversification take place.

Another positive is that thermal and metallurgical coal prices have held up very well in comparison to iron ore over the last month. This has also been the case over the past year, with COVID-19 and China coal bans having little impact on underlying commodities. Higher prices for thermal and metallurgical coal boosted customers profit margins and the ability to service PN’s contracts.

Chart 1. Recent Commodity Price Performance

Source: CBA Research August 2021

Chart 2. PN Revenue stability over various commodity cycles

Source: Pacific National Investor Presentation 2021

Improving ESG Profile

Not only is rail freight more competitive, but it is also more ESG-friendly from a carbon emissions perspective. Rail freight is safer, greener, more cost effective, and can reduce passenger congestion compared to other methods of transportation. Moving freight by rail produces 16 times less carbon pollution per kilometre than by road.

PN’s expansive network of trains, infrastructure, and partnerships forms the basis of their credit strength here. PN has terminals in every mainland capital city, and a varied clientele – which will help the company leverage the Inland Rail Network. The 1,700km Inland Rail Network will complete Australia’s national freight network, connecting producers to markets and create new opportunities for businesses, industries, and regional communities.

A 2017 Deloitte Access Economics report found:

  • Road freight incurs 14 times greater accident costs than rail freight per tonne-kilometre and 16 times as much carbon pollution as rail freight per tonne-kilometre.
  • Moving freight by rail instead of road generates benefits for society of around 1.45 cents per tonne-kilometre.

Chart 3. Rail Versus Road Freight ESG Facts

Source: Pacific National Investor Presentation 2021

Relative Value

At 3.5% yield, it offers around 1% discount to the BBB AUD corporate curve. In the BBB corporate bond market, PN’s two fixed-rate bonds (27s and 29s) stack up extremely well. Outside Qantas, it is increasingly difficult to find bonds yielding 3%.

Aurizon, its closest competitor, is rated two notches above PN. Aurizon’s credit metrics are only slightly better than PN, so it arguable whether those two notches are sufficiently warranted. However, Aurizon is regulated under the Central Queensland Regulatory Network (CQRN), which provides some ratings stability.

Chart 4. Relative Value

Source: Bloomberg FIW function

Chart 5. Comparable Bonds

Security Price Yield Spread Diff Low High Avg +/- bps #SDs
Avg of Comparables 2.29 134 82 61 85 77 5 0.9
PNHAU 3.7 09/24/29 103.16 3.24 216
BACAU 4 ½ 12/30/30 113.46 2.82 163 53 15 60 45 8 0.6
AZJAU 2.9 09/02/30 101.18 2.75 156 60 45 94 62 -2 -0.2
TQLAU 3 ¼ 08/05/31 104.6 2.71 146 70 59 74 67 3 0.9
BACAU 3.1 06/30/26 104.73 2.03 133 83 63 91 79 4 0.8
MELAIR 3 ¾ 11/04/26 109.41 1.85 108 108 83 111 100 8 1.1
MELAIR 4.55 11/11/25 112.06 1.6 97 119 75 123 108 11 1

Source: Bloomberg COMB function

Business Profile

PN is a freight operator that carries coal, regional exports, bulk goods, grain, and agricultural products on the Australian eastern seaboard. The company operates through two divisions – coal (42% of revenue) and freight (around 58% of revenue).

PN’s coal division is the second largest coal rail haulage provider in Australia, hauling thermal and metallurgical coal for export from mine to port, and for domestic use from mine to power stations and steelworks in New South Wales and Queensland.

PN’s freight division provides haulage for:

  1. containerised and break-bulk freight (steel) between Sydney, Melbourne, Brisbane, Adelaide, and Perth, as well as;
  2. regional freight rail services in New South Wales, Western Australia, north Queensland; and
  3. a range of bulk goods around Australia.

PN is owned by a consortium comprising affiliates of: Global Infrastructure Management LLC (27%), Canada Pension Plan Investment Board (CPPIB) (33%), CIC Capital Corporation (CIC) (16%), GIC Private Limited (GIC) (12%), and British Colombia Investment Management Corporation (BCI) (12%).

Chart 6. National Footprint

Source: Pacific National Investor Presentation 2021

Chart 7. FY21 Results

AUDm FY21 FY20 FY19
Revenue 2,315 2,465 2,536
EBITDA 820 784 887
Net operating cashflow 511 621 647
Net debt to EBITDA (x) 3.7 3.9 3.2
EBITDA to net interest (x) 4.9 3.7 4.2
Net debt 3,021 3,031 2,855
Total NTKs (M’s) 56,252
Total Tonnes (M’s) 156.2
TEUs (‘000) 881.0

Note: Net debt reflected as external debt at hedged values, less cash and including lease liabilities
Source: Pacific National Investor Presentation 2021

Chart 8. Debt Maturity Profile

Source: Pacific National Investor Presentation 2021

Chart 9. Moody’s Comparison

Source: Moody’s Financial Metrics March 2021

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