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Data Centers – are they infrastructure?
Getting out of the office to meet management teams and conduct site tours is one of the most engaging and essential responsibilities for the investment team. Georgia and Steve’s recent visit to the 407 Express Toll Route (ETR) toll road in Toronto, Canada, reinforced our view that toll roads are more than just bond proxies; they highlight how concession infrastructure can provide exposure to economic growth and can create value even when interest rates are rising.
The 407 ETR, a major toll road in Toronto, spans 108 km and has seen over 525 km of additional lanes added since 1999, all without public funds. The concession for this asset expires in 2098. Ferrovial, a holding in the Portfolio, owns 43% of the 407 ETR.
Long-term concessions such as the 407 ETR benefit from strong cash flow generation over time, driven by increasing traffic volumes and higher tolls. GDP and population growth drives activity and leads to higher traffic congestion. This in turn increases toll road volumes because people perceive their “value of time” to be greater and have a higher “willingness to pay” tolls to avoid delays.
This demand can be captured by either expanding road capacity (though lead times can be lengthy) or implementing variable pricing models, such as that used on the 407 ETR and other Managed Lanes in North America. The resulting revenue growth can be powerful and can outweigh the impact of higher discount rates. Topline growth typically translates to bottom-line and dividend growth, given toll roads’ high operating leverage (high margins) and financial leverage (long-term, fixed-rate debt).
Post-pandemic traffic patterns on the 407 ETR are evolving. While weekday trips remain below 2019 levels, total vehicle kilometres travelled (VKT) have returned to pre-pandemic levels, thanks to more frequent longer trips and a shift toward weekend travel. Average peak tolls have risen significantly, with a 15% increase in February 2024.1 Pricing is a key value driver for the 407 ETR, and it has flexibility to set tolls by segment and time of day to manage traffic.
Looking ahead, lane expansions are another key catalyst for value creation. The 407 ETR still has room for growth, especially in segments C1 and C7, with plans to add one more lane in each direction by 2030. Western and eastern sections also have potential for expansion through to 2050, triggered by traffic thresholds and to maintain service quality.
Operating under a social license is crucial for infrastructure assets like the 407 ETR. Customer satisfaction, a priority for management, temporarily dipped with the February toll increase but has since recovered. Over 25 years, the 407 ETR has provided substantial community benefits, contributing $23 billion in economic value, including $19 billion in user benefits like time savings, reliability, and reduced vehicle operating costs, as well as $3.5 billion in productivity and safety-related savings.”2
The 407 ETR management team is mindful of climate change risks that could impact road surfaces long-term, such as winter storms, heat waves, and flash floods. In collaboration with government efforts, the 407 ETR has planted 10,000 trees along the highway, with plans for more annually, and aims to reduce emissions by 25% by 2030. Although there are currently no plans for EV charging stations, they may be considered near entry and exit ramps in the future.
The meeting with the 407 ETR management team reaffirmed the toll road’s attractive features for long-term investors, including strategic location, toll growth that captures value of time and willingness to pay, high operating leverage, limited competition, and resilience during economic downturns. These qualities support the 407 ETR as a long-term investment for Ferrovial, being a key holding in the Portfolio.
Steven Kempler and Georgia Hall at the Boardroom of the 407 ETR, Toronto
2 https://newsroom.407etr.com/2024-03-01-Economic-and-Community-Impact-of-407-ETR
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