Rating Action Overview

• Australia-based toll road company WestConnex (WCX) has issued A$650 million fixed rate notes, maturing in March 2031, through its financing subsidiary WestConnex Finance Co. Pty Ltd. (WestConnex FinCo) to partially refinance an existing bank bridge facility.
• On March 30, 2021, we assigned our 'BBB+' rating to the debt, reflecting the expected operating performance of the company as well as the project structure.
• The outlook for WCX is stable, reflecting good recovery of the two operational stages, WCX M4 and WCX M5, post COVID and our expectation that the minimum DSCR will remain above 1.75x over the life of the project.

Project Description And Key Credit Factors

WCX is a tolled Sydney metropolitan motorway comprising six roads under three separate concessions that are physically joined. The six roads are: New M4, M5 East, M8, M4-M5 Link, Rozelle Interchange, and M5 South West (M5 South West is currently 100% owned by Transurban and will transfer to WCX once the current concession expires in December 2026). All concessions expire at the same time in 2060.

Four of the six roads are fully operational extensions of existing mature toll roads and will represent the majority of the revenues even once all roads are open. WCX operates as a closed tolling road network. Road tolls are based on the distance travelled and a maximum toll trip cap will apply for vehicles using multiple sections of the road network.

WCX is tolled and operated as an integrated entity despite being financed as three separate concessions. Accordingly, WCX operations benefit from being an integrated network.

Tolling and road operations are managed across WCX by the same parties--Transurban, Fulton Hogan Egis (FHE), and WCX--to ensure WCX is run as a single business. The tolling system and structure sits across all the roads and will provide a toll trip cap depending on how far through the WCX system a vehicle travels.

We view Transurban's operating role at WCX as positive for the project. Transurban is a highly experienced toll road operator with a significant operating presence in the Australian market across major toll roads in various states. It has a strong operational track record.

Strengths

Long concessions with a strong regulatory regime. WCX benefits from long concession agreements to 2060 with the New South Wales (NSW) state government. The NSW toll road market is a mature one, has a supportive regulatory regime, and a long history of private sector involvement.

Strong toll price setting provisions. The concession agreements contain price setting provisions that provide an ability to increase tolls at the greater of 4% a year and Consumer Price Index (CPI) until 2040 and the greater of CPI and 0% thereafter.

Benefit from exposure to Sydney metropolitan area demographics and urban road congestion. The catchment areas for WCX are highly populated regions of Sydney. Alternative free roads are congested and the likelihood for additional alternate routes being built is remote.

High EBITDA margins. WCX is expected to operate with EBITDA margins in the mid 80% range over time.

Risks

Exposure to traffic volume risk.  Lower future traffic levels or growth rates than expected or prolonged ramp-up on any of the WCX stages could weaken debt service cover ratios (DSCRs) especially during the debt amortization period.

Refinancing risk. The majority of debt is presently short-term bullet debt. The project will face refinancing and interest rate risk at multiple points throughout its life.

Potential for additional indebtedness to impact rating. Under the debt document terms the project is able to borrow additional debt in the ordinary course of business (including to fund distributions to equity) subject to the maintenance of a credit rating of 'BBB' or above, or if no public rating is in place, a minimum DSCR test (backward and forward looking) of 1.8x for purposes other than distributions.

Structural subordination of WCX M5 and WCX M4-M5 Link. Project DSCRs include distributions from two separately project financed assets. The security package does not incorporate direct security over WCX M5 and WCX M4-M5 Link.

Rating Action Rationale

The rating assigned reflects the underlying operational and financial stability of the project. A key driver of the rating is the strong competitive position and low market risk of the project. Sydney roads are heavily congested at many times of the day and the city has a long history of toll-road traffic dating back to the 1990s evidencing traffic stability and growth. The minimum DSCR of 3.51x under our base case, with a resilient downside, supports the rating at current debt levels.

Revenues are exposed to traffic risk but not pricing risk. WCX revenue is dependent upon levels of traffic usage. Traffic on Sydney toll roads has grown steadily over many years as evidenced by data on the western ends of the M4 and M5 corridors since the 1990s. Toll-road traffic in Sydney has historically been stable and reflected underlying GDP unless hampered by capacity constraints. Toll elasticity has been very low even as tolls have increased at 4% a year (i.e., greater than historic inflation) on a number of Sydney toll roads. The M4 East and M8 have both recently opened to traffic but benefit significantly from being eastern extensions of long operational, mature toll roads: the M4 West and M5 South West, respectively.

Tolls escalate at the greater of CPI or 4% a year prior to Dec. 31, 2040, and the greater of CPI or 0% post Dec. 31, 2040, until the end of the concession.

Traffic levels have recovered strongly from initial COVID lows. Traffic levels on Sydney toll roads have continued to improve from their COVID lows and most Sydney toll roads are now operating at levels at or above 90% of pre COVID traffic. During COVID, traffic on Sydney toll roads generally, including WCX M4, dropped initially by around 50%. Commercial traffic was more resilient and only dropped initially by around 30%.

Operating risk is managed by a combination of parties. Transurban is providing the benefit of its extensive operational expertise across most areas of operations. This includes the GLIDe tolling system, which has been used on Transurban's other Australian toll roads for many years. FHE provides the day-to-day incident response and maintenance services.

A Master Services Agreement exists between Transurban and WCX under which Transurban provides various services, including access to personnel, to WCX.

Weaknesses in project structure modify the stand-alone credit profile (SACP). Additional indebtedness covenants in the project documentation permit the project to raise additional debt to a rating level of 'BBB'. Because of this, we apply a two-notch negative adjustment to the project's preliminary SACP of 'a+'.

We also consider the lack of direct security over the assets of WCX M5 and WCX M4-M5 Link as a weakness given the inclusion of distributions from these two entities in the cash flow available for debt service for WestConnex FinCo.

Outlook

The outlook for WCX is stable, reflecting good recovery of the two operational stages, WCX M4 and WCX M5, post COVID and our expectation that the minimum DSCR will remain above 1.75x over the life of the project. The current minimum DSCR of 3.51x, which occurs in December 2021, may not stay at this level if WCX increases the project debt during the life of the project as is permitted under the project documentation. We expect that debt issuance, both refinancing of existing bank facilities over the next five years and any additional debt, will be at rates that support the rating level.

Downside scenario

We could lower the rating on WCX if the minimum DSCR fell below 1.75x. This would be highly unlikely to occur at current debt levels unless traffic levels are significantly below our expectations producing a change in the downside assessment.

More likely, we could lower the rating if one or a combination of the following were to occur:

• WestConnex FinCo borrowed additional debt such that the minimum DSCR dropped below 1.75x.
• Our estimated credit metrics for WCX M5 deteriorated either due to materially lower traffic than forecast or increased borrowings at WCX M5 or decreased dividends payable to WestConnex Finco.
• Our estimated credit metrics for WCX M4-M5 Link deteriorated either due to materially slower ramp or materially lower traffic than forecast or increased borrowings at WCX M4-M5 Link or decreased dividends payable to WestConnex Finco.

Upside scenario

We consider it unlikely that we would raise the rating given the existence of a current additional indebtedness covenant allowing the project rating to move to 'BBB'. Even if the structural subordination of both WCX M5 and WCX M4-M5 Link is removed in the future through refinancing the respective project debt at WestConnex FinCo, the possibility of additional gearing based on these cash flows creates a future weak point for the project credit profile, which would need to be considered. The project company's future approach to managing debt levels will provide insight into whether the project is to be managed at the 'BBB+' level.

Ratings Score Snapshot

Operations phase SACP (Senior Debt)

• Operations phase business assessment: 3 [1=best to 12=worst]
• Preliminary SACP: a+
• Downside impact on preliminary SACP: a [no impact]
• Liquidity: Neutral [no impact]
• Comparative analysis assessment: Neutral [no impact]
• Adjusted preliminary operations phase SACP: a+
• Operations counterparty ratings adjustment: [no impact]
• Financial counterparty ratings adjustment: [no impact]
• Operations phase SACP: a+

Modifiers (Senior Debt)

• Parent linkage: De-linked [no impact]
• Structural protection: Weak [-2 notches]
• Subordination: [-1 notch]
• Senior debt issue rating: BBB+

Operations phase SACP

Our operations phase SACP of 'a+' for WestConnex FinCo reflects the preliminary operations phase SACP of 'a+' with no adjustment from our downside stress analysis.

The preliminary operations phase SACP reflects our assessment of WCX OPBA of '3' and the current expected minimum DSCR of 3.51x.

This is supported by the following:

• Asset Class Operations Stability Assessment of '3', reflecting that asset management and facilities maintenance is straightforward, with limited need for particular specialist skills.
• We modify this score upward by one category to reflect a positive impact on Operations and Maintenance by Transurban.

Counterparties

• Revenue Counterparty: We consider WCX M5 and WCX M4-M5 Link to be material, irreplaceable counterparties as distributions from these two projects are used to service WestConnex FinCo debt. Either of these two toll roads could act as a rating cap to the issue rating but do not constrain the rating at the present time.
• O&M Counterparties (Operators): We consider that both FHE and Transurban could be replaced in their respective roles if required. The services provided by FHE are straightforward and could be provided by numerous parties in the market. In the case of Transurban, operations and tolling services for WCX M4 were already being provided by other parties (including the state of NSW) prior to Transurban's equity investment into WCX. Therefore, we do not assign any O&M (operator) Counterparty Dependency Assessment (CDA).

Financial counterparties

• The transaction could also be affected by the credit quality of the financial counterparties involved in the transaction, which provide the revenue account and the DSRA. This is currently not a constraint.

Liquidity

• We consider the liquidity in the project structure to be neutral to the rating. The senior debt has the benefit of a DSRA equal to six months of debt service.
• Given the project's use of bullet maturity debt, there is a risk that our liquidity assessment will weaken if these maturities are due in less than nine months and there is no well-defined and credible plan to refinance the upcoming maturing debt.

Other modifiers

Structural protection: Weak

We assess structural protection as weak, largely as a result of the additional indebtedness covenants in the project documentation, which permits the project to raise additional debt to a rating level of 'BBB'. Because of this, we apply a two-notch negative adjustment to the project's preliminary SACP of 'a+'.

We also consider the lack of direct security over the assets of WCX M5 and WCX M4-M5 Link as a weakness given the inclusion of distributions from these two entities in the cash flow available for debt service for WestConnex FinCo. This is accounted for in our notching for weak structural protection.

Distributions from WCX M5 and WCX M4-M5 Link to WestConnex FinCo represent subordinated cash flows from WCX M5 and WCX M4-M5 Link given that they are residual cash flows (after all expenses, debt service and reserve replenishment at the project level) and they are subject to project finance standard distribution lock-up provisions. These lock-up ratios, for both WCX M5 and WCX M4-M5 Link, are a DSCR less than 1.40x on a 12-month look back basis.

Related Criteria

• Criteria | Structured Finance | General: Counterparty Risk Framework: Methodology And Assumptions, March 8, 2019
• Criteria | Corporates | Project Finance: Project Finance Transaction Structure Methodology, Sept. 16, 2014
• Criteria | Corporates | Project Finance: Project Finance Operations Methodology, Sept. 16, 2014
• Criteria | Corporates | Project Finance: Key Credit Factors For Road, Bridge, And Tunnel Project Financings, Sept. 16, 2014
• Criteria | Corporates | Project Finance: Project Finance Framework Methodology, Sept. 16, 2014
• Criteria | Corporates | Project Finance: Project Finance Construction And Operations Counterparty Methodology, Dec. 20, 2011
• General Criteria: Principles Of Credit Ratings, Feb. 16, 2011

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