Rating Action Overview

• Traffic on Transurban Queensland Finance Pty Ltd.'s (TQF) roads has recovered to pre-COVID levels.
• We expect TQF's ratio of funds from operations (FFO) to debt to approach 6% and debt to EBITDA to move toward 9x in fiscal 2022. Recovery of the ratios to within our key credit metrics by June 2022 may require TQF to take action depending on traffic performance over the coming 12 months.
• On June 30, 2020, S&P Global Ratings revised its outlook on TQF to stable from negative. At the same time, we affirmed our 'BBB' long-term issuer credit rating on TQF and the issue ratings on the company's outstanding debt.
• The stable outlook reflects that on TQF's parent, Transurban Finance Co. Pty Ltd. (Transurban).

Rating Action Rationale

We revised the outlook to stable from negative and affirmed the ratings on TQF to reflect support from its parent, Transurban Group. Although TQF benefits from the credit quality of its ultimate parent, Transurban Group, TQF formally targets a stand-alone credit profile (SACP) in the investment-grade category. Prior to COVID, TQF had been operating at slightly above our FFO-to-debt threshold (6%) and at a debt to EBITDA of closer to 10x than 9x, particularly after increasing its debt in 2019. We expect these ratios to move back toward their threshold levels during fiscal 2022 (ending June 30, 2022) as traffic performance continues to improve but management action may be required to ensure it achieves the thresholds.

If required, we would expect TQF and Transurban to take remedial action in time to protect the stand-alone profile in line with TQF's treasury policy. Depending on traffic performance during fiscal 2022, there is a risk that the SACP on TQF could drop one notch to 'bb+'. This will, however, not affect the TQF issuer rating because the rating will benefit from uplift as a strategic member of the Transurban group.

We could also lower the rating if TQF's performance and key ratios significantly deteriorated, leading to the SACP worsening by three notches to 'bb-'. However, we view this scenario as unlikely given the profile of the business, Transurban's intention to maintain an investment-grade rating across its assets and the TQ Board policy to maintain a stand-alone investment grade credit profile for TQF.

The stable outlook on the parent, Transurban, reflects traffic recovery on most of Transurban's roads and strengthened credit metrics following the 50% sale of Transurban Chesapeake. We expect Transurban to maintain its FFO-to-debt ratio between 8%-9% from and beyond fiscal 2022 even if net debt increases for use in acquisition and development opportunities.

TQF's liquidity remains strong. TQF has no unfunded debt maturing in the next 12 months and low capital expenditure (capex). We expect TQF to continue to pay dividends from free cash flow subject to credit metrics.

TQF's financial risk profile is likely to remain highly leveraged.  Despite the recovery of traffic on TQF's roads we expect the company's leverage to remain high over the next 18 months. We continue to use a positive comparable rating adjustment modifier in recognition of Transurban adopting a strategy to operate at metrics consistent with our expectation for an investment-grade SACP.

Outlook

The stable outlook on TQF reflects the same outlook on Transurban and our expectation that the ratings on TQF and Transurban would move in tandem.

The stable outlook on Transurban results from the recovery of traffic to pre-COVID levels on most of Transurban's material roads and a strengthened net debt position following the sale of 50% of the Transurban Chesapeake business.

Downside scenario

We would lower the rating on TQF if the same occurred for the rating on Transurban.

We could consider lowering the SACP on TQF if the FFO-to-debt ratio (as a primary measure) remained below 6% or the debt-to-EBITDA metric (as a secondary measure) is not kept below 9x on a sustained basis from and including fiscal 2022. Either of these could occur from any combination of lower-than-expected future traffic levels and an increase in debt. Any downward revision of the TQF SACP to 'bb' or above would not affect the TQF credit rating due to rating uplift from the parent.

Upside scenario

We would raise the rating on TQF if Transurban was also upgraded. We view this scenario as unlikely over the next two to three years. An upgrade based solely on an improvement in TQF's stand-alone credit quality appears remote, because it would require a substantial two-notch uplift in its SACP.

Our Base-Case Scenario

We expect modest traffic growth on TQF's roads over the next one to two years now that traffic has recovered to pre-COVID levels.

Other current assumptions include:

• Toll charges continue to rise in accordance with relevant concession agreement provisions.
• Future dividends are paid at 100% of free cash with no capital releases contributing to dividends.
• Improvement in EBITDA margins to pre-COVID levels.

Liquidity

We continue to assess TQF's liquidity as strong. This is based on our expectation that the company's sources of liquidity will exceed uses by more than 1.5x over the next 12 months, even if EBITDA drops 30%.

TQF has no unfunded debt maturing in the next 12 months and minimal capex.

Principal liquidity sources:

• Cash and undrawn bank lines of approximately A$320 million as of June 2020; and
• Our estimate of FFO of around A$300 million for fiscal 2022.

Principal liquidity uses:

• Capex of less than A$50 million; and
• Dividend payments of approximately A$225 million.

Group Influence

We assess TQF as a strategically important subsidiary to Transurban. Under our criteria, we assess a subsidiary as strategically important where it:

• Is unlikely to be sold;
• Is important to the group's long-term strategy;
• Has the long-term commitment of senior group management or incentives exist to induce such commitment; and
• Is reasonably successful or has realistic medium-term prospects of success relative to group management's specific expectations or group earnings norms.

Our assessment is based on the following:

• It is unlikely that Transurban would sell off the TQF assets as its acquisition was in line with the long-term strategic goals of the company. TQF has been actively growing its asset base.
• TQF's assets lengthen Transurban's average concession life.
• TQF has a long history of operations and we believe the company would remain successful.

Supporting the rating on TQF is our view of the creditworthiness and group credit profile of the consolidated Transurban group comprising the triple-stapled entities--Transurban Holdings Ltd., Transurban Holding Trust, and Transurban International Ltd.--and affiliates. We assess the group's creditworthiness and the group credit profile by adopting the same scope of consolidation as the company under the published consolidated financial statements, rather than the group's preferred presentation to the market using pro rata consolidation.

Our assessment of the Transurban group results in the rating on TQF benefiting from a one-notch uplift from its SACP.

Ratings Score Snapshot

Issuer Credit Rating: BBB/Stable/--

Business risk: Excellent

• Country risk: Very low
• Industry risk: Low
• Competitive position: Excellent

Financial risk: Highly Leveraged

• Cash flow/Leverage: Highly Leveraged

Anchor: bb+

Modifiers

• Diversification/Portfolio effect: Neutral (no impact)
• Capital structure: Neutral (no impact)
• Financial policy: Neutral (no impact)
• Liquidity: Strong (no impact)
• Management and Governance: Satisfactory (no impact)
• Comparable rating analysis: Positive (+ 1 notch)

Stand-alone credit profile: bbb-

• Group credit profile: bbb+
• Entity status within group: Strategically Important (+1 notch from SACP)

Related Criteria

• General Criteria: Group Rating Methodology, July 1, 2019
• Criteria | Corporates | General: Corporate Methodology: Ratios And Adjustments, April 1, 2019
• Criteria | Corporates | General: Reflecting Subordination Risk In Corporate Issue Ratings, March 28, 2018
• Criteria | Corporates | General: Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Dec. 16, 2014
• Criteria | Corporates | General: The Treatment Of Non-Common Equity Financing In Nonfinancial Corporate Entities, April 29, 2014
• General Criteria: Methodology: Industry Risk, Nov. 19, 2013
• Criteria | Corporates | General: Corporate Methodology, Nov. 19, 2013
• General Criteria: Country Risk Assessment Methodology And Assumptions, Nov. 19, 2013
• General Criteria: Methodology: Management And Governance Credit Factors For Corporate Entities, Nov. 13, 2012
• General Criteria: Principles Of Credit Ratings, Feb. 16, 2011
• General Criteria: Stand-Alone Credit Profiles: One Component Of A Rating, Oct. 1, 2010

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