The shares are up c.15% over the past couple of months but we think there is more to go. European confidence indicators continue to edge up and Eurotunnel is, in particular, a strong play on the buoyant UK economy. Overweight.
* After the strong run, is valuation a concern?
It is not easy to benchmark Eurotunnel’s valuation given virtually no relevant comps, no earnings, high operational & financial leverage, long concession life (until 2086) and a relatively low FCF (4% 2014) and div yield (2% 2014).
* It is worth exploring how Eurotunnel’s financial profile could change over next 4 years...
FCFE yield could double to c.8% by 2018 when we expect Eurotunnel to reach 5x net debt/EBITDA. It would then be able to maintain a dividend that implies a sustainable yield >10% (p.4). Putting our 2018e dividend on a 5% yield (top end of peer range) and discounting it back to today represents ~50% upside potential.
* …but our PT does not fully discount this scenario.
There are risks to the scenario above. Eurotunnel might have different thoughts on cash allocation, for example. Although Eurotunnel has a potentially compelling dividend story, there are other infrastructure companies that look able to sustain higher dividend payouts too. Based on our fundamental analysis, we estimate the shares trade on a 12% IRR, while our PT implies 11%.
* Sentiment and trading momentum are key, both of which suggest the shares can go further.
In short, we don’t think valuation should cap the shares yet, which, given Eurotunnel’s high operational leverage, means sentiment is key. PMIs continue to edge up, and we expect trading momentum to improve and regulatory concerns to ease. 2015 catalysts remain on the horizon, with Sulphur regulation increasing the Ferries’ fuel bill and new Eurostar services on track.