What's new?

Transurban chief executive Chris Lynch proposed an "outlandish" concept this month. The toll roads operator will now pay distributions from operating earnings instead of debt.

Although this sounds like sensible business practice, the market met the news with a savage reaction.

Listed infrastructure funds were initially popular due to the certainty of earnings from their underlying assets, such as toll roads and airports. In addition, the easy availability of cheap debt over the past few years allowed management to juice up distribution payments.

By turbo-charging yields in this way, investors became even more enamoured with companies such as Transurban.

How management generated the yields was of little concern to investors, just as long as the income kept flowing. And of course, widespread investor enthusiasm brought with it the icing on the cake - a strong share price. With the credit bubble pricked and the cost of debt considerably higher, this business model is no longer viable.

The consensus is Lynch was "brave" to take such action. It's hard to see the bravery involved in putting your company's operations on a sustainable course. He really had no choice.

Even so, the decision to admit that the decade-long game of leveraging low-growth property and infrastructure assets is over would not have been taken lightly. No longer can these assets be magically revalued every half-year, courtesy of low or falling interest rates, allowing debt levels to expand.

At least for Lynch, raising the white flag was made a little easier given that he joined Transurban last October. After all, the change of emphasis wasn't his idea. Had Lynch overseen the strategy from the early days, admitting defeat would have been much tougher, not to mention potentially career-ending.

The outlook

In addition to the revised distribution policy, Lynch is also strengthening the balance sheet through a capital raising of up to $1 billion. In doing so, he has reduced the risk associated with the business and laid the foundations for sustainable future growth. As such, Transurban is by no means in terminal decline.

Price

The decision to cut future distributions turned the company's gradual share price decline over the past year or so into a cliff face.

From $5.41, the share price collapsed to about $4 last week.

This has seen Transurban return to price levels last visited four years ago.

It is worth noting that a fall in Transurban's stock price to $2 would trigger a review by its lenders. If hedge funds decide to target the company's debt covenants, as they did for Babcock & Brown, there is the potential for selling pressure to mount.

Worth buying?

Despite the market's reaction, Lynch's willingness to set the company on a sustainable path should prove positive. The income reliability of Transurban's toll road assets is certainly attractive.

However, the stock is likely to remain volatile through this transitional period, making a seat on the sidelines an attractive option for the time being at least.