Brookfield Infrastructure Partners (BIP)

Rail RoadThe next step in the valuation of Brookfield Asset Management (BAM) is to understand the components of the company starting with Brookfield Infrastructure Partners (BIP). Brookfield Infrastructure Partners is the first major entity spun off in Brookfield Asset Management’s transformation to a global asset manager. BIP was launched in 2008 and operates infrastructure assets in North and South America, Australasia, and Europe that provide essential products and services for the global economy.

Infrastructure assets are typically long life and require relatively minimal maintenance capital expenditures, enjoy varying degrees of barriers to entry and tend to appreciate in value over time. Modern society will always require infrastructure assets to deliver; raw materials, energy and people. BIP’s investments are positioned to deliver these essential needs.

Worldwide macroeconomic issues continue to create opportunities for the well-funded, contrarian and value oriented Brookfield family of companies. Brookfield Infrastructure has been especially active over the past few years significantly expanding their infrastructure platform as opportunities surface.

An added benefit in owning BIP’s real assets is geographic and currency diversification and regulated or contracted revenues that provide a hedge against inflation and repressive financial policies underway as countries try to manage record debt levels.

Brookfield Infrastructure Valuation Summary:

Since their launch as a publicly traded entity five years ago the results are impressive showing a 33% total return in 2012 alone. Going forward BIP appears to have ample growth opportunities due to increasing infrastructure needs worldwide and an existing global presence. The company appears well positioned for the future and will likely be an outstanding income and growth investment.

Please be advised this valuation has been updated; click here for the update.

Map of Operations:

BIP Map of Operations[Source]: Brookfield Infrastructure Website: Map of Operations

Operating Profile:

Brookfield Infrastructure breaks the business down into three operating areas: The Utility Platform consists of a regulated coal terminal handling 20% of global waterborne metallurgical coal, electrical transmission lines providing 98% of electricity to Chile’s population, and 2.1 million connections of regulated electric and natural gas distributions in Australasia, Europe and South America.

The Transport and Energy Platform consists of 5,100 kilometers of railroad track in Western Australia, 30 port terminals primarily in the United Kingdom and Europe, 3,200 kilometers of toll roads in Brazil and Chile. Energy transmission and distribution consist of 15,500 kilometers of natural gas transmission lines providing 60% of Chicago and north Indiana’s natural gas, 300 billion cubic feet of natural gas storage, and a district heating and cooling water system serving Toronto Canada.

The Timber Platform encompasses 343,000 acres of timberlands and 8,000 acres of developmental lands in Canada and the U.S.

BIP Platforms

 

[Source]: Brookfield Infrastructure Corporate Profile, February 2013

Investment Attributes:

Infrastructure assets are often characterized with barriers to entry and strong competitive positions, the investment attributes include:

  • Assets costly to construct with long lives providing a vital service
  • Demand tends to be inelastic given the scarcity of the resources being offered
  • At times monopolistic pricing power, often regulated, with long term stable cash flows
  • Hybrid investments showing both fixed income like cash flows with potential for capital gains
  • Assets that can be expanded allowing for value to grow over time
  • Investments range from low-risk regulated assets to moderate risk loosely regulated assets
  • Varying amounts of inflation protection and different levels of vulnerability to economic cycles.

In BIP’s case the cash flows are stable with approximately 85% supported by regulated or contracted revenue streams. BIP’s stable cash flow, segment diversification, and global footprint provide a strong base for sustainable earnings and future growth. It also provides a level of diversification to investors usually only achievable through multiple investments or holdings. The large capital investments required are funded by equity issuance and long-term debt that is not guaranteed by Brookfield Asset Management.

BIP Profile Pie Charts

[Source]: Brookfield Infrastructure Corporate Profile, February 2013

Future Growth:

Growth through Increased Demand:

Demand for infrastructure is increasing dramatically due to worldwide population and economic growth and the rapid growth of the middle class in emerging economies. The much needed spending on infrastructure and a growing deficiency in government budgets provide a huge opportunity for private sector involvement.

Estimates of global infrastructure spending range considerably. A survey of 300 senior infrastructure professionals by Infrastructure Investor [Source] estimate infrastructure investments would range between $34 and $60 trillion through 2030. The 2030 projections are focused on 25 countries, including large or emerging economies in China, Brazil, India, North America and Indonesia, among others. This presents incredible potential for companies like Brookfield Infrastructure that are well-funded and a global presence.

BIP has surplus capacity in the ports, railroads, and natural gas transmission to absorb some of this growth, without further investment, as it occurs. The toll roads in South America will benefit from increasing vehicle use in emerging markets like Brazil and Chile with a growing middle class and economic development.

Growth through Existing Pipeline of Projects:

The second source of growth for BIP is an organic growth pipeline, evolving to a large extent, from the opportunistic acquisitions made over the past few years. The pipeline holds approximately $5 billion of projects under consideration:

BIP Growth Pipeline

[Source]: Brookfield Infrastructure Corporate Profile, February 2013

Growth through Inflationary Price Increases:

The third source of growth is almost passive in nature and does not require capital investment. Approximately 65% of BIP’s current revenues are indexed to inflation and will capture inflationary price increases.

Historic Performance:

Management’s objective is to maximize long term value for unit holders.  “Our objective is to maximize long-term value for unitholders. To achieve this goal, we target annualized total returns of 12% to 15% – from our current operations and the assets that we acquire – over the long term. This return will be generated from the in-place cash flow of our current operations plus growth.” [Source]

As prospective investors we should ask: have they delivered on these objectives historically?

BIP Returns through 2012[Source] Brookfield Infrastructure Partner’s 4Q12 Letter to Unitholders

BIP FFO Growth

Although past performance does not guaranty the future; since the launch five years ago the results are reassuring.

Management:

These results are of course products of sound management. Fortunately the executive management team so successful at Brookfield Asset Management is the team supporting Brookfield Infrastructure (and the other listed entities) going forward. We don’t have to wonder about their track record. They produced compounded annual returns of 19% over the past 20 years at BAM. BIP’s Chief Executive Officer, Sam Pollock, for example joined Brookfield Asset Management in 1994 and was previously Brookfield Asset Management’s Chief Investment Officer.

It also takes a good business to produce impressive results, certainly over the long haul. As Warren Buffett explains in his 2006 letter to Berkshire Hathaway shareholders on page 11 [Source]: “Not all of our businesses are destined to increase profits. When an industry’s underlying economics are crumbling, talented management may slow the rate of decline. Eventually, though, eroding fundamentals will overwhelm managerial brilliance. (As a wise friend told me long ago, “If you want to get a
reputation as a good businessman, be sure to get into a good business.”)” 
It sure helps when you have both sound management and a good business.

Favorable Structure of Master Limited Partnerships (MLPs):

There is good news for those of you who may have invested in U.S. MLPs and experienced the numerous state income tax filings (wherever that partnership operated) or worried about unrelated taxable business income (UBTI) in retirement accounts. In addition to the business benefits of MLPs, Brookfield Infrastructure is committed to structuring operations through holding corporations in various jurisdictions to avoid unit holder state tax filings or generating UBTI.

MLP Tax

[Source]: Brookfield Infrastructure Corporate Profile, February 2013

Investors in an MLP buy units of the partnership rather than shares of the stock thus the term “unit holders” and payments to the unit holders are referred to as “distributions” rather than dividends. There are two levels of MLP ownership, the general partners and the limited partners.

The general partner, in BIP’s case is Brookfield Asset Management. BAM as general partner manages the operations and all services including management are provided by the general partner. The publicly traded limited partner (BIP) pays the general partner (BAM) for the services provided through an agreed to fee structure and performance incentives. The limited partner units are publicly traded and the general partner units are not.

The master limited partnership structure is widely used in by energy pipeline companies that are capital intensive business with stable cash flows the U.S. Similar characteristics exist in the infrastructure industry where the unit holders can benefit in a number of ways:

Alignment of Interests: The general partner BAM is paid an incentive to increase distributions to the limited partners. BAM collects a 15% incentive then a 25% incentive after certain distribution levels are reached. This gives the general partner an incentive to increase limited partner distributions.

The general partner can also own limited partner units as is the case with BAM owning 28% of BIP limited partner units aligning BAM’s interest with unit holders in BIP. It is also then in the general partners interest to increase distributions since they also receive the distributions through direct ownership as well.

BAM as a general partner is also paid 1.25% of market capitalization of the limited partnership as an incentive. This provides an incentive to also increase the market value of the limited partner’s units.

Favorable Tax Treatment: Shareholders in a corporation pay double taxation, first at the corporate level then at the personal level when dividends are received. Partnership owners are taxed only once, when they receive distributions.

Reinvestment of Cash Flow: Since there is no partnership equivalent of corporate income tax funds from operations that are not paid out as distributions can be reinvested in the business on a pretax basis. This provides for tax free compounded returns (capital gains) where reinvestment opportunities exist.

Lower Cost of Capital: Without the equivalent of corporate income tax MLPs typically enjoy a lower cost of capital than a taxed corporation.

Valuation:

Benjamin Graham, considered the “Father of Value Investing” argued businesses should be purchased below their current intrinsic value to provide a “margin of safety” with little or no regard for future growth. This creates a dilemma however with companies, perhaps not selling at discounts to current intrinsic value, but with increasing intrinsic value as is occurring with BIP.  Warren Buffett explains how Berkshire Hathaway resolved the dilemma in their 1992 letter to shareholders [Source“In our opinion, the two approaches [growth and value] are joined at the hip: Growth is always a component in the calculation of value, constituting a variable whose importance can range from negligible to enormous and whose impact can be negative as well as positive.”

One solution is to consider future growth but not to pay for it by treating growth as (part of) the margin of safety. Brookfield Infrastructure Partners is clearly growing, so we don’t want to ignore it. We use the growth built around management’s stated targets outlined in the February, 2013 Corporate Profile [Source] as part of our margin of safety. That view is important with companies like BAM/BIP that operate with long term growth strategies or we may forever be locked out of great investments and income streams.

Management’s total return target of 12%–15% per share is the sum of current yield (distributions) and capital appreciation. An underlying premise of our valuation is that these returns can only be achieved where there are comparable increases in cash flow through operations improvement, organic growth, acquisitions, or improving business conditions. A second premise in the valuation is the capital structure of the company remains relatively constant over time.

Management’s job is to decide how best to utilize the excess cash generated in the business. They can either reinvest it in the business, if opportunities exist to do so at sufficient returns, or return it to shareholders as distributions (or share repurchases). If investment opportunities exist that will generate 12-15% returns in this low (near zero percent) rate environment, my vote will always be to maximize reinvestment.

Please be advised this valuation has been updated; click here for the update.

Risks:

As with any equity investment there are various risks to consider including the following with BIP:

Political Risk: Some of BIP’s large investments are in emerging economies where socio-economic factors can result in politics that, at times, adversely influence the business environment. Not that we are totally immune from these factors in the industrialized world.

There are several offsetting factors to consider as well. Brookfield has years of operations experience in the emerging economies where they operate. Management seems to use their global presence defensively where political risks are uncertain. For example, infrastructure assets in Australia, enables BIP to benefit from rapidly growing economies in Asia.  BIP assets are located in politically stable Australia but supply resources to parts of Asia without the direct investment in potentially higher risk countries.

The management team has an excellent track record over a long period of time demonstrated with prudent capital allocation, critical thinking and a refreshing ability to walk away where risk is unacceptably high.

Interest Rate Risk: MLP units are often viewed as income investments and can trade somewhat like bonds, rising when interest rates fall and vice versa. We are likely facing higher interest rates in the future. BIP also uses debt finance its business so a rise in interest rates will, all else equal, decrease returns.

Offsetting the interest rate risk to some degree is BIP’s ongoing growth and financial strength enabling its current strategy of refinancing debt at record low interest rates present today and lengthening terms. Further, increasing rates tend to occur in improving economic environments where capacity utilization of infrastructure assets tends to increase and improve cash flows.

Summary:

In BIP’s 4Q12 letter to unit holders [Source], CEO Sam Pollock sums up the ongoing momentum well: “In 2012, we made significant strides in solidifying Brookfield Infrastructure’s position as one of the leading, global infrastructure businesses. During the year, we advanced a number of organic growth initiatives that demonstrated our ability to successfully deliver large-scale development projects, and we closed several opportunistic acquisitions that significantly enhanced our footprint. It is this formula of organic growth along with M&A execution that we expect will propel our growth going forward.”

“With respect to organic growth, we successfully commissioned our $600 million Australian railroad expansion below budget and ahead of schedule, and we significantly advanced the construction of our $750 million Texas electricity transmission system, which we expect will be up and running by mid-2013. On the acquisitions front, we closed a number of transactions that were the result of an outreach program that we initiated in 2008. Our strategy was to develop relationships with European infrastructure companies that own high quality assets in Latin America. In 2011 we redoubled these efforts as we thought that attractive investments could surface in this region, triggered by the European sovereign debt crisis. During the past year, we deployed $1 billion of capital in European businesses or in assets acquired from European owners as a direct result of this strategy.”

BIP Summary Table

BIP closed out 2012 with excellent year of strategy execution providing unit holders with total return of 33% for the year including a distribution increase of 15% to $1.72/unit for a current yield of about 4.5%. Over the past 5 years during one of the worlds largest financial crises they produced a total positive return of 20% per year. These level of returns will not continue forever, however it is hard not to be optimistic, based on their past performance and future prospects.

Going forward BIP appears to have ample growth opportunities thanks to increasing infrastructure needs worldwide. It has an existing global presence, facilitated by its affiliation with well-funded Brookfield Asset Management, to continue growing for the foreseeable future.

BIP appears well positioned for the future and will likely be a significant growth platform for Brookfield Asset Management and an outstanding income and growth investment in itself.

Up in the next post, Brookfield Renewable Partners (BEP, BREP)

Disclosures: Long BAM, BIP, BREP, BEP

References:

  • Brookfield Infrastructure L.P. Website [Source]
  • BIP Investor Presentation, Corporate Profile [Source]
  • BIP 4Q12 Letter to Unitholders [Source]
  • BIP 4Q12 Earnings News Release [Source]
  • BIP 4Q12 Supplemental Information [Source]

 

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