Description

Brookfield Infrastructure Partners (BIP) owns and operates a globally diversified group of utility, transport, energy, and data infrastructure businesses that generate stable inflation indexed cash flows. BIPs largest assets include rail networks in Southwest Australia, Brazil, and North America; toll roads in South America and India; ports in the UK, Australia and North America; transmission lines in Brazil and Texas; natural gas pipelines in Brazil and North America; distributed energy systems in North America; cell towers in France, New Zealand, and India; fiber networks in France and New Zealand; data centers in South America; the largest metallurgical coal terminal in the world; and over 3 million UK utility connections.  

Given the level of long-term interest rates and the quality of BIPs assets, I believe it’s too cheap at a 4% distribution yield and ~20x run rate AFFO.  With 30-year treasuries yielding roughly 2%, why should a business with 95% regulated (or long-term contracted) revenue indexed to inflation with volume upside and a long runway for a capable management team to continue deploying capital at 12-15% returns yield 4%?    

BIP targets 3-4% organic growth from inflation indexation and 1-2% organic growth from real GDP growth (more traffic on its toll roads, more containers moving through its ports and rails, more gas traveling through its pipelines, etc.). These are pretty high certainty long-term assumptions in my opinion.  It’s important to note that these targets don’t imply management is banking on 3-4% global inflation; revenue is indexed to inflation, but (a) these are levered assets and interest costs don’t increase at all with inflation and (b) operating costs usually don’t quite increase by the level of general inflation either (a utility connection in the UK has very little cost to service once installed, as an example). 

Management also targets retention of 15-20% of AFFO to reinvest in the business at 12-15% returns for high-certainty incremental capex projects like widening toll roads, expanding transmission lines, or building out new connections in its distributed energy business. This should easily add 2-2.5% to AFFO growth before any M&A is considered.

Between this inflation indexation, volume growth, and organic reinvestment in the existing assets, earnings should grow annually by 6-8.5%.  But Brookfield Asset Management (BAM) gets IDRs equal to 25% of the growth in distributions, so that 6-8.5% turns into 4.5-6.5% growth net to the BIP unitholders. 

So before considering M&A, BIP unitholders get a security with very stable, bond-like cash flows yielding nearly twice the 30-year treasury rate that is inflation protected and likely to grow by 4.5-6.5% providing a total return of 8.5-10.5%.  That on its own seems like an attractive security to me in today’s rate environment and likely to outperform the S&P by a couple hundred basis points or more over time. 

But there is also significant upside from continued M&A at attractive returns. I think BIP can continue investing ~$1.5B/year (consistent with the last few years) in acquisitions at target returns of 12-15%, which they have achieved on their cumulative M&A history. I think it’s more likely than not that BIP can continue acquiring assets at attractive returns given their experience, track record, and scale. Infrastructure is where BAM has its longest track record, where relationships matter most because many of the sellers are government entities who care about the buyers operating expertise, and where there's more synergy potential and underwriting knowledge gained from owning nearly $60 billion of infrastructure assets around the world.  

Historically BIP has issued equity to fund M&A; but, now that they have a more mature business, they’re able to instead recycle mature assets that don’t need as much operating expertise at 6-10% yields to fund new higher growth investments.  If they can sell $1B of mature assets (below run-rate in the last couple years) annually at 8% yields (similar to recent sales) and buy $1B of assets annually at 12% IRRs (below long-term averages), that adds another 2.5% net to the unit holders. 

So, assuming:

 1. BIP assets grow organically with inflation + real GDP;

      2. BIP can continue reinvesting 15-20% of AFFO in company average ROIC organic growth          projects; and

      3. BIP can sell $1B of mature assets at 8% IRRs and reinvest at 12% IRRs,

  then BIP should earn unitholders a total return of 11-13% over a long-term holding period consisting of a 4% distribution yield and 7-9% distribution growth, which is the high end of managements target 5-9% range that they have handily beaten since inception in 2008 (10% CAGR). 

Furthermore, with 30-year treasuries yielding 2% and negative rates in many other parts of the world, I think it’s more likely than not that the distribution yield falls over time. Any re-rating of the distribution yield would be further upside to the 11-13% returns I believe unit holders can expect on yield and growth in distributions.

Catalyst

Around the end of March BIP is distributing shares in BIPC, which will be a new corporate entity that opens BIP up to a wider universe of potential investors as it is currently structured as a partnership which limits the investor base.