Brookfield Infrastructure Partners (BIP): The Global Infrastructure Play

Brookfield Infrastructure Partners L.P. (NYSE: BIP) is a growing collection of high-quality global infrastructure assets.

-Distribution Yield: 4.41% 
-Distribution Growth Rate: 12.8%
-Balance Sheet Strength: BBB+, Quite Stable

I believe BIP is an exceptionally well managed business, but the value is fully reflected in the units at the current price of $39 and therefore there is not a large margin of safety.

Overview

Brookfield Infrastructure Partners, L.P. (BIP) is a publicly traded partnership that was spun off from Brookfield Asset Management (BAM). Brookfield Infrastructure’s businesses are, as you could have guessed by the name, all about infrastructure. They own (or hold a joint venture with) the following infrastructure:

Utilities, $2,218 million in partnership capital

DBCT- Enormous coal terminal that provides port export services from Australia
Transelec- Electric transmission lines in Chile
Ontario Transmission- Electric transmission lines in Canada
Powerco- Electricity and gas distribution in New Zealand
IEG- Electricity and natural gas connections in UK
EBSA- Electricity distribution in Columbia.

Transportation and Energy, $3,273 million in partnership capital:

NGPL- Natural gas storage and pipeline in the US
Brookfield Rail- Australian rail infrastructure
PD Ports- Collection of shipping ports in UK
Euroports- Ports in Europe and China
IEG Distribution- Sole natural gas distributor in Channel Islands and Isle of Man
TGN- Sole natural gas distributor in Tasmania
Autopista Vespucio Norte- Chilean toll roads
OHL Brasil- Brazilian toll roads

Timber, $602 million in partnership capital:

Island Timberlands- timberland in British Columbia
Longview Timber- timberland in Northwestern US

Partnership Advantage

The advantage of a publicly traded partnership (including MLPs) over a corporation is that a partnership is not subject to as much double taxation as corporations are. When a corporation makes a profit, they are heavily taxed on that profit. Then, out of their after-tax profit, they may pay dividends to shareholders, and the shareholders then have to pay taxes on those dividends. So each dollar of a dividend is taxed twice- once at the corporate level and once at the shareholder level. Brookfield Infrastructure is a partnership and so is a flow-through entity. Unit-holders of a partnership pay taxes on their portion of the income. This way, earnings are only taxed once- at the individual level. It’s usually advantageous to be a partnership over a corporation, but the law only allows certain types of entities to become partnerships.

Since Brookfield Infrastructure is a partnership, it means you’ll generally receive tax advantages as a unitholder compared to a shareholder in a corporation. Your income will typically be taxed fairly modestly, and your taxes will be partially deferred (which is good, because you can use that money for compounding until you pay it). The disadvantage is that a partnership potentially complicates your taxes because you need to file an additional form. This is the type of investment for which it is often prudent to seek advice from a tax or financial adviser.

Cash Flow Stability
Regulated: 41%
Contractual: 39%
Other: 20%

Segment Diversification
Transport and Energy: 54%
Utilities: 32%
Timber: 14%

Global Diversification
Australia: 45%
North America: 30%
South America: 14%
Europe: 11%

Growth

Brookfield Infrastructure was hit fairly hard in the financial crisis, but has rebounded nicely, and the more regulated and stable parts of its business acted as a useful buffer for the more volatile and economy-dependent aspects. Since then, the company has been issuing equity and debt to expand very quickly by purchasing new investments and expanding existing assets.

Funds from Operations Growth

Year	FFO Per Unit
2012	$2.41
2011	$2.41
2010	$1.79
2009	$1.03
2008	$1.54

FFO (funds from operations) is calculated as net income excluding several items such as depreciation, amortization, deferred taxes, and other items, and is among the most meaningful of metrics for an asset-heavy partnership.

Between 2011 and 2012, overall FFO increased from $392 million to $462 million, which is an increase of around 18%. As can be seen by the table, however, FFO per unit was flat at $2.41 over the year.

The primary reason for the flat FFO per unit is that like other partnerships, BIP issues new units to fund growth. However, while we shouldn’t expect FFO per unit to increase at the same rate as overall FFO, we should still expect growth in this important metric to pay for increasing distributions per unit. According to BIP management in the fourth quarter conference call, the other reason cited for the flat FFO per unit is that due to the particular timing, a portion of the proceeds from the equity offerings that were invested into projects during this period were not yet reflected into increased cash flow for this period.

For example, BIP advanced construction of their $750 million Texas electricity transmission system which is expected to be up and running in mid 2013. In addition, BIP management expects a “ramp up” of cash flows in 2013 from the expansion of their Australian railroad and a full fiscal year’s contribution from their fairly new toll road businesses.

Limited Partnership Capital Growth

Year	Partnership Capital
2012	$6,100 million
2011	$4,206 million
2010	$3,357 million
2009	$1,858 million
2008	$900 million

BIP has been growing its size rapidly due to its acquisition activities. The company fuels these purchases with unit issuance along with a percentage of the FFO, but if performed at attractive valuations, results in increased per-unit performance including FFO and distributions. Distributions have continued to grow, and it appears that 2013 figures for FFO should be strong.

Balance Sheet

BIP has a reasonable balance sheet for an asset-heavy infrastructure business. The partnership is rated BBB+, and in the prior year they were able to easily access $400 million in capital from issuing corporate bonds and refinanced a total of $3.3 billion in debt at an average rate of 4.6%.

The balance sheet holds $19.7 billion in assets (with well under $1 billion consisting of goodwill) and $11.9 billion in liabilities.

Distribution

Brookfield Infrastructure currently pays cash distributions (similar to dividends) of $0.43 per unit per quarter, or $1.72 per unit per year. As of this writing, that is a 4.41% distribution yield. Management targets to grow the distribution by 3-7% going forward and pay out 60-70% of FFO. The current payout is on the low end of this range.

Distribution Growth

Year	Distribution
2013	$1.72*
2012	$1.50
2011	$1.32
2010	$1.10
2009	$1.06

The partnership has grown distributions at an average rate of over 12% during this period. The 2013 figure is extrapolated to assume that the current $0.43 quarterly distribution will continue throughout the year, which should likely be the case at minimum.

Investing Thesis

Brookfield Infrastructure represents a good partnership to invest in high quality, safe, cash-generating assets like utilities while also buying higher growth assets that are more sensitive to global economic trends. I particularly like their Australian infrastructure and South American toll roads.

Their coal export terminal, DCBT, in northeastern Australia serves Japan, Korea, China, and India, so they have direct access to emerging economic powerhouses. Management still lists $3.5 billion in potential expansions for this project, so this remains a huge capital sink for the partnership to continue receiving returns on.

Their $480 million expansion in Chilean and Brazilian toll roads during this last year was a good move in my view. Their Chilean toll road near Santiago is set to increase the toll at a rate of inflation + 3.5%, and traffic has been increasing at a high single digit annual growth rate over the last three years. Their Brazilian toll road investment includes partial ownership of 3,200km of roads including major roads around Sao Paulo.

Partnership management has made very prudent acquisitions and investments over the past 4 years, and has a very large (up to $5.5 billion) backlog of current and potential future investments for organic growth of their operations. According to the Q4 2012 unitholder letter over 65% of revenues are indexed to inflation.

With a fairly low distribution payout ratio, they preserve substantial capital for growth at lucrative rates of return and offer an attractive combination of yield and growth.

Incentive Distribution Rights
Brookfield Infrastructure has a rather low level of incentive distribution rights (IDRs) to the general partner. Many publicly traded partnerships have agreements where once certain target distribution levels are paid to limited partners, the general partner is entitled to up to 15%, 25%, and eventually 50% of total cash. Often, 50% is the highest target level (although mathematically, they never actually reach 50%; they just approach it as they grow the distribution). As the general partner is entitled to a percentage of cash approaching 50%, it increases the cost of capital for the partnership, because any new projects or acquisitions need to provide a large enough return to grow distributions to limited partners- despite paying a substantial percentage of the returns to the general partner.

Brookfield Infrastructure, on the other hand, has a maximum IDR distribution agreement for 25%. So the distribution situation will approach 25% of available cash going to the general partner, plus a management fee, and 75% going to the limited partners. This keeps the long term cost of capital very reasonable.

Target Returns
BIP management has stated that they expect to grow the distribution at 3-7% per year. With a 4.41% distribution yield per year, that provides for roughly 7.4-11.4% total returns, assuming a constant yield.

In contrast, BIP management has stated that 12-15% total returns are targeted. This implies achieving distribution growth on or above the top end of the target distribution growth. In recent years, their returns have far outpaced their expectations. Based on past performance combined with somewhat more conservative future assumptions, I’m fairly optimistic that Brookfield Infrastructure can meet the long-term midpoint of their targets or higher. Low double digit total returns in this environment are fairly appealing.

Risk

The partnership has elements of both risk and safety. On one hand, they hold necessary infrastructure like utilities, and they have long-term profitable contracts and giant economic moats around their businesses. On the other hand, they are rather leveraged like almost all asset-heavy businesses are, and some of their businesses such as timber, ports, and terminals are very dependent on the global economy.

One thing I like is that their risk is spread out on almost every continent and several countries. But much of their success is indirectly driven by China and other growth areas in Asia, and any major setback in these countries could have adverse affects on Brookfield Infrastructure (and particularly, their timber businesses and their Australian commodity infrastructure, which are some of their most attractive assets). In addition, entities like this that have attractive tax structures carry the risk of not meeting their requirements to remain a partnership, and are vulnerable to tax reform.

BIP has invested more heavily in Australia than previously projected, and now a full 45% of the business is invested in that continent. In addition, several of the largest growth opportunities remain in Australia, such as the potential for a multi-billion dollar coal terminal expansion, the continued expansion of the Australian railway, and the potential for Australian ports. To a certain extent, this concentrates risk to the region, and concentrates risk to Chinese consumption of Australian exports. I view these assets as some of the partnership’s most attractive assets, but with the concentration, I also view them as the largest risks now.

A global slowdown, and particularly a Chinese slowdown, would likely greatly affect these assets, and also their timber sales. The good news is that in times of recession, BIP management may have additional attractive acquisition opportunities like they did in this past recession. But it would be financially troublesome if BIP were to over-extend with infrastructure in this region.

Brookfield Infrastructure has:
-Leverage/interest risk
-Currency risk
-Pricing risk (timber)
-Volume risk (ports, terminals, toll roads)
-Regulation risk (electricity, other utilities)
-Tax Reform risk
-Australian weather risk
-Chinese economic risk
-other risks not insured

Conclusion and Valuation

I published a very bullish report on BIP back in March 2010 when the units were $18 and the distribution yield was comfortably over 6%. Three years later, those units paid over $3.60 in cumulative distributions and the units are now up to $39. This has been a big market outperformer, which is great news but we need to apply a critical eye towards the viability of continued outperformance and strong income generation.

After an increase in price for the units, my 2011 BIP report recommended to wait for dips under $24, and then later in 2011 I released an update article after the company increased its distribution and wrote that I was bullish on the units at that current price of around $25. In early 2012 with the price over $30, my report suggested looking for dips under $30, but the units hovered a bit over $30 for the first half of the year. So this has been a period of strong fundamental performance, strong capital appreciation, and continued upward revisions of the fair price target for each report.

Now in early 2013, I think it’s prudent to wait for dips again, but I do think the current price is reasonable as well. According to the Dividend Discount Model, the current price of a bit under $40 can be justified with the estimate of 8% distribution growth over the next 10 years and only 5% distribution growth thereafter with a 10% discount rate. The types of acquisitions and expansions BIP makes over the coming years, and how much they pay for those investments, will have a large impact on the actual returns to unitholders.

That doesn’t lead to a huge margin of safety when the units are roughly at their all-time high and the S&P 500 and DJIA are inching up to their all-time highs as well, but fundamentally, it’s hard to say the units are overvalued. Compared to many publicly traded MLPs, BIP does deserve a mild premium because a) their IDRs max out at 25% rather than 50% which leaves more long term capital for limited partners and b) their lowish yield is due to their 60-70% FFO payout ratio, which is lower than what an MLP typically pays and means they can invest more capital into their growth.

Overall, while I wouldn’t call the current price overvalued, as long as there are other investments at attractive prices, I’d prefer to look for price dips.

Full Disclosure: I own units of BIP.
You can see my dividend portfolio here.

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