BNN-Bloomberg-Market Call, Stephen Takacsy's Top Picks: November 7, 2022

BNN-Bloomberg-Market Call, Stephen Takacsy's Top Picks: November 7, 2022

Stephen Takacsy, president, chief executive officer and chief investment officer, Lester Asset Management

FOCUS: Canadian stocks  

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MARKET OUTLOOK:

Volatility continues to rule stock and bond markets in 2022 due to aggressive central bank interest rate hikes to get inflation under control by suppressing demand. Rising interest rates will no doubt slow down parts of the economy such as real estate and consumer discretionary spending. Canada and the U.S. should be able to engineer a “soft landing” as those economies are coming from a strong place with low unemployment, high personal savings and strong currencies.

We believe that inflation is already showing signs of easing as supply and demand come more into balance and supply chain disruptions normalize. The stock and bond markets are trying to sniff a possible end to the tightening cycle which will take its cue from inflation data and central banks appear to be slowing down rate hikes to give some time for the hikes to take effect. Investor sentiment is extremely bearish (a great contrarian signal) and it is impossible to time when sentiment will turn, but when it does markets usually rise sharply (we have seen a few possible head fakes lately).

We are staying invested but well diversified in recession-resistant businesses that have pricing power such as telcos, pipelines and utilities. Particularly we are staying invested in those benefitting from strong tailwinds such as renewable power and the transition to clean energy. This includes Boralex and Northland Power, which are both present in Europe where power prices have risen dramatically. These safe high dividend-yielding sectors look particularly attractive having corrected dramatically over the past few months. Other long-term investment themes we like include aging demographics (Savaria, Park Lawn, Siena Senior Living, Neighbourly Pharmacies), digitization (CGI, TECSYS, MDF Commerce) and infrastructure (Logistec, WSP Global, and Brookfield Infrastructure). We have been taking advantage of volatility to add high-quality companies whose shares have come down to compelling valuations such as Cargojet, Richelieu Hardware, Pollard Banknote and Canadian Tire. 

TOP PICKS:

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Stephen Takacsy’s Top Picks

Stephen Takacsy, president, CEO, and chief investment officer at Lester Asset Management, discusses his top picks: Neighbourly Pharmacy, Cargojet, and Park Lawn.

NEIGHBOURLY PHARMACY (NBLY TSX)

A safe way to invest in healthcare in Canada. 

NBLY is Canada’s third-largest pharmacy chain with 284 locations in seven provinces, mainly located in rural communities. Its strategy is to consolidate this still very fragmented industry and generate operating efficiencies while improving the top line like front-of-the-store sales. This is a recession-proof business with steady growth from aging demographics and new revenue sources from an increasing scope of practice whereby pharmacies can prescribe more medication to help alleviate the burden on the public system. The company did an IPO at $17 in early 2021, then rose to nearly $40 before settling back more recently in the low $20. They also did recent financing at $29 to acquire its largest competitor with significant insider buying. Since the IPO the number of stores, revenue and EBITDA run rates have doubled to around $830 million in sales and $97 million in EBITDA. The company released good results a few weeks ago with strong same-store sales growth and increased margins. In the low $20s the stock is now attractively priced considering its strong growth, margin and free cash flow profile, at around 11X EBITDA.

CARGOJET (CJT TSX)

Monopoly in the sky.

CJT is a high-growth, high-margin, high ROIC company having locked up around 90 per cent of Canada’s overnight air freight market. Think of it as a contracted pipeline in the sky. It has 34 aircraft and also offers international sub-charter and charter services. It recently announced a large new contract with DHL and its Canadian e-commerce business continues to grow by double digits. CJT takes little or no risk since it signs long-term guaranteed take-or-pay-like contracts before it buys a new plane with blue chip clients like Canada Post, Amazon and DHL. Because it’s in the transportation sector, generates some overseas revenues, and does a lot of e-commerce business with Amazon, it has been “thrown out with the bathwater.” The stock was expensive for many years and it is now very cheap trading at only 8.5X EBITDA for such a high-quality business with limited competition and high barriers to entry.

PARK LAWN (PLC TSX) 

Aging demographics and industry consolidation.

The only publicly traded company in Canada in the “deathcare” industry. PLC owns funeral homes, crematoria and cemeteries in Canada and the US. It’s a recession-proof high-margin high-barriers-to-entry business with strong tailwinds from aging demographics. Strong management team based in the U.S. where they are focused on an a mergers and acquisition strategy to consolidate a still very fragmented industry as the number two player after Service Corporation. EBITDA is expected to double to $150 million by 2026, at a 15 per cent CAGR. Stock was added to TSX Composite last year. The massive pullback from $42 to $22 caused by the market correction and tough comps during the pandemic’s higher death rate is a great entry point into this unique business trading at around 10X 2023 EBITDA with a  healthy balance sheet, good organic and mergers and acquisition growth and strong free cash flow.

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Source

https://www.bnnbloomberg.ca/stephen-takacsy-s-top-picks-november-7-2022-1.1842830

BAM...Letter to Shareholders

BAM...Letter to Shareholders

Overview

Our business continues to perform extremely well, demonstrating its resilience and diversification. Private assets also continue to show their advantage for investors by better allowing owners to wait out volatile markets, and this in turn encourages greater allocations to alternatives. By contrast, the volatility of equities and, particularly, fixed income, which is meant to be a safe haven, has disappointed investors recently. This further emphasizes the benefits of alternatives.

Our net income and cash flows were very strong which, given everything going on in the world, demonstrates our resilience, stability, and strength. Distributable earnings before realizations were $1.2 billion, up 39% from last year, and the business continues to see sequential income growth.

We were very active in the third quarter and beginning of the fourth, with the breadth and scale of our franchise enabling us to complete several transactions. We acquired 25% of a €17.5 billion German telecom tower portfolio; agreed to a $30 billion partnership with Intel for their semiconductor facility in Arizona; established an $8 billion strategic partnership between our Transition group and Cameco to own Westinghouse Electric for the long term—while simultaneously winding up the very successful restructuring phase of our private equity group’s ownership; made $7 billion of investments in our Transition fund; and closed on the acquisition of three real estate companies with $9 billion of assets at deep discounts to replacement cost. In addition, we are on track to have our largest fundraising year ever, with inflows of $33 billion since the end of last quarter.

Market Environment

It looks as though interest rates may peak in the next six months and many of the major economies of the world will experience a recession. As inflation abates, we think interest rates will slowly come down, but this might take some time, depending on how long it takes to harness inflation.

The current environment has created dislocation in the financial markets, with access to capital becoming a challenge for many. We believe this will abate over time but for the time being, it has led to a significant slowdown in transaction volume despite an increased need for capital for many companies.

Fortunately, we have approximately $125 billion of deployable capital and the skills to navigate these markets and execute transactions. As a result, the current markets present a good opportunity for us. This applies to all our businesses, but we think it will be particularly positive for both our Insurance Solutions business, which has been largely sitting on cash until now, and our Oaktree franchise, which specializes in investing in less-than-ideal markets.

Operating Results

Distributable earnings before realizations were $1.2 billion in the quarter and $4.2 billion over the last 12 months, representing increases of 39% and 29%, respectively, over the comparable periods. Our underlying operations performed well, supporting distributions from investment of $2.6 billion over the last twelve months. Insurance Solutions operating earnings increased to approximately $160 million for the quarter, benefitting from the closing of American National.

We are on track to have our largest fundraising year ever and in that regard had another strong quarter, with capital inflows of $33 billion since the end of last quarter. Our fifth flagship infrastructure fund and our sixth flagship private equity fund held first closes and stand at approximately $21 billion and $8.4 billion, respectively, and in early November we launched the next vintage of our opportunistic credit strategy, with an expectation that it will exceed the $16 billion of the previous fund. We have completed fundraising for our fourth flagship real estate fund, raising $17 billion for this strategy. We raised $14 billion in the quarter across our other strategies, with significant contributions coming from our perpetual private infrastructure fund and our infrastructure debt fund.

Our monetization activities have also been progressing well, and we sold $5 billion of assets at excellent values. Despite the slowdown in deal activity more broadly, we continue to observe that cash-flow-generating, inflation-linked assets like the ones we own still encounter strong demand. After the end of the quarter, our private equity business announced the sale of Westinghouse, which will generate $8 billion of proceeds and $4.5 billion of total profit.

We also continue to finance and refinance assets and businesses, a reflection of our competitive advantages of quality assets, scale operations, a conservative balance sheet, high levels of liquidity, and a strong reputation in the capital markets. As we look at our financings across the portfolio, we feel confident in our ability to refinance upcoming maturities, even if the current market environment were to persist.

Overview of Investor Day

We hosted our annual Investor Day in September. For those who were unable to attend, the webcast and materials are posted on our website. We laid out the growth profile for each of our three key pillars: the Corporation, the Manager, and Insurance Solutions. Before year-end, we expect you will receive shares of the Manager through a distribution. After that, you will own part of the Manager directly versus only through the Corporation.

As we outlined at Investor Day, our business is well positioned to benefit from the secular tailwinds that we are experiencing with the transition to net zero, the global data infrastructure build-out, and the ownership of inflation-protected, highly cash generative assets.

In addition, our scale, flexibility, and global presence all position us well to be a partner of choice for the large corporate sector. As a result, we believe our growth prospects are stronger than ever.

If we achieve our plans, we should be able to grow distributable earnings by over 25% on a compound annualized basis over the next five years. If we successfully utilize the synergies of our three business pillars, then we may outperform these plans.

Corporation

The Corporation, post spinoff, will own circa $150 billion of private and listed investments, including a 75% interest in the newly listed Manager. As a result, we will have one of the largest discretionary pools of alternative assets globally. The Corporation will not face any restrictions on how we use this capital, and our sole focus will be on allocating capital among our operating businesses and new business initiatives, while targeting a 15%+ total return for our shareholders over the long term. We will leverage the Manager to source investment opportunities and opportunistically look to grow our business as opportunities arise. In this environment, we feel the odds favor something large and interesting showing up.

Manager

The Manager is increasingly diverse and growing faster than ever. By year-end, we plan to have distributed and listed a 25% interest in it, creating optionality for you to own our pure-play leading alternative asset manager. Initially, we expect it to generate approximately $2 billion of distributable earnings, pay out approximately 90% of that in cash dividends, and have no debt (actually net cash of $3 billion). If we achieve our growth plans, over the next five years we should double distributable earnings—and we plan to return over 90% of that to shareholders through dividends.

Insurance Solutions

Insurance Solutions has grown substantially since we announced our plans to build out this strategy two years ago. The acquisition of American National, our growing pension risk transfer business, and the acquisition of numerous reinsurance blocks have grown our insurance capital to approximately $45 billion. The addition of direct origination capabilities means that we can now underwrite insurance policies directly, creating greater flexibility in the operation. With the ability to deploy insurance capital into our alternative strategies and therefore out-earn return targets, we think this business has excellent long-term growth potential.

The Future is Renewable

Renewables are fast becoming a major source of electricity generation in most countries around the world. The many reasons for this are outlined below. Combined, they are adding to the tailwind for our business and accelerating its growth.

They are the cheapest:

Renewables are now the cheapest form of electricity in most major markets around the world. Construction costs have come down dramatically as a result of advances in technology and manufacturing scale. In addition, the wind and sun have no variable cost. In an inflationary world, this is very powerful.

They are carbon free:

In a world where most individuals and almost all corporations now recognize that we need to transition to a less-carbon-intensive world, renewables are the most productive and simplest way to reduce carbon emissions. Capable of producing energy with zero emissions, they are therefore the base of all global corporations’ carbon reduction plans.

They are easy to build:

Electricity can be generated from natural gas, coal, nuclear, hydro, wind, solar and sometimes (but not often) oil. In contrast to the long construction times of a natural gas-fired plant, coal plant, or nuclear facility, wind and solar plants can be built relatively simply and without risk of major cost over-runs. Essentially, these involve relatively simple construction projects which can be completed in 12 to 24 months, depending on the site.

There is growing need:

As the world continues to electrify, it is expected that 50% more electricity will be required in most markets. We believe the increase in demand is a trend for at least the next 20 years and reverses a 20-year flat demand curve. This is due to the large increase in global population, the increase in demand that occurs as those populations become wealthier, and the demand from industry and cars as they move from natural gas and oil-based gasoline to electricity.

They offer national security:

Countries have recently learned what it means not to have local control of their electricity supply. Renewables and nuclear are the only locally sourced forms of electricity—unless a country has local natural gas, which most don’t. As a result, wind and solar are now identified as strategic resources for many countries and will increasingly be seen as a fundamental ingredient of national sovereignty.

They will soon be baseload:

The greatest criticism of wind and solar has been that there are times when the wind doesn’t blow and the sun doesn’t shine. Technology, though, is quickly moving towards breakthroughs that will allow batteries to store electricity efficiently, and for hydrogen to be utilized to store electricity in conjunction with renewables. As these technologies advance, renewables will soon become baseload electricity, eliminating the need for other historically important technologies to augment wind and solar.

Taken together, these factors make the renewables business a very exciting place to be for the next 20 years as the world transitions to reduced carbon intensity.

Our Vast Capital Flexibility Differentiates our Franchise

We recently closed an innovative transaction that demonstrates the strengths and breadth of our franchise very well. We think it is an exceptional transaction for all parties involved, and we hope that we will be able to bring this type of transaction to our constituents in the future.

By way of background, in 2018 we acquired Westinghouse Electric Company in a bankruptcy proceeding. Westinghouse had tried to expand into construction of nuclear plants with fixed price contracts, and unfortunately miscalculations forced it to file for bankruptcy. Westinghouse’s business was primarily—and is now exclusively—the ownership of one of the only four nuclear technologies in the world, along with the servicing, maintenance, and fueling of the installed fleet of nuclear power plants. The business has proven to be an exceptional one during our five recent years of ownership.

The purchase was made in our private equity fund because Westinghouse needed a turnaround. The purchase price was $4 billion; we invested approximately $1 billion of equity and financed the balance with $3 billion of debt. The turnaround was extremely successful and to date the company has distributed cash greater than the original equity investment; its debt is lower; it’s generating approximately $800 million of annual run-rate EBITDA; and its growth prospects are accelerating.

Westinghouse today is the leading provider of highly technical aftermarket products and services to the nuclear power infrastructure market and government agencies on a global basis. It is a global leader with a large installed technology base, a large backlog of contracted revenue, leading technology, and a highly specialized workforce of 9,000 employees with over 2,500 highly experienced and trained nuclear engineers located around the world. These attributes enable Westinghouse to develop and provide the critical, very specialized services required to meet global net-zero targets. As a result, Westinghouse benefits from long-term contracts, significant recurring revenue, high customer retention, and high barriers to entry. Few companies have a moat like this one.

Recently, we decided that our private equity fund should sell this asset as it had fully achieved its plans. We set out to run a sale process, acknowledging two impediments to the full sale that our private equity fund wanted to achieve. The first was that Westinghouse’s low-cost long-term debt is very valuable and would be required to be repaid on a change of control. The second was that few businesses are able to own Westinghouse, as it is a strategic asset to the U.S. and numerous other countries and operates very sensitive infrastructure globally. This limited the universe of potential buyers, and if it were sold outright, there was significant risk that governments wouldn’t approve the buyer.

During the sale process we decided that, given what is going on in energy globally, this could be the ideal Transition asset and a new pillar on which our renewable company and global transition partners could contribute to a carbon-free future. A sale to our Transition fund had the advantage (to the benefit of all parties) of not presenting change-of-control risks on the financing (as we control both), and few approvals required to buy the asset.

Further advancing their efforts, our Transition group partnered with Cameco, one of the world’s largest miners and fabricators of uranium (the feedstock for nuclear plants), who agreed to acquire a 49% interest in Westinghouse based on a valuation of about $8 billion. Cameco is a highly strategic partner to the investment and longer term, this could be game-changing for Westinghouse. The long-term plan is to build a vertically integrated nuclear operator for the western world.

For our private equity business, this sale completes a highly successful investment and turnaround, and it delivers a return of 6x capital and an IRR of approximately 60% to investors in our Brookfield Capital Partners Fund and our listed Brookfield Business Partners. For the record, seldom do investments return both this scale of profit ($4.5 billion) and an approximate IRR of this quantum. For our Transition fund, we are now positioned at the heart of the nuclear transformation that we foresee unfolding over the coming decades.

Closing

Thank you for your interest in Brookfield. Watch out for the arrival of your new Manager shares in your account which should happen this year, and please do not hesitate to contact any of us should you have suggestions, questions, comments, or ideas you wish to share.

Sincerely,

Bruce Flatt
Chief Executive Officer
November 10, 2022

BBU - Q3 2022 Letter to Unitholders

BBU - Q3 2022 Letter to Unitholders

Overview

We had an excellent quarter on many fronts, progressing our capital recycling initiatives with an agreement to sell our nuclear technology services operation, advancing our growth initiatives and generating strong financial performance. Third quarter Adjusted EBITDA increased 40% over the prior year to a record $627 million, driven by new businesses acquired over the past 12 months and supported by the resilience of our ongoing operations.

Resilient and Growing Cash Flow

Our objective is to create long-term growth in intrinsic value per unit, primarily through capital appreciation. Our strategy is simple: buy great businesses for reasonable value and take a hands-on approach to improve the operations of the businesses we own. We fund our growth, in part, through our capital recycling initiatives including cash generated within our operations and the sale of our business interests at the right time.

We have been deliberate over the last few years investing in larger-scale providers of essential products and services. Today, about 75% of our annual EBITDA is derived from large-scale, market-leading operations with stable and resilient cash flows. The durability of these operations has been an enormous advantage in the current environment and will continue to support resilient performance across all market cycles.

As our business has evolved, we have also continued to build value within our operations. To put this in context, the EBITDA of businesses we have acquired over the past five years has improved by approximately $275 million, at our share, and most of this value creation has been achieved by focusing on repeatable processes to enhance business performance across all sectors and regions in which we operate. The execution of our value creation plans, combined with the quality of businesses we own today, means the earnings of our operations should continue to grow.

Apart from growth, the intrinsic value of our business, which we define as the present value of all cash flows our operations will generate in the future, should also continue to increase. Our annual free cash flow has increased to $3.65 per unit, representing a compound annual growth rate of approximately 30% since we launched our business in 2016. This substantial level of cash flow, separate from any capital recycling, provides us with significant flexibility to reinvest in our operations, reduce borrowings or fund future growth activities.

Free Cash Flow¹

	Dec-2016	Dec-2018	Dec-2020	Sept-2022	CAGR
Free cash flow	$130 million	$450 million	$550 million	$800 million	40%
Free cash flow per unit	$0.95	$2.00	$2.45	$3.65	30%

1. Free cash flow represents BBU’s proportionate share of Earnings from Operations excluding gains (losses) on acquisitions/dispositions, less BBU’s proportionate share of estimated maintenance capex and depletion. Figures rounded for presentation purposes.

Strategic Initiatives

Last month, alongside our institutional partners, we reached an agreement to sell Westinghouse, our nuclear technology services operation, to a strategic consortium led by Cameco Corporation and Brookfield Renewable Partners for approximately $8 billion. This agreement was the result of a sales process that began earlier this year.

We acquired Westinghouse out of bankruptcy in 2018 at a time when nuclear energy was not widely viewed as a reliable clean source of baseload power. We appointed a world-class management team and over the past four years worked closely with them to strengthen the organizational structure, refocus on profitable service and product offerings and invest in new technologies. Since our acquisition, Westinghouse has strengthened its position as an industry leader and its EBITDA has nearly doubled to an annual run rate of approximately $800 million. Today the business is ideally positioned to benefit from strong industry tailwinds driven by increased recognition of nuclear power playing a critical role in achieving global decarbonization goals and energy security.

We expect to generate approximately $1.8 billion in net proceeds from the sale of our 44% interest in Westinghouse, which combined with distributions received to date, will equate to approximately 6x our invested capital of $405 million. The transaction is expected to close in the second half of next year, subject to unitholder and various regulatory approvals.

The monetization of Westinghouse is a precursor of what is to come. We have other businesses which will reach a mature state, and subject to market conditions and other factors, should provide us substantial monetization opportunities. In addition, we have been very active over the last few years, investing more than $5 billion at our share to acquire larger scale and more resilient operations. It will take time for us to build value within these operations, but at the low end of our value creation expectations these businesses should generate $12 billion of proceeds for our business when it comes time to monetize them.

Growth Initiatives

In October, alongside our partner, we closed the privatization of Nielsen. As a reminder, Nielsen is the market leader in third-party audience measurement, data and analytics. The business is an essential service provider to the $100 billion video and audio advertising industry, providing critical measurement data for advertising buyers and sellers. The business’ scale and longstanding customer relationships position it well to be the leading provider of a unified measure of viewership across all media platforms. We look forward to supporting its growth strategy.

We expect to invest approximately $400 million through convertible preferred equity for a 7% share of the equity, on a converted basis. This structure provides us downside protection and governance rights, while positioning us to participate in our share of the business’ profitability and growth alongside our partner in the investment.

We also continue to focus on opportunities to grow our existing businesses.

Our engineered components manufacturer recently completed the acquisition of TexTrail, a leading distributor of axles and other trailer components. The transaction builds on the business’ highly successful bolt-on acquisition growth strategy and provides opportunities to continue scaling its distribution operations. We invested $100 million for our share of the acquisition.

Last month, our Brazilian fleet management operation completed the acquisition of Unidas, a leading full-service rent-a-car platform in Brazil. We are doubling the size of our existing fleet management platform which will provide meaningful opportunities to reduce costs, grow the combined revenues and continue scaling our operations in the region. We are focused on carving out the business and integrating the combined operations. We invested $125 million for our 35% share of the equity.

Liquidity

Our capital position is strong. During the quarter we issued $750 million of preferred equity securities to Brookfield Asset Management which provides us with efficient, non-dilutive long-term capital to continue funding our growth. We ended the quarter with approximately $2.8 billion of pro forma liquidity at the corporate level after accounting for the planned syndication of our recently closed acquisitions and expected proceeds from the sale of Westinghouse.

Operating Results

Business Services

Our Business Services segment generated third quarter Adjusted EBITDA of $229 million.

Our residential mortgage insurer contributed strong results driven by higher premiums earned following elevated underwriting activity over the past few years and continued low mortgage default rates. New premiums written are declining, as we expected, given the impact of higher mortgage rates and reduced housing affordability in Canada. The business remains in a strong capital position to manage through a period of normalizing Canadian housing market activity.

Our dealer software and technology services operation is performing well since we closed our acquisition in July. During the quarter we appointed a new CEO who previously served in that role at the company. We are in the early stages of executing our value creation plan to enhance customer service, improve productivity and refocus on product and service offerings that improve margins and profitability.

At our Australian healthcare services operation, high rates of surgery cancellations and elevated operating costs continue to affect performance. The labor environment is slowly improving and absenteeism, sick leave and overtime are all trending toward normal levels. We are working closely with the management team to support the operations and expect business performance to improve as the operating environment normalizes.

Industrials

Our Industrials segment generated third quarter Adjusted EBITDA of $228 million.

Our advanced energy storage operation generated strong performance, benefiting from higher selling prices and a favorable mix of higher margin advanced battery sales compared to the prior year. Increased overall battery volumes benefited from improved original equipment manufacturer demand as auto production challenges eased. We are working closely with the business to continue managing the impact of a higher cost environment.

Performance at our engineered components manufacturer benefited from the contribution of recent add-on acquisitions. The business is focused on integrating the recently closed TexTrail acquisition as well as identifying opportunities to reduce costs to offset lower volumes across North America and parts of Europe.

Infrastructure Services

Our Infrastructure Services segment generated third quarter Adjusted EBITDA of $205 million.

Our nuclear technology services operation performed well and remains on track to generate strong full-year EBITDA and cash flow. Contribution from the recent BHI Energy acquisition was offset by the impact of disruption caused by the conflict in Ukraine. Increased activity during the fall outage season is expected to contribute to strong fourth quarter financial results.

Demand at our lottery services and technology operation has been resilient and we are supporting initiatives to mitigate the impacts of supply chain challenges and higher input costs. In September, the operator of the U.K. National Lottery concession formally awarded us a 10-year contract to provide products and services. Efforts are underway to implement the contract which is expected to begin in early 2024.

Utilization levels in our modular building leasing services business remain stable as strong demand in Germany and Asia Pacific is offsetting reduced activity in the U.K. and other parts of Europe. Higher penetration of value-added products and services and pricing actions are supporting margin performance. We are continuing to assist the business in reviewing potential add-on acquisition opportunities to enhance its product offering and expand its geographic footprint.

In August, our offshore oil services operation voluntarily entered Chapter 11 reorganization proceedings with the objective of executing a comprehensive financial restructuring to reduce debt and strengthen its financial position. The business is planning to emerge from the Chapter 11 process with a significantly deleveraged balance sheet. We, along with our institutional partners, expect to own a substantial majority of the business following the reorganization, subject to court approval.

Closing

In September, we held our annual Investor Day where we provided investors with an update on our strategic initiatives to build value within our business. It was great to see many of you in the audience again this year. If you missed it, the webcast is available under the News & Events section of our website.

We welcome your input as partners in our business. Please do not hesitate to reach out to any of us should you have suggestions, ideas or comments you wish to share.

Sincerely,

Cyrus Madon
Chief Executive Officer
November 4, 2022

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Source

https://bbu.brookfield.com/regulatory-filings/letters-to-unitholders/q3-2022-letter-unitholders

BIP - Q3 2022 Letter to Unitholders

BIP - Q3 2022 Letter to Unitholders

Overview

Brookfield Infrastructure delivered another strong quarter with funds from operations (FFO) of $525 million, which represents a 24% increase year-over-year. Our success was driven by above-target organic growth that continues to benefit from inflationary tailwinds and the successful commissioning and replenishment of our capital backlog. Last year’s outsized capital deployment, which included the privatization of Inter Pipeline, also meaningfully contributed to the increase in FFO.

Our solid financial position situates us well in this current market environment, where capital is becoming increasingly scarce. Liquidity across our business remains robust, as a result of the successful execution of our asset rotation strategy, prudent management of our balance sheet and high-quality asset base. Furthermore, the high proportion of fixed-rate debt in our capital structure has insulated us from rising interest rates, and the large component of cash flows generated in or hedged to the U.S. dollar has largely protected us from foreign exchange volatility in the current period.

During our 13-year listed history, we have made several deep value investments in marquee regulated or contracted assets. Examples include the privatization of Babcock & Brown Infrastructure in 2010 and the acquisition of two Brazilian utilities during a period of political turmoil in 2016. These investments have provided unitholders with some of our strongest returns realized to-date and are a direct result of our contrarian approach to investing, as well as our access to flexible and large-scale capital. We believe our competitive advantages will continue to allow us to make deep value acquisitions during periods of market dislocation, like we are currently experiencing.

With $2.8 billion of capital deployed to date during 2022, of which approximately $1.9 billion is expected to close in the next few months, we are well on our way to achieve our objectives for 2023.

Operating Results

FFO per unit of $0.68 increased by 15% compared with the same period last year. Results were supported by strong growth from our base business and the contribution associated with recently completed investments. Organic growth for the quarter was robust at 10%, reflecting the benefits of elevated inflation impacting tariffs and the commissioning of approximately $1.2 billion of capital projects in the last 12 months. Additionally, approximately $2 billion of capital was deployed in acquisitions over the same period that contributed to results.

Utilities

FFO from our utilities segment was 8% above the prior year at $196 million. The base business benefited from inflation indexation and the commissioning of approximately $500 million of capital into the rate base during the last 12 months. Results also benefited from the contribution of two Australian utility acquisitions completed earlier this year. The positive contributions were partially offset by the impact of increased borrowing costs at our Brazilian utilities, as well as the prior year contribution from our North American district energy platform that we sold last year. Removing the impact of additional financing costs and capital recycling, FFO increased 10% over the same period last year.

Our U.K. regulated distribution business continues to succeed in its multi-utility offering, with connection sales in the quarter exceeding the prior year by 5%, driven by electricity and water sales. Installations are 20% above prior year and the orderbook remains at a record level of 1.5 million connections.

In September, our North American residential infrastructure business completed a tuck-in acquisition of the largest Quebec-based rental water heater provider, with 280,000 customers under contract. This investment expands our geographic footprint and will serve as a base for expansion into Eastern Canada. It also provides a platform to expand into new products and sales channels in that region.

During the quarter, our North American submetering operations partnered with Brookfield’s real estate business to expand operations into the Brookfield-managed residential portfolio, securing an agreement to take over the metering for over 45 multi-family buildings across 15 U.S. states. This strategy has been successful for us in the past, specifically at our district energy platform and now in our indoor systems business, where we can accelerate growth plans by leveraging the Brookfield ecosystem.

At our European residential infrastructure business, we are advancing the roll out of the heat pump rental product launched last quarter. Offering customers a financing solution to reduce the upfront cost has led to approximately 1,400 units sold in the first four months, exceeding our expectations. We are now focusing on installation efforts as we continue to build up our rental backlog. To complement our heat pump offering in Europe, we plan to launch a solar product in the near-term to provide energy optionality and grid independence to customers.

Transport

FFO for the transport segment was $203 million for the quarter, an increase of 12% compared to the prior year. Results benefited from strong organic growth driven by higher rates in line with inflation and stronger volumes. At our diversified terminals, volumes were up 7% compared with the prior year driven by our U.S. LNG export terminal that commissioned a sixth commercial liquefaction train earlier in the year. Volumes at our rail operations were up 2% over the prior year, and tariffs at our Brazilian rail operation benefited from a 20% increase, which more than offset the impact of foreign exchange. Across our global toll road portfolio, traffic levels increased 3% compared to the prior year, while tariffs increased over 10%. Prior year results included contributions from businesses that were sold including our U.S. container terminal in the second quarter and our Chilean toll road operation in 2021.

Our Australian export terminal recently announced that it had agreed on access pricing with all its existing users for a 10-year period, to be applied retroactively from July 1, 2021. The new rate reflects a 29% increase to the previous framework, with all users subject to 100% take-or-pay volumes and annual price escalation for inflation. This outcome provides significant cash flow certainly while preserving the strong contractual protection associated with this critical infrastructure.

Midstream

Our midstream segment generated $172 million of FFO, an approximately 65% increase over the prior year. This result was primarily due to the contribution from our diversified Canadian midstream operations (Inter Pipeline), which only partially contributed in the comparable period. At a base business level, results continue to be strong with high utilization of our infrastructure and elevated market sensitive revenues.

Recently, our U.S. gas pipeline reached a negotiated settlement agreement with our customer base. This agreement provides rate certainty for the small portion of our business that is subject to max rates for the next five years. We anticipate any impact on our future FFO to be more than offset by various commercial opportunities we see in the current natural gas environment.

We remain on track with our ramp up of the Heartland Petrochemical Complex (HPC). In October, our propane dehydrogenation plant, which processes propane into polymer grade propylene, commenced production. Having completed commissioning of the back-end of the complex earlier this year, this step completes the integrated start-up. During the quarter, we commenced our first product sales, with total sales volume of approximately 18 million pounds.

We continue to pursue carbon reduction initiatives to advance our ESG program. Inter Pipeline and our Western Canadian natural gas gathering and processing operation were awarded rights to potentially develop carbon capture and sequestration hubs near our facilities. We believe that these initiatives will not only significantly reduce emissions and demonstrate our commitment to sustainable operations, but also further develop commercial relationships with upstream customers.

Data

Our highly contracted data businesses continue to perform well in the current environment with FFO increasing to $60 million for the quarter. Underlying growth from additional points of presence, incremental megawatts commissioned, and inflationary price escalators were partially offset by the impact of foreign exchange during the quarter.

In July, our U.K. wireless infrastructure operator activated indoor systems in three separate branches of the U.K.’s largest shopping mall. These are the largest indoor systems activated since acquisition and the arrangement will be underpinned by a 20-year contract. Operationally, the business has benefited from the inflationary environment through contractual price escalation, which has more than offset the impact of higher operating costs.

During the quarter, our Indian tower operations entered into a commercial arrangement with Vodafone India, allowing it to onboard tenancies across our 154,000 towers. Vodafone is the third largest mobile network operator in the country and has approximately 25% of wireless subscriber’s market share. We have now secured arrangements with the four largest mobile network operators in India, which positions the business to capture additional tenancies as wireless device demand grows in the country.

Balance Sheet and Liquidity

In recent months, central banks have intensified their hawkish policy stance, reiterating their commitment to reducing inflation to target levels through future rate hikes. This rising rate environment, combined with heightened inflationary pressure has reduced investor risk appetite, creating dislocation in the debt markets as lenders are being more selective with their balance sheets. Despite this volatile backdrop, capital markets remain supportive of our business given our investment grade credit profile and the highly contracted and regulated nature of our cash flows.

During the quarter, we continued to access the capital markets to proactively extend near-term maturities. Our financing strategy has proven successful as less than 2% of our asset-level debt matures over the next 12 months. In addition, we have significant corporate liquidity of $2.3 billion that will increase to nearly $3 billion following the completion of secured asset sales. Notable financing initiatives completed recently include:

• Our North American gas storage business obtained new bank financing to redeem $375 million of senior notes maturing in 2023 and provides us with improved financial flexibility.
• Our Brazilian gas pipeline refinanced $1 billion of debt maturing in 2023 through the issuance of new local debentures and offshore bank financing, extending the average term by five years and significantly de-risking the balance sheet.
• Subsequent to quarter-end, our Australian rail network obtained commitments for $325 million of fixed-rate, private placement debt to refinance debt maturing in 2023 and 2024. The issuance benefited from strong investor demand and included tranches with 10-to-15-year terms and priced in-line with the cost of maturing debt.

Our corporate balance sheet remains well capitalized with no corporate maturities until 2024. We also continue to maintain an active currency hedging strategy to protect our cash flows and investment values, with over 80% of our FFO generated during the quarter denominated in or hedged to the U.S. dollar. This prudent risk management approach has served us well through the recent currency volatility.

Earlier this year, we signed agreements to sell three mature businesses for approximately $600 million of proceeds. These sales were in addition to the sale of our U.S. container terminal that closed earlier this year for approximately $350 million. Of the three secured sales, our New Zealand telecom tower portfolio sale closed November 1st, our Brazilian electricity transmission lines are expected to close in November and the Indian toll roads are on track to close by year end. In addition, several sales processes are underway that, combined, are expected to generate approximately $1.5 billion of proceeds.

Strategic Initiatives

In August, we announced a partnership with Intel Corporation to invest in a $30 billion semiconductor foundry in Arizona. Brookfield will be providing approximately $15 billion over the construction period for a 49% interest in the facility. The majority of our capital commitment has been sourced from non-recourse debt, with base interest rate exposure fully hedged concurrent with signing. Moreover, the majority of the Brookfield’s approximately $2 billion equity investment ($500 million net to BIP) is back-end weighted closer to the operational phase of the project.

This investment is structured to achieve an attractive risk-adjusted return. We draw parallels to other data investments such as hyperscale data centers that are generally contracted on a long-term basis, with highly creditworthy counterparties, where we do not assume technological risk. In this instance, we view Intel to be a creditworthy and market-leading partner. The transaction is expected to close by the end of 2022 and is thematically an example of the large-scale capital required to support the onshoring of critical supply chains.

For the balance of the year, our focus will be on closing the remaining two announced transactions, HomeServe and DFMG, in Q4 2022 and Q1 2023, respectively. Once closed, we will transition our focus to the execution of our growth plans in both businesses.

• At HomeServe, we are splitting the company’s U.S. and European operations to integrate them with existing portfolio businesses in each geography. We plan to accelerate growth by expanding our residential infrastructure product and service offering to a wider customer base.
• At DFMG, we are acquiring a marquee portfolio of 36,000 towers in Germany and Austria that also includes a greenfield development portfolio of an additional 5,200 build-to-suit towers. These additional towers are to be constructed over the next five-years and underpinned by the credit quality of Deutsche Telekom. In addition to the built-in organic growth, we plan to use this business as a platform for follow-on opportunities in the fragmented European telecom tower market.

2022 Investor Day Recap

At Brookfield Infrastructure’s annual Investor Day, we emphasized our record financial performance and outsized level of asset rotation activity during 2022. Going back a decade, we demonstrated how our track record of providing growth in FFO has resulted in a 9% compound annual growth rate in per-unit distributions over the same period. We expect that 2023 will be another strong year, with FFO per unit growth above our target range. Our remarks were framed around the current macroeconomic tailwinds influencing our organic growth and capital deployment plans.

The power of compounding organic growth during this unique operating environment. Our ability to deliver organic growth, at the high-end or above our targeted 6-9% annual range, can be broken down into four elements:

• Higher inflation. Our business is uniquely positioned to benefit from inflation. Approximately 70% to 75% of our EBITDA is favorably impacted by inflation, with another 10% to 15% margin protected through fee-for-service models. In most geographies where we operate inflation remains elevated, and we expect to continue capturing above-average inflation in our results.
• Record capital backlog. Our backlog is at record levels, providing high visibility into near to medium term capital expenditures. We plan to shortly commission the Heartland Petrochemical Complex and a portion of our Brazilian electricity transmission portfolio and have them begin generating cash flow for our business. These projects combined will add approximately $2 billion to our asset base, which is more than replaced in our backlog by the Intel transaction, which adds $3.7 billion of future capital expenditures at our share.
• Accretive asset rotation. The current phase of asset rotation is expected to be highly accretive due to outsized organic growth profiles associated with our new investments. Through the acquisitions of HomeServe, DFMG, Uniti, Intellihub and AusNet, we expect to add $300 million of contracted growth over the next three years, as compared to approximately $10 million for the assets we sold.
• Capital structure. Proactively managing our capital structure and foreign exchange risk will enable the three key elements of organic growth noted above to compound without being materially impacted by rising interest rates and foreign exchange volatility in the near-term. Currently, 90% of debt issued outside of Brazil is fixed rate and over 80% of our FFO over the next 24 months is expected to be denominated in, or hedged to, the U.S. dollar.

The “Three Ds” driving deployment. Three prominent macroeconomic themes have resulted in Brookfield Infrastructure effectively securing our annual new investment target of $1.5 billion for 2022 and 2023. We believe these themes will continue to create significant investment opportunities going forward.

• Digitalization refers to investment opportunities derived from exponential increases in data consumption. Large scale capital is required for greenfield development or the retrofit of digital backbone infrastructure, including fiber, wireless infrastructure and data centers.
• Decarbonization investment opportunities for Brookfield Infrastructure relate directly to investments in utilities or residential energy infrastructure businesses that benefit from capital deployed to reduce or eliminate emissions from the expansion of their networks or installation of new energy efficient products.
• Deglobalization supports the reshoring of essential and strategic manufacturing processes and supply chains.

All three “mega trends” are expected to drive significant capital deployment opportunities for Brookfield Infrastructure in the years to come.

BIP is an excellent investment choice during uncertain times. Our financial resilience is rooted in the highly contracted nature of our cash flows and strong balance sheet. We have exceptionally solid growth in front of us, and a lot of that has to do with the tailwinds behind our organic growth as well as the secular trends that are providing tremendous opportunities to deploy capital in the coming years.

Outlook

Elevated inflation levels and rising overnight lending rates will remain the primary near-term macroeconomic factors impacting the global economy. The current tone from most central banks is that interest rates will continue to rise until rates of inflation have fully abated to their target levels. While lower economic growth and higher interest rates will be unpopular, given the recent events in the U.K., most governments will defer to central banks to achieve their inflation objectives. Consequently, the investment themes for the balance of 2022 and 2023 will likely be centered around operating margin resilience and financial strength. This investment environment should therefore favor companies that have strong balance sheets and access to capital, as well as business models that are immune to inflationary pressures.

We are well positioned from an M&A perspective for 2023. Given the transactions we have secured, our capital deployment objectives for 2023 have already been met. In the event that institutional infrastructure investors pause their investment activities to take stock of the current environment and recalibrate their strategies, this would provide us with a unique opportunity to pursue investments with reduced competition.

Brookfield Infrastructure performs well in all business environments. We have adhered to our financial strategy, with a capital structure comprised of long-term debt at fixed rates, limiting the impact rising interest rates has on our business. Also, a significant portion of our revenue frameworks have embedded inflation indexation, which allows us to expand our margins during periods of higher inflation. These factors, combined with our substantial capital backlog, should allow us to continue to grow our FFO at our targeted levels for the foreseeable future.

The Board and management team are excited about the balance of the year for Brookfield Infrastructure and wish to thank our unitholders and shareholders for their ongoing support.

Sincerely,

Sam Pollock
Chief Executive Officer
November 2, 2022

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Source

https://bip.brookfield.com/bip/reports-filings/letters-unitholders/bip-q3-2022-letter-unitholders