Brookfield Infrastructure Partners, Letter to the Unitholders, 1st Quarter, 2019, Part Two

Brookfield Infrastructure Partners, Letter to the Unitholders, 1st Quarter, 2019, Part Two

Balance Sheet and Funding Plan

Our balance sheet remains strong, with total liquidity of approximately $3 billion at the end of the period, of which approximately $1.9 billion is at the corporate level. Liquidity was strengthened during the quarter by a C$100 million preferred share issuance, and the sale of a 33% interest and a financing in our Chilean toll road business that generated after-tax proceeds of approximately $365 million.

In-line with our capital recycling strategy, we considered this to be an opportune time to monetize a portion of our Chilean toll road investment, as the asset has reached the mature phase of its lifecycle. We acquired a 51% interest in our Chilean toll road operation through a series of transactions during 2011 and 2012, for a total of $340 million. Since acquisition, we implemented a number of initiatives to improve operating margins and raised investment-grade debt that lowered our cost of capital. This, coupled with strong traffic growth and a favorable tariff regime, has resulted in significant value appreciation. In February, we completed the partial sale of our interest and realized a multiple on invested capital of approximately three times. Additionally, as this investment is held at amortized cost under IFRS, the partial sale resulted in a $350 million accounting gain that was recognized this quarter. Since we monetized a non-controlling interest and retained control in a consolidated investment, accounting rules require the gain to be recorded directly to our unitholder’s equity balance.

Over the course of the year, we expect to further enhance liquidity levels as we execute on our capital recycling program. In this regard, we have entered into an agreement to sell our bulk European port operations, with a sale expected to be completed in June of this year, subject to regulatory approvals. We expect to receive net after-tax proceeds of $130 million from the sale, which is approximately equal to the carrying value of the business. We remain on-track to generate additional proceeds of $1.5 - $2 billion in the next 12 to 18 months from several other sales processes that are underway.

We are also focused on managing near-term maturities amidst favorable capital market conditions. In March, our Australian port operations opportunistically refinanced A$1 billion of debt, on the back of strong financial results. The offering was very well-received by lenders and annual interest costs for the business were reduced by approximately 50 basis points. We currently have no material individual maturity that will need to be refinanced in the next five years, and once we complete a number of ongoing normal course financings, our average duration across the business will be over eight years.

Sam Pollock,

Chief Executive Officer,

May 3, 2019

Brookfield Infrastructure Partners, Letter to the Unitholders, 1st Quarter, 2019, Part One

Brookfield Infrastructure Partners, Letter to the Unitholders, 1st Quarter, 2019, Part One

Overview

We are pleased to report that Brookfield Infrastructure is off to a strong start in 2019. The business generated funds from operations (FFO) of $351 million in the first quarter, or $0.88 per unit, up from $333 million in the prior year. On a per unit basis, our results were up 4% compared to the prior year, and after taking into account our recent 7% distribution increase, our payout ratio for the quarter was 71% of FFO.

Last quarter we indicated that we had committed approximately $700 million of capital to be deployed into three transactions. In the first quarter, we closed on two of these investments for approximately $430 million: a data center business in South America and a fully-contracted natural gas pipeline in India. We are also progressing the third transaction, the second phase of the Western Canadian midstream business acquisition, which is expected to close early in the third quarter of the year. As cash flows from these investments get fully reflected in our results in future quarters, our run-rate FFO will further increase.

Results of Operations

Results for the quarter reflect strong performance by each one of our operating segments, which in total delivered 10% organic growth over 2018, exceeding our annual long-term target range of 6-9%. Organic growth was generated by inflation-indexation across approximately 75% of our businesses, solid GDP-driven volume growth, predominantly at our transport operations, and contributions from accretive capital projects commissioned during the period. Our results also benefited from recently acquired businesses. These positive factors were partially offset by the impact of a weaker Brazilian real, which reduced earnings by $13 million in the quarter.

The utilities segment contributed FFO of $137 million, compared to $169 million in the prior year. Underlying performance was strong as our operating groups were able to grow results by 5% on a same-store basis over the prior year. This was predominantly driven by inflationary increases to our rate base, combined with another strong quarter at our U.K. regulated distribution business. These contributions were offset by having less capital invested following the sale of our Chilean electricity transmission business in March of last year, higher interest expense associated with a financing completed at our Brazilian regulated gas transmission operation, and a $9 million impact from foreign exchange.

Our U.K. regulated distribution business maintained its momentum, following a record year of performance in 2018. Sales and connections activity exceeded the prior year by 8% and 16%, respectively, and at the end of March, our order book stood at an all-time high of 1.1 million connections, which is 12% higher than the prior year. In particular, the multi-utility product offering continues to be attractive to developers, as evidenced by the strong results which have materialized from our fiber offering, where sales are 50% higher than the prior year.

At our Brazilian electricity transmission business, we are making good progress on the development of 4,300 km of transmission lines. The first three segments, which total approximately 1,600 km of lines, are fully operational and construction for the remaining 2,700 km is on track. In April, we exercised our first option to acquire a 50% interest in 500 km of operating lines from our partner, bringing our ownership to 100%. We plan on exercising our buyout options for the remaining operating lines later this year.

FFO from our transport segment was $139 million for the quarter, in-line with prior year results. The segment benefited from organic growth of 6%, driven by higher tariff and traffic levels across our global toll road portfolio, strong volumes at our container terminals and higher revenues at our Australian rail operations. These positive contributions were partially offset by the previously announced sale of a 33% interest in our Chilean toll road operation that closed in February and the expiry of one of the state concessions at our Brazilian toll road business. FFO for this segment was also reduced by $4 million as a result of foreign exchange, primarily the result of a decline in the Brazilian real.

Despite uncertainty over Brexit, our U.K. port operation is thriving. Container and bulk volumes remain robust, exceeding the prior year by 45% and 5%, respectively. Volume increases from our bulk and unitized customers have been driven by new contract wins and strong organic customer growth. With our container terminal nearing capacity, we are now proceeding with the fourth phase of its expansion, comprising a total capital investment of $17 million. This will increase throughput capacity by a further 20% by mid-2020.

The energy segment contributed FFO of $107 million, which represents a 62% improvement from the prior year. This step-change increase is attributable to organic growth and contributions from two recently acquired North American businesses. Our North American natural gas transmission business delivered another strong quarter, generating FFO that was 23% higher versus the prior year. Results for this business are benefiting from robust demand for transport services and contributions from the first phase of its Gulf Coast expansion project. At our gas storage operations, FFO was 43% above last year as the business earned higher spreads related to cold weather conditions.

Within our distributed energy operating group, several new growth initiatives are underway at our recently acquired North American residential energy infrastructure business. We recently partnered with multiple homebuilders to be the exclusive provider of smart home technology for over 3,000 new homes. This offering will create opportunities for the sale of additional products and services to this new customer base. We are also currently progressing a partnership with a utility in Texas for a pilot program that will offer our residential infrastructure products to a subset of its existing clients. If the pilot is successful, the program has the potential to generate meaningful sales leads when we roll out this offering to the full customer base.

FFO for the data infrastructure segment was $28 million, up from $19 million last year. Recent investments in our global data center portfolio contributed FFO of $7 million for the quarter. FFO from our French telecommunications infrastructure business grew by 13%, due to inflationary increases and new points-of-presence added to our tower network.

Commercialization of the second of four fiber-to-the-home concessions held by our French telecommunications infrastructure business has commenced, with a level of take-up above underwriting and market averages thus far. Our build-to-suit tower program continues to grow, with over 300 towers built over the last 12 months. We currently have a contracted backlog of over 900 towers, which are expected to be delivered over the next three years, providing us with strong visibility into the next phase of organic growth for the business.

Sam Pollock,
Chief Executive Officer,

May 3, 2019

The Letter to the Shareholders

The Letter to the Shareholders

Not all public companies write a letter to their shareholders but they should. It provides the company with the opportunity to communicate to their shareholders the current affairs of their company. Not to mention the prospects for the future of their business and how the management team plan to achieve their goals for the future.

The fact that most public companies don’t bother to do this should tell the investor something about the company. If they can’t be bothered to write the letter, then why should I be bothered about investing in the stock of their company?

The companies that do take the time to write the letter tend to be more shareholder-friendly towards their investors and it can make for fascinating reading…Certainly much more valuable than the mindless knee-jerk reactionary news of the public media.

Lastly, the letter to the shareholders have wager value (see earlier posts about this), in that it is under-utilized information that most people are not aware of. It can often be very educational as the investor who takes the time to read these reports can get a free education from the front lines of a real company conducting their affairs in the business world.

In the next few posts I will pass along the Letter to the Shareholders from the company that holds the biggest position in my investment portfolio, Brookfield Infrastructure Partners (BIP.UN on the TSX, BIP on the NYSE)

Stephen Takacsy on BNN-Bloomberg’s Market Call – June 3, 2019

Stephen Takacsy on BNN-Bloomberg’s Market Call – June 3, 2019

MARKET OUTLOOK

Markets rebounded strongly this year from oversold conditions as fears of an impending recession faded, central banks stopped raising interest rates and the U.S.-China trade war was pushed out. We took some profits, raising 10 per cent cash as the stock market was getting expensive amid slowing global growth and trade war uncertainty. Now that a U.S.-China trade deal failed to materialize and tariffs are being imposed, we're even more cautious as corporations start getting impacted. Also, IPOs such as Uber priced at ridiculously high valuations signal a market top. Nevertheless, we still see many good long-term opportunities in the neglected and mispriced Canadian small- and mid-cap sector.

UPDATE

Grande West Transportation (bought at $1.66): sold 50 per cent of our position around $0.80 as new orders have been slower than anticipated.

TOP PICKS

SWISS WATER DECAF COFFEE (SWP.TO)

Burnaby, B.C.-based Swiss Water (formally called Ten Peaks) is the world’s only chemical-free processor of decaffeinated coffee. It also provides coffee storage and handling services. They sell to large chains like Tim Horton’s and McDonald’s and specialty roasters such Third Wave specialty coffee shops and global importers. International demand for chemical-free decaf is growing, so the company is building a new plant to double capacity which should be completed this fall. First-quarter results were very strong, showing continued double-digit volume growth and gross margin expansion. The stock is very cheap at roughly 10 times price-to-earnings and 8 times earnings before interest, tax, depreciation and amortization (EBITDA) for a high barriers to entry, global growth and cash-flow-generating business. Pays an attractive 4.4 per cent dividend.

POLLARD BANKNOTE (PBL.TO 0.27%)

Pollard is the second largest supplier of printed instant lottery tickets in the world. North American ticket sales have been growing at a compound annual growth rate of 6 per cent for over 20 years. Barriers to entry are very  high with only three players licensed in North America. Scientific Games has 70 per cent market share while Pollard has around 22 per cent and IGT 8 per cent. Pollard has been gaining share with state lotteries by creating innovative content on tickets and also focusing on technology and lottery management. Pollard has also expanded into charitable gaming, iLottery and display merchandising. Pollard has been growing profits organically and by acquisition and plans on being even more acquisitive and increasing its public float, which should drive its stock price much higher over the next few years. We recently purchased more shares around $22.

BLACKBERRY (BB.TO 1.32%)

Many investors don’t realize that BlackBerry is now a pure software company with a growing double-digit recurring revenue base from three streams: Enterprise security software for mobile communication, which the company is traditionally known for and it's transitioning into a software-as-a-service model; the QNX operating system, the gold standard for the automobile industry for infotaiment and advanced driver assistance systems and for which BlackBerry gets a royalty per car (120 million cars so far); and a large patent licensing business. BlackBerry also just acquired Cylance, a leading cybersecurity software firm that uses AI and machine learning technology to predict and prevent cyberattacks before they happen. The stock trades at only 3.5 times revenues. We expect BlackBerry to be acquired within a few years at 7 to 10 times revenue by the likes of Microsoft for $20 to $30 per share.

Stephen Takacsy, Lester Asset Management

Stock Market Volatility is Increasingly Creating Opportunity

Stock Market Volatility is Increasingly Creating Opportunity

Increased program trading and passive indexing is creating greater volatility in the stock markets – and in many cases, increasing discrepancies between a stock’s trading price and its true value. For example, a stock that is in a ‘hot’ industry, or fits neatly into an index, may trade at greater than intrinsic value because of these non-company related influences. On the opposite end of the spectrum, smaller companies or those that do not neatly fit into indices may trade at a significant discount to fair market value.

This has been compounded by the reduction of investment research caused by changes to global securities regulation, which in turn has impacted brokerage firms’ ability to provide research in exchange for commissions. As a result, substantial coverage for smaller companies has been reduced or dropped altogether.

Despite this, the underlying businesses are often doing well; this has led in some cases to excellent value purchases in the stock market, compared with what might be considered fair market value. The problem for regular stock market investors is that conditions may not change in the future, and therefore it may be a very long time, if ever, before true value is recognized in the stock market. For businesses that distribute cash flows to shareholders, this may not be as relevant as a large portion of returns can be in the form of cash returned to investors. But for many companies that require cash for reinvestment, the trading value can often be at a large discrepancy to fair value, with no visible event to change the trading valuation (commonly referred to as a Value Trap).

Historically, we have largely used one of three strategies to acquire assets: (i) we carve out assets from sellers who wish to realize cash from a non-core business; (ii) we buy assets in stressed situations, including by acquiring debt in the market and converting it to equity, and (iii) we take companies private in friendly transactions. The first two of these strategies continue to contribute to our sourcing of transactions. Increasingly, however, for investors such as ourselves that are capable of buying entire businesses out of the stock market, the third strategy is becoming the largest source of transactions as market volatility creates greater opportunity.

To put this into context, in the past two years we have taken seven public companies private. We attribute some of this to the above conditions as it enables us to begin discussions with a company at a reasonable starting point for value. In addition, in many cases, investors are frustrated and fatigued, and therefore choose to move on at a reasonable premium to the share price. In real estate, we took Forest City private in the U.S. In renewables, we took TerraForm Global private and acquired Saeta Yield in Spain. In private equity, we have an offer outstanding for Healthscope in Australia. In infrastructure, we privatized Enercare in Canada. All told, these take-private transactions led to the acquisition of over $55 billion of assets. More importantly, we believe we acquired great businesses at reasonable value.

One never knows what the future holds, but for now we see this trend of share price volatility increasing and consequently, there may be more opportunities to buy great businesses for value in friendly transactions with management teams that wish to join us, while at the same time providing existing investors with liquidity and an opportunity to exit at a favorable price.

Bruce Flatt,

Excerpt from Brookfield Asset Management’s Quarterly Letter,

May 9, 2019

Market Environment

Market Environment

The global economic environment is very favorable for investors. Economies are generally strong, but not too strong. Employment levels are among the strongest for many decades. Interest rates are paused at very low levels, and the risk of significant increases in the medium term seems low. Financing for transactions is freely available to good borrowers, but not in major excess. Covenants are lighter than they were five years ago, but the extreme excesses seen in the past do not seem prevalent yet today.

Despite this apparent ‘goldilocks’ market environment, we continue to worry about a world where politics are polarized almost everywhere, interest rates are low globally, and equity valuations are at their peak. With respect to equities, technology-related stocks seem to have particularly high valuations, although to date this has proven to be justified for some, as they have become among the greatest companies ever created. Passive investing is the latest trend to dramatically affect both equities and some classes of debt securities, and the full effects are yet to be seen. In this environment, we continue to cautiously invest capital but ensure that we remain liquid, with substantial cash and dry powder.

The North American economies are strong and South American countries are still recovering from their tough recessions. Europe is slower, but the U.K. is amazingly resilient. Australia is okay, China is slowing but is still robust when compared to global alternatives, and India is struggling with over-leverage. Overall, we think the global markets remain very constructive for our businesses.

Bruce Flatt,

Excerpt from Brookfield Asset Management’s Quarterly Letter,

May 9, 2019

The Under Appreciated Value of Capital Cycle Analysis

The Under Appreciated Value of Capital Cycle Analysis

In our public markets investments at Volta Global, we are fortunate not to be constrained to a specific strategy or segment of the markets. We are only looking for the best opportunities for long-term capital appreciation, in a completely sector and asset class agnostic manner.

Such opportunities often do present themselves as a result of two situations:

Finding truly great businesses with sustainable competitive advantages that are temporarily mispriced due to market “noise” or short-term events (the much espoused “Buffet/Munger approach”).

Significant developments taking place in the supply side of an industry that often go unnoticed by the market.

Situation #1 is widely covered, and any student of the markets will be very familiar with those teachings. Situation #2 is less appreciated but equally powerful, and forms the basis of “capital cycle analysis” — an investment philosophy long championed by Marathon Asset Management (and excellently covered in their book Capital Returns.)

While capital cycle analysis is a very simple fundamental concept — companies are impacted by changes in the supply side of the industry in which they operate much more than changes in the demand side — it is also the one that most investors and analysts often ignore. They instead devote a majority of their time and effort into analyzing the demand side, which is much harder to accurately predict, and in the long run much less impactful to a company’s profitability, and thus their stock price.

I strongly recommend reading Capital Returns in its entirety, but the key aspects of the approach can be quickly summarized as follows:

Stock prices are mostly driven by long-term levels of profitability, and reward companies that can consistently earn returns above their cost of capital.

Changes in the supply side of an industry are more important to profitability than those on the demand side, yet the vast majority of professional analysts and investors are trained to focus their attention on the demand side. The implication then is that changes in the supply side tend to be under appreciated by the market, and slower to show up in company stock prices.

Value vs. Growth is a mostly irrelevant construct for capital cycle analysis — high valuations alone are not enough to kill a positive supply side dynamic, and companies in industries going through a lasting positive change in supply side dynamics can sustain high valuations for longer periods of time than the market expects.

Many investors are not well suited to performing proper capital cycle analysis, which requires both an “outside view” (tough for industry “experts” to have) and a very long-term perspective (very tough for most active managers to have these days).

Jeff Evans, Volta Global